Price Skimming Strategy: How Does Price Skimming Work?

Price skimming is the practice of introducing a new product or service at a high initial price and then, through a series of price drops, lowering that product’s price point to reach additional customer segments. By coming in at a high price, a brand may initially begin with a niche customer base of early adopters. It may also craft a brand image based on exclusivity and perceived high quality. As the business gradually offers the product at a lower price, it can grow its market share.

A skimming pricing strategy typically follows a common progression.

1. 1. A high initial price: At the beginning of its lifecycle, a new product comes to market at its highest price point. In some cases, this will be a higher price than what other competitors on the market are offering.
2. 2. Steady price changes: Over time, the product loses its cutting-edge status and the product pricing decreases. Lower prices let the brand reach new market segments—particularly price-sensitive customers who balked at the initial launch price.
3. 3. A legacy product: Eventually products reach the end of their lifecycle and get supplanted by new technologies and innovative products arriving on the market. Around the time the product gets formally discontinued, it reaches its all-time low price, where it may be snatched up by the most cost-conscious consumers.

From fashion brands to software as a service (SaaS) companies, there are many real-world examples of price skimming. To see one example of price skimming in action, consider the mobile phone market.

1. 1. Product launch with a premium price: A legacy phone brand with a large group of loyal customers will introduce new models at their highest possible price. The brand’s highest-price phone might cost more than similar models from competitor brands.
2. 2. Leaning into the brand image: The high price helps the legacy brand confer an image of premium-quality devices, and it supplements this with paid advertising plus what it hopes will be positive word-of-mouth campaigns.
3. 3. Occasional dynamic pricing: Dynamic pricing is the practice of raising or lowering prices depending upon market conditions. This can occur when the legacy brand introduces its new phone in early fall, only to have the price drop around Black Friday when its retail partners offer the phones at reduced prices. The price will then go back up when the holiday season ends.
4. 4. Price skimming on older models: Permanent price skimming typically occurs when newer models enter the market. The new models debut at high initial prices, while prior years' models get discounted. The older the model, the greater the discount.

A price skimming strategy comes with several competitive advantages.

1. 1. Rapid profitability: When a company charges high prices, it can theoretically turn a profit on every transaction. (In penetration pricing, where a company enters a new market at a very low price point, profit margins can be next to zero.) This helps the business pay down its development costs.
2. 2. Brand prestige: In the minds of many customers, high prices signify prestige and cutting-edge innovation. This perception can sometimes supersede the actual quality of the product being sold but still position the brand’s products as luxury items.
3. 3. Anticipation from the rest of the market: A high initial price can net your brand some early adopters, but other buyers will hold out in the hopes of getting a lower price down the line. This builds up what marketers call a consumer surplus, and every time you incrementally lower the price, you grab some more of that surplus market—theoretically at the highest price they would be willing to pay.

Price skimming strategies do come with disadvantages that counterbalance their upsides.

1. 1. Price discrimination: High prices may exclude many consumers from purchasing in your product, at least in the initial stages of a price skimming strategy.
2. 2. Leaving market share on the table: Some brands will never reach customers because they never come down to an affordable price point. For this reason, some brands eschew price skimming; they keep their prices as low as possible to encourage massive sales volume. In the long run, they make more money by having millions of low-margin transactions as opposed to thousands of high-margin transactions.
3. 3. Vulnerability to penetration pricing: Unless the product has no direct competition, brands that charge premium prices run the risk of getting overrun by upstart competitors who undercut them on price. Some customers consider price above all other shopping metrics, and if your brand is consistently more expensive than that of your rival, you may end up handing that rival some lifelong customers.

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