Price Skimming: Maximizing Profits and Market Positioning for Businesses

What is price skimming?

Companies sometimes send price increase letters to inform customers of increases in their pricing and explain why. Typically, companies increase their prices as a product becomes more popular and there's more demand. This is called dynamic pricing, in which companies change prices based on customer demand.

But what if you started with higher prices? Price skimming is a pricing strategy used to bring new products to market. Under this model, businesses set prices high and lower them as new competitors emerge.

The price skimming strategy is just one of many different pricing methods and strategies, but it can help you target a particular type of customer segment without alienating others.

The price skimming pricing strategy generates high profits in the short term while attracting early customers who don't mind paying more for a better or new product. Then as a business reduces its prices based on what others are willing to pay for it, it can appeal to a wider audience.

Many top brands use price skimming when they launch a new product because they know their customers are willing to pay more for first access to a brand-new product. Then, they reduce the prices after several months to appeal to more price-sensitive customers.

The price skimming strategy isn't the right option for every business. Companies that use price skimming often have new, innovative, or in-demand products and know their customers will be willing to pay more for them immediately after launch. Businesses that use this product pricing strategy have these things in common:

Product differentiation

A skimming pricing strategy only works for products that are different from those in their markets. They must stand out in some way that makes customers believe it's different from everything else available.

Think of the cell phone, for example. At one point, cellular devices were innovative and completely revolutionized our lives. Now, consider how price skimming works. The first cell phone company was able to set a higher price for early adopters, but as the market became more crowded over time, the cost of phones drastically decreased.

Target market analysis

Before you use any pricing strategies, you should understand what your target audience is willing to pay for your products or services. Price-sensitive customers may not be willing to pay a premium for a new or innovative product; instead, they'll wait for the prices to decrease.

Some customers expect higher prices. For instance, you may have loyal customers because you sell higher quality products than the competition, and your customers are willing to pay for that quality.

Competitive landscape

The price skimming model only works in a less crowded market. If you already have a lot of competition, price skimming might not be viable because the customers in this segment are already paying less for high-quality products from your competitors. Instead, your product must be the first or most innovative in a market.

If you're in a competitive marketplace, you may have more success with another pricing strategy, like penetration pricing, which is the complete opposite of price skimming. Instead of setting a markup with higher prices when launching a product, you launch your product at a lower price to attract more customers.

Demand elasticity

Demand elasticity, also known as price elasticity of demand, refers to how demand is affected by fluctuations in pricing, including price drops and increases. Typically, the demand for a product decreases when the price rises, but it typically decreases more for some industries and products than others.

To take advantage of the price skimming strategy, you need inelasticity. An inelastic demand curve means that the demand for a product doesn't change when the price changes.

Price skimming can be an effective strategy for many businesses. The goal is to increase sales volume without alienating your largest potential customer segments. There are many advantages and disadvantages of price skimming, but knowing whether it's the right strategy for you is the first step.

Then, once you've determined it is a viable pricing strategy, you can begin to think of ways to implement it.

Market research and analysis

Market research can help you identify your target customers, assess competition, and analyze demand trends. You should have already conducted market research before developing a product to make sure there's a need for it in a market. Then, your market analysis can tell you who your competitors are and what their pricing strategies are.

One of the most important pieces of information you should get from market research is whether your industry has an inelastic or elastic demand curve. If demand drops when prices increase and your product isn't much different from your competitors, this strategy may not be your best option.

However, if you have product differentiation and loyal customers willing to pay a premium, you may still find success with price skimming in a market that has an elastic demand curve.

Set an initial high price

After determining whether price skimming is right for your business, you must determine your price. Remember, the whole point of price skimming is to charge early adopters more at first before reducing your prices after several months.

To set your prices, you should consider the perceived value of your products. If your brand is known for its quality, customers may be willing to pay more for them. In addition, you'll need to differentiate your product in the market by highlighting the benefits and features that make it stand out.

Ultimately, you must demonstrate value and show your customers why your price is higher than the competition.

Manage pricing over time

You should continuously monitor your pricing strategy to determine when to begin gradual price reductions. As time passes and all the early adopters have already purchased your product, you'll need a decrease in demand, which means adjusting your prices for cost-conscious customers who don't have your product yet.

You'll also need to address competitive responses. When you sell your products at a higher price, competitors will sell similar products at lower prices. This opportunity can allow you to demonstrate your value and quality to customers. Yet, if prices are much lower than yours, you'll need a plan for addressing these competitive responses.

A high initial price can help you earn more revenue when launching a new product. However, a successful price skimming strategy requires much more than setting premium pricing. You must have a competitive advantage that sets your products apart from the competition and loyal customers willing to pay more for them.

Conduct thorough market research

Market research will tell you if customers will pay premium prices for your products. If you sell products in a crowded market, your market research may show that selling at a lower price point is the best option. Price skimming can help you increase your profit margins early, but not for every business.

Develop a comprehensive pricing strategy

Having the highest initial price in a market means only some customers will purchase them. More price-conscious customers will purchase products from your competition. However, the price skimming strategy allows you to adjust your prices to attract new customers.

How much you reduce your prices will ultimately depend on demand, your competition, and the market itself.

You should continuously monitor how these price changes affect your sales and bottom line.

Monitor competition closely

Price skimming doesn't make sense in crowded markets because customers already pay less for products they're happy with. However, if you differentiate your brand and its products to demonstrate value or quality, customers may be more willing to pay a premium. However, you'll still need to monitor your competition.

Your competitors may be able to sell similar products for less, and if your industry is relatively elastic, consumers may not be willing to pay more for higher-quality products.

How much and when you reduce your price may depend on what's going on in the market and what your customers are doing, so you'll need to monitor your customer and other businesses closely throughout the process.

Continuously evaluate and adjust pricing

Evaluating and adjusting your prices can help you stay competitive in crowded markets. A price skimming strategy can be effective for businesses that can differentiate their products and demonstrate value. However, selling new products at a substantially higher price than the competition can alienate valuable customers, resulting in a loss of potential sales.

Before implementing a price skimming model, you should learn as much as possible about the market and how prices affect consumer demand. Then, when you're ready to reduce your prices, edit your pricing page and notify your loyal customers. Our suite of marketing tools can help you communicate price changes with customers and monitor sales and demand to help you monitor the effect of price changes on your business.