Skim pricing, also known as price skimming, is a pricing strategy where a company charges a relatively high initial price for a new product or service, and then gradually lowers the price over time to attract more price-sensitive customers. This strategy is typically employed by companies that are first to market with a unique or innovative offering, and face little to no competition initially.

Rationale Behind Skim Pricing

The primary objective of skim pricing is to maximise profits in the short term by targeting early adopters and customers who are willing to pay a premium for a new and innovative product or service. Companies employing this strategy aim to recover their initial development and production costs as quickly as possible before competitors enter the market and exert downward pressure on prices.

Skim pricing is based on the diffusion of innovation theory, which explains how new products or ideas spread through a social system over time. According to this theory, there are different segments of consumers:

Innovators: These are the risk-takers who want to be the first to adopt a new product or service, and are generally not price-sensitive.

Early Adopters: This group is also eager to try new products or services but may be slightly more price-conscious than innovators.

Early Majority: This segment adopts new products or services after they have been proven and accepted by the innovators and early adopters, and tends to be more price-sensitive.

Late Majority: This group is sceptical of new products or services and will only adopt them after they have become well-established and widely accepted.

Laggards: These are the last to adopt new products or services, often due to tradition or lack of resources.

Skim pricing targets the innovators and early adopters first, capitalising on their willingness to pay a premium for a new and unique offering. As demand from these segments is fulfilled, the company then gradually reduces the price to attract the more price-sensitive early majority and late majority segments.

Illustration and Example of Skim Pricing

Consider a technology company, TechCorp, that has developed a cutting-edge virtual reality headset for gaming and entertainment. Being the first to market with this innovative product, TechCorp decides to employ a skim pricing strategy.

Initially, TechCorp set a high price of $799 for the VR headset, targeting the innovators and early adopters who are eager to experience the latest technology and are willing to pay a premium. As demand from these segments is met, TechCorp gradually reduces the price to $599, making the product more accessible to the early majority of consumers who are interested in the VR headset but are more price-sensitive.

Eventually, as competition enters the market with similar offerings, TechCorp may further reduce the price to $399 or lower to appeal to the late majority and capture a larger share of the mass market.

Advantages of Skim Pricing

Perceived Quality: A high initial price can create a perception of high quality and exclusivity for the product or service, which can be beneficial for premium or luxury brands.

Cost Recovery: Skim pricing allows companies to quickly recover their initial development and production costs, which can be substantial for innovative or technologically advanced products.

High Profitability: By targeting consumers who are willing to pay a premium, skim pricing generates high profit margins, at least in the short term.

Supply Chain Benefits: The higher markup associated with skim pricing can benefit distributors and retailers, who earn a higher percentage of the selling price.

Disadvantages of Skim Pricing

Deterrence: If the initial high price is not justified by the perceived value or benefits of the product or service, it may deter potential customers from purchasing.

Limited Sales Volume: By setting a high initial price, the company may limit the potential sales volume and fail to achieve economies of scale.

Short-term Strategy: Skim pricing is not a viable long-term strategy, as competitors will eventually enter the market with similar offerings, exerting downward pressure on prices.

Consumer Loyalty: If the price of a product or service drops significantly after its initial launch, early adopters who paid the high skim price may feel resentful, potentially damaging customer loyalty and brand reputation.

When Is Skim Pricing Appropriate?

Skim pricing is generally most appropriate in the following situations:

• The company is the first to market with a truly innovative or unique product or service, and faces little to no competition initially.
• There is a segment of customers who are willing to pay a premium for the new offering, such as innovators and early adopters.
• The company has incurred substantial development and production costs that need to be recovered quickly.
• The product or service has a limited lifespan or is subject to rapid technological obsolescence, making it imperative to maximise profits in the short term.

However, if the market is highly competitive or the product or service is not perceived as truly innovative or unique, skim pricing may not be an effective strategy, and companies may need to consider alternative pricing approaches.

Skim Pricing vs. Penetration Pricing

It's worth noting that skim pricing is in contrast to penetration pricing, which is another common pricing strategy. With penetration pricing, a company sets a relatively low initial price for a new product or service to quickly gain market share and attract a large customer base. This strategy is often used when there is significant competition or when the product or service has a low cost of production, allowing for lower prices and higher sales volumes.

The choice between skim pricing and penetration pricing depends on various factors, including the nature of the product or service, the competitive landscape, the target market, and the company's overall objectives and resources.

Skim Pricing vs. Penetration Pricing

Characteristic	Skim Pricing	Penetration Pricing
Initial Price	High	Low
Target Customers	Innovators, Early Adopters	Mass Market
Objective	Maximise Short-term Profits	Gain Market Share
Competitive Environment	Low Competition	High Competition
Cost Recovery	Rapid	Slower
Sales Volume	Low (initially)	High

In summary, skim pricing can be an effective strategy for companies introducing truly innovative or unique products or services, particularly when there is a segment of customers willing to pay a premium for being first to market. However, it is a short-term strategy, and companies must be prepared to adjust their pricing as competition emerges and market dynamics change. Careful consideration of the product, market, and competitive landscape is essential to determine whether skim pricing is the right approach for your business.

FAQs

How do you determine the right initial high price for skim pricing?

The initial skim price should be set high enough to maximise profits from the innovators and early adopters who are willing to pay a premium, but not so high that it deters even those customers. Factors to consider include the perceived value and uniqueness of the product, development and production costs, and competitor pricing for similar offerings.

How long can a company sustain a skim pricing strategy?

Skim pricing is generally a short-term strategy, as competitors will eventually enter the market with similar offerings, exerting downward pressure on prices. The duration of the skim pricing strategy depends on factors such as the speed at which competitors can replicate the product or service, and the rate at which new technologies or innovations emerge.

Is skim pricing suitable for all types of products and services?

No, skim pricing is most appropriate for truly innovative or unique products and services that face little to no competition initially. It may not be effective for commoditized products or services, or those with readily available substitutes, as customers are unlikely to pay a premium in such cases.

How can a company maintain customer loyalty after reducing prices following a skim pricing strategy?

To maintain customer loyalty, companies should be transparent about their pricing strategy and communicate the reasons for the initial high price and subsequent reductions. Offering incentives or loyalty programs for early adopters can also help mitigate any resentment over the price drops.

What are the risks of skim pricing, and how can they be mitigated?

Some risks of skim pricing include potential deterrence of customers due to the high initial price, limited sales volume and inability to achieve economies of scale, and the threat of competitors entering the market with lower-priced alternatives. These risks can be mitigated by carefully researching customer willingness to pay, monitoring competitor activity, and having a plan to transition to a more sustainable long-term pricing strategy.