Reading: Skim Pricing

Introduction

With a totally new product, competition either doesn't exist or is minimal, and there's no market data about customer demand. How should the price be set in such a case? There are two common pricing strategies that organizations use for new products: skim pricing and penetration pricing.

The Economics of Price and Demand

In order to understand these pricing strategies, let's review the demand curve. In a typical economic analysis of pricing, the demand curve shows the quantity demanded at every price. In our graph below, the demand increases by 100 units each time the price drops by $1. Based on this demand, if a company priced its product at $4, consumers would buy 200 units. If the company wanted to raise its prices, it could charge $5, but then consumers would buy only 100 units. This is an oversimplified example, but it shows an important relationship between price and demand.

The key thing to understand about this model is that when all else is equal, demand decreases as price increases. Fortunately, the marketer does not have to regard everything else as fixed. She can make adjustments to product, promotion, or distribution to increase the value to the customer in order to increase demand without lowering price. Still, once the other elements of the marketing mix are fixed, it's generally true that a higher price will result in less demand for a product, and a lower price will result in more demand for a product.

What Is Skim Pricing?

Price skimming involves the top part of the demand curve. A firm charges the highest initial price that customers will pay. As the demand of the first customers is satisfied, the firm lowers the price to attract another, more price-sensitive segment.

Using our example of the demand curve, the price might be set at $5 per unit at first, generating a demand of only 100 units.

The skimming strategy gets its name from skimming successive layers of "cream"—or customer segments—as prices are lowered over time.

Why Might Skim Pricing Make Sense?

There are a number of reasons why an organization might consider a skimming strategy. Sometimes a company simply can't deliver enough of a new product to meet demand. By setting the price high, the company is able to maximize the total revenue that it can generate from the quantity of product that it can make available.

Price skimming can also be part of a customer segmentation strategy. Take a look at the graph, above. You'll remember from our discussion of the product life cycle and customer adoption patterns that the Innovators—the adventurous customers on the left who are game to try new products—are less price sensitive and place a premium on being first to own a new product. A skim-pricing strategy targets these customers and sets a higher price for them. As the product starts to move through the Early Adopters stage, the marketer will often reduce the price to begin drawing Early Majority buyers.

A skimming strategy is most appropriate for a premium product. Today we can see many examples of skim pricing in the electronics industry when new product innovations are introduced. Electronics companies know that many buyers will wait to purchase new technologies, so they use skim pricing to get the highest possible price from the Innovators and Early Adopters.

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