Price Skimming

Information about Price Skimming

Price Skimming

Price skimming is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time. It is a temporal version of price discrimination/yield management. It allows the firm to recover its sunk costs quickly before competition steps in and lowers the market price.

Price skimming is sometimes referred to as riding down the demand curve. This can be seen in the series of diagrams on the right. The first diagram shows the demand schedule, price, and quantity demanded at time t=1. Additional short run demand schedules representing times t=2 and t=3 are added in subsequent diagrams. As time goes by, price decreases and volume increases. When the 3 equilibria are joined we obtain the price skimmers’ long run demand schedule (shown in bright green).

The objective of a price skimming strategy is to capture the consumer surplus (the area in blue, between the single market clearing price (P*) and the highest price charged (P1)). If this is done successfully, then theoretically no customer will pay less for the product than the maximum they are willing to pay. In practice it is impossible for a firm to capture all of this surplus.

Limitations of Price Skimming

There are several potential problems with this strategy.

Elastic Demand

It is effective only when the firm is facing an inelastic demand curve. If the long run demand schedule is elastic (as in the diagram below), market equilibrium will be achieved by quantity changes rather than price changes. Penetration pricing is a more suitable strategy in this case. Price changes by any one firm will be matched by other firms resulting in a rapid growth in industry volume. Dominant market share will typically be obtained by a low cost producer that pursues a penetration strategy.
A price skimmer must be careful with the law. Price discrimination is illegal in many jurisdictions, but yield management is not. Price skimming can be considered either a form of price discrimination or a form of yield management. Price discrimination uses market characteristics (such as price elasticity) to adjust prices, whereas yield management uses product characteristics. Marketers see this legal distinction as quaint since in almost all cases market characteristics correlate highly with product characteristics. If using a skimming strategy, a marketer must speak and think in terms of product characteristics in order to stay on the right side of the law.
The inventory turn rate can be very low for skimmed products. This could cause problems for the manufacturer's distribution chain. It may be necessary to give retailers higher margins to convince them to enthusiastically handle the product.
Skimming encourages the entry of competitors. When other firms see the high margins available in the industry, they will quickly enter.
Skimming results in a slow rate of diffusion and adaptation. This results in a high level of untapped demand. This gives competitors time to either imitate the product or leap frog it with a new innovation. If competitors do this, the window of opportunity will have been lost.
The manufacturer could develop negative publicity if they lower the price too fast and without significant product changes. Some early purchasers will feel they have been ripped-off. They will feel it would have been better to wait and purchase the product at a much lower price. This negative sentiment will be transferred to the brand and the company as a whole.
High margins may make the firm inefficient. There will be no incentive to keep costs under control. Inefficient practices will become established making it difficult to compete on value or price.

Marketing is a social process which satisfies consumers' wants. The term includes advertising, distribution and selling of a product or service. It is also concerned with anticipating the customers' future needs and wants, often through market research.
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price is the assigned numerical monetary value of a good, service or asset.

The concept of price is central to microeconomics where it is one of the most important variables in resource allocation theory (also called price theory).
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Aspinwall Classification System (Leo Aspinwall, 1958) classifies and rates products based on five variables:

Replacement rate (How frequently is the product repurchased?)
Gross margin (How much profit is obtained from each product?)

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Service can refer to:

Public services, services carried out with the aim of providing a public good
A penetrant, as defined by a building code
Service (Systems Architecture), the provision of a discrete business or technology function within a systems environment; i.

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Price discrimination exists when sales of identical goods or services are transacted at different prices from the same provider. In a theoretical market with perfect information, no transaction costs or prohibition on secondary exchange (or re-selling) to prevent arbitrage, price
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In economics and in business decision-making, sunk costs are costs that have already been incurred and which cannot be recovered to any significant degree. Sunk costs are sometimes contrasted with variable costs, which are the costs that will change due to the proposed course of
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Consumer surplus or Consumer's surplus (or in the plural Consumers' surplus) is the difference between the price consumers are willing to pay (or reservation price) and the actual price.
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Penetration pricing is the pricing technique of setting a relatively low initial entry price, a price that is often lower than the eventual market price. The expectation is that the initial low price will secure market acceptance by breaking down existing brand loyalties.
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Diffusion is the process by which a new idea or new product is accepted by the market. The rate of diffusion is the speed that the new idea spreads from one consumer to the next.
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Microeconomics (or price theory) is a branch of economics that studies how individuals, households, and firms make decisions to allocate limited resources,^[1] typically in markets where goods or services are being bought and sold.
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In microeconomics, production is the act of making things, in particular the act of making products that will be traded or sold commercially. Production decisions concentrate on what goods to produce, how to produce them, the costs
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Price Skimming

Information about Price Skimming

Limitations of Price Skimming

See also