Price skimming is a business strategy used to spread the profits over a period of time. When products are first introduced on a market, vendors charge high prices, and then, gradually, over time, these prices decrease lower and lower. Another term used to describe price skimming is called “riding down the demand curve.” The idea is to capture the consumer surplus. This means that the minimum consumers actually pay will be the most they are willing to pay. However, this is pretty lofty. Strategy definitely plays a part in price skimming.
Price skimming comes from the idea of milk skimming. To yield milk, one repeatedly skims the cream from the top, decreasing the fat content each time. Thus, over time, milk is produced at whole, 2 percent, 1 percent, and fat free. Price skimming diminishes the price of the product in the same format.
Decreasing the price over time can also benefit a company, because by the time the price decreases, after a year or so of initial marketing, more people know about the product. By then, word has spread and a reputation has developed. Although, the price decreases for the product, a higher volume of sales occurs.
Aside from gaining profits overtime and retaining the production and development costs at the beginning when the prices are high (before the competition lowers the prices), companies further consider the consumer psychology. Many associate high prices with luxury and quality. Companies want their products to have this reputation from the start, so they begin at high prices.
In order for price skimming to work, companies must have supporters of their products. Many times, when products first become available, companies spend much funding on promoting and marketing their new ideas. They want to draw people in immediately, so that individuals will pay for their products. Then, as time continues and more vendors carry said products, they will lower their prices and the supply and demand of the product will stabilize.
Price skimming walks a thin line, because there are laws about price fixing and regulations when it comes to consumers’ rights. Some of these include price discrimination and yield management. Companies have to provide viable evidence that the price skimming acts in conjunction with the consumer psychology and thinks within terms of product characteristics.
Some of the limitations with price skimming include a low inventory turn rate, the encouragement of entry of competitors, and a slow rate of stuff diffusion and adaptation. Further, if companies drop the prices too fast, consumers may think something is wrong with the product or feel like they have been taken advantage of (since they paid the premium price). The strategy has to be very well thought out to combat these issues.
Overall, price skimming can prove to be a very rewarding strategy for companies. However, the whole idea revolves in the strategy. Companies need a well-thought out plan to confront some of the negative sides of price skimming. They need a good marketing team that will create supporters of the new product. Then, they have to carefully watch the product and consumer trends over the next little while to be sure to lower the price at the right times and at the right increments. If companies will consider these factors, price skimming can be successful for them.