A guide to price skimming

When you go to launch a new product, setting the right price can feel like a high-stakes poker game with your customers. Before you get to the final decision, you should run customer discovery, evaluate what competitors look like, and develop a clear value proposition. All of these play into setting the price you put in front of customers.

Although seemingly negative, price skimming can be another important strategy in your product pricing toolbox. People often confuse price skimming for some kind of illegal pricing method when in fact it helps you maximize your product’s worth. This article explains how price skimming actually works by covering its advantages and drawbacks so you can make your own informed decision.

What is price skimming?

Price skimming is a strategic approach to pricing where you set a premium price at launch and gradually decrease it over time. This allows you to capture the value proposition early from those most willing to pay a higher price (think passionate early adopters). As competition enters the market, you can strategically lower the price to attract more price-sensitive customers, maximizing your overall revenue potential.

What are some alternative pricing strategies?

When it comes to product pricing, you should know the difference between three popular models: Price skimming, penetration pricing, and freemium pricing. The following chart outlines the three so that you can chose the one that makes the most sense for your particular product:

Advantages of price skimming

Now that you have a sense of price skimming, these are some of the benefits you can expect:

• Capture the maximum value early — By setting a high initial price, you can capture the highest willingness-to-pay from early adopters who value the novelty and exclusivity of the product
• Signal premium quality — A high launch price can communicate a perception of superior quality and innovation, attracting customers who value these attributes
• Manage production costs and maximize profit at launch — New products might have higher initial production costs. Price skimming allows you to recoup these costs at launch before lowering the price for a larger market
• A price anchor for the market and for price sensitive customers — The initial high price establishes a reference point for future price reductions. Customers perceive subsequent price drops as good deals, even if the final price is still higher than production costs
• Control market entry — Price skimming can be used to discourage direct competition in the early stages of a product launch. This allows the company to establish a strong market position before competitors with potentially lower prices enter the market

Disadvantages of price skimming

Although price skimming can provide value, it comes with downsides as well:

• Limit market penetration — The high initial price can limit the product’s reach and slow down overall sales volume. This can be risky if there’s a potential for rapid innovation or competition in the market or industry
• Discourage price-sensitive customers — More budget-conscious customers might be discouraged by the high price and opt for competing products with lower prices
• Require effective and gradual price reductions — Lowering the price too quickly or inconsistently can damage the product’s perceived value and loyalty from early adopters who paid a premium price. Price reductions need to be strategic and well-communicated
• Risk public perception issues — If not managed carefully, price skimming can create a perception that the company is greedy or exploiting customers. This can damage brand image and customer trust
• Not suitable for all product types or categories — Price skimming is most effective for innovative products with limited competition and a loyal customer base. For more established products or highly price-sensitive markets, other pricing strategies might be more suitable

Considerations for price skimming

Determining what pricing strategy to adopt requires careful consideration of the market conditions, your target customer segment, and your product’s value proposition. Price skimming can offer a superior pricing strategy depending on:

Market conditions

Limited competition or first mover advantage

Ideally, you want minimal competition initially, or your product should have a significant competitive advantage that justifies the higher price. This allows you to establish a strong market position and capture early profits before competitors arrive with potentially lower prices.

Early stage of the product life cycle

Price skimming is most effective during the introduction stage when there’s high initial demand and limited competition. As the product matures and competition increases, the price typically needs to be adjusted to stay competitive.

Target customer segment

High initial demand and willingness to pay

There must be a segment of your target market with a strong desire for your product and a willingness to pay a premium for early access or exclusivity. This is often seen with:

• Passionate early adopters who value being the first to own the latest technology or innovative products are typically less price-sensitive and willing to pay a premium
• Established brands with loyal customers who trust a brand’s reputation and quality might be more accepting of a higher initial price for a new product launch

Inelastic demand

Price skimming works best when the demand for your product is relatively inelastic. This means that a price increase won’t significantly decrease the number of customers willing to buy it. Hence, customers in your target market are not highly price sensitive. Luxury goods or products with a loyal customer base often exhibit inelastic demand.

Product characteristics

High upfront development or production costs

Price skimming allows you to recoup high costs quickly before lowering the price for a broader market. This can be seen in industries like pharmaceuticals or high-end software with significant research and development expenses.

Innovation and competitive advantage

This could be highly innovative new products that offer groundbreaking features improvements or features not available elsewhere. Even established products with a clear advantage over competitors can benefit from price skimming. Customers are willing to pay more for the unique value proposition or to be among the first to experience it (e.g., new iPhone models).

Examples of price skimming

Now let’s take a look at some real-world examples of price skimming so you can better understand its implementation.

Apple products

Apple is a classic example of price skimming. New iPhones and MacBooks are released at premium prices, targeting loyal customers and early adopters who value the latest technology and design.

As the product matures and competition increases, Apple gradually lowers the price, making it accessible to a broader audience. This allows it to capture both the high willingness-to-pay of early adopters and the larger market of price-sensitive customers later.

Gaming consoles

The latest generation of gaming consoles, like the Sony PlayStation 5 or Xbox Series X, often launch at a higher price point. This strategy targets enthusiastic gamers who want to experience the newest features and performance.

Later on, price drops and bundles with games become available, attracting a wider audience of casual gamers who might be more price-sensitive.

New software and services

New software or SaaS products may initially offer limited features at a higher price to capture early adopters willing to pay for the initial value and exclusivity. As the product matures, additional features are added and lower-tier pricing options are introduced, making it more attractive to a wider range of customers with varying needs and budgets.

4 steps for implementing price skimming

To make implementing price skimming easy, you can follow these four steps:

1. Perform market research and customer analysis

• Identify your target market by developing a clear understanding of who’s most likely to value your product’s unique features and be willing to pay a premium price early on
• Research how your competitors price similar products and identify any gaps where you can position your offering with a premium price
• Estimate demand elasticity by gauging how sensitive your target customers are to price changes. Inelastic demand is ideal for price skimming

2. Set your initial high price

• Consider your production costs and desired profit margin
• Factor in the perceived value proposition and exclusivity associated with your product
• Analyze competitor pricing and market conditions to set a price that captures early demand without discouraging potential customers

3. Develop a price reduction strategy

• Plan for gradual price decreases over time. This could be based on specific timeframes, introduction of new features or product revisions, or reaching sales targets
• Communicate the value proposition consistently. Throughout the price skimming period, emphasize the unique benefits and features that justify the initial high price
• Consider offering lower-priced versions or bundles later. This can attract a broader audience without devaluing the premium version

4. Monitor market response and adapt accordingly

• Track sales figures and customer feedback early on. Be prepared to adjust your pricing strategy based on market response and competitor actions
• Communicate price changes transparently. Explain the reasoning behind price reductions to maintain customer trust and brand image

Price skimming best practices

If your product fits the ideal criteria for a price skimming approach and you intend to adopt the strategy, then here are some additional tips to set you up for success:

• Price skimming can be a double-edged sword — While it can generate high initial profits, it can also limit market reach and damage customer perception if not implemented strategically
• Communicate the value proposition clearly and consistently — Justify the high initial price by highlighting the unique features, benefits, and innovation your product offers
• Plan for potential brand dilution — If price reductions are too drastic or frequent, it can damage the perceived value of the premium product
• Develop an exit strategy by carefully managing price reductions — Lowering the price too quickly or inconsistently can damage the product’s perceived value and loyalty from early adopters. Have a plan for how and when you will gradually lower the price to reach a broader market as competition increases or your product matures
• Carefully manage customer perception as well — Avoid a reputation for being greedy by clearly communicating the value proposition and justifying the initial high price

Final thoughts

Price skimming can be a powerful tool for maximizing your product’s value, particularly during its initial launch. In ideal use cases, implementing the strategy carefully can position you to capture early profits, establish a premium brand image, and control market entry.

However, remember that price skimming isn’t a long-term solution. It’s important to focus on continuous innovation and strategic price reductions to ensure your product remains competitive and accessible to a broader audience as the market evolves. This sets your product up for long-term success and sustainable growth.

Featured image source: IconScout