There are dozens of different pricing strategies you can use in your business, and one of the more unique options is the price skimming strategy.
Price skimming is an approach to pricing your products that capitalizes on novelty, timeliness, exclusivity, and/or innovation. When used and adjusted effectively, this strategy can maximize the revenue of individual product lines – particularly when they first launch.
In this article, we’ll highlight the definition, history, pros, and cons of the price skimming strategy in addition to explaining when it may (or may) not make sense for your business to employ.
Want to know how much your business could earn with a price skimming strategy? Download our free sales pricing calculator to see how much revenue and profit you’ll drive, and compare the numbers to eight other pricing models, including penetration pricing, value-based pricing, and premium pricing to choose the best pricing model for your business.
What is Price Skimming?
Price skimming is when you launch a product with a higher-than-usual markup and then incrementally lower the price over time. Typically, price skimming applies to new, innovative products. As time passes and the product becomes less novel and more accessible, the price steadily declines.
The name “skimming” comes from the idea of looking at all potential buyers like a stack – those at the top are willing to pay the most, while those at the bottom want to pay the least.
Once all who are willing to buy at the high price have made their purchase, you “skim” them off the top of the stack, and adjust the price to what the next group of buyers are willing to pay.
Price skimming is typically employed for new technologies. DVD players are a good example of this. When DVD players first hit the market in the late 90s, they could cost you up to $1,000. Now, if you do a quick search on Amazon, you’ll see that a new DVD player will set you back a mere $33.
Certainly, there’s an argument to be made that the price decreased so drastically because of various technological and cultural factors, but take a second to think about paying $1,000 for a DVD player in the late 90s – if you had the money and were a movie buff, it doesn’t seem so crazy.
Unlike cable, a DVD player allows you to choose your own entertainment for the evening, and DVDs have more features and offer a better quality viewing experience than VHS tapes (remember those?).
You also see price skimming at some fashion or clothing stores. When new designs are released, they’re usually priced at their highest point. However, as newer items make their way onto the racks the supply of the now older design dwindles, these items often move to the clearance section and are continuously marked down until they are sold.
The Pros of Price Skimming
1. It can maximize early revenue
Companies that employ price skimming tactics do so to recoup investments early and sell as many products as possible at the highest price point the product is likely to see. This immediately boosts both revenue and profit, which the company can utilize to expand marketing and distribution, as well as cover R&D costs.
2. It can help create buzz
Price skimming works well when paired with a slow rollout strategy. When price skimming is their tactic, companies know that their market share will be small to start. However, as the price drops, the anticipation to access the product at a more affordable price often rises.
For some products, consumers and businesses eagerly await the opportunity to purchase it when the price is right – especially when they can’t afford it at first. It’s a classic example of “you always want what you can’t have,” but with a skimming strategy, you may be able to have it a few months down the line.
3. You can adjust over time
One of the biggest perks of a well-implemented skimming strategy is the ability to change your price as the market shifts. Starting off high, you can determine how price sensitive your buyers are and offload as much inventory as possible at the highest profit margin.
From there, it’s your call as to when the price goes down and which price you’ll drop to. This puts the pricing model completely in your control, and you can adjust your selling price based on market conditions and buyer behavior as you see fit.
4. It can help your brand
Since skimming is – in the grand scheme of daily purchases – a relatively uncommon approach, employing it well can create a certain perception of your brand by the market.
All of these terms are often associated with products that are released with a price skimming model. If that’s an image you’re aspiring towards for your brand, price skimming might be the right call for your product.
The Cons of Price Skimming
1. You can frustrate early buyers
Technophiles eager to get the “new big thing” or those who front a larger-than-needed sum of money to buy your product might be disappointed – or worse, angry – when they see the price of what they purchased a month ago drop 20% overnight.
The counter to this? The price skimming strategy is not exactly a secret in many industries, like tech. While early adopters may be annoyed when the price goes down, they tend to know what they’re getting into and are usually willing to pay more to get their hands on the product first.
2. It can backfire when it’s expected
I don’t know about you, but I always wait a few months after a new iPhone comes out before I consider buying it, since I know the price will certainly decrease after the initial buzz dies down.
Side note: I still miss my headphone jack (*editor's note: same).
Moral of the story? When your skimming strategy becomes a norm, it can defeat the purpose of that pricing in the first place, as many buyers could choose to instead wait to buy when they know the price will soon decrease (I see you, Apple).
This could botch your rollout strategy and limit your revenue during the first wave of pricing. Therefore, it makes sense to use price skimming sparingly, if you anticipate buyers will react this way.
3. It can’t last forever
When a rival business sees how much money can be made on a product, they’ll oftentimes swoop in with a similar product at a lower price. This leaves you with two options: leave your price the same and hope that its prestige and quality will keep your sales unaffected, or change your price to a lower price point earlier than planned to stay competitive.
Let’s also remember that – even without competition – you’ll likely hit a limit of people you can feasibly sell to at each price point. Eventually, price skimming dictates you will have to lower your prices, so keep that in mind when making your sales forecasts.
4. It can damage your brand
Price skimming offers a ton of benefits to your brand, but conversely, it can also harm your brand. Companies that engage in price skimming can come across as greedy, dishonest, or manipulative, reinforcing the notion that price skimming should not be utilized by all companies or for all products.
When Price Skimming Does (and Doesn’t) Make Sense
Let’s take a look at some situations where price skimming might (or might not) work out.
Does make sense: new technologies
From the DVD player to the smartphone and even the smart TV and Teslas —truly revolutionary technology products like these are almost expected to be rolled out with a skimming pricing model. And the general market tends to be excited rather than annoyed when the price drops.
Doesn’t make sense: B2B SaaS
Most B2B SaaS companies want to expand their user base as quickly as possible to generate a steady amount of recurring revenue. Limiting that growth potential with sticker shock can damage that early foundation and restrict compounding growth potential.
Instead, B2B SaaS companies might want to employ penetration pricing or freemium pricing by acquiring users at a low cost and gradually increasing revenue from those customers with added on services, account users, or increased pricing later on.
Does make sense: clothing and fashion
Fashion and clothing stores are known for changing their prices seasonally as new styles are introduced. By that logic, using price skimming to keep the price tag high at first and then moving the item to the sale rack when the time is right is a great strategy for these vendors.
Since most clothing stores only make a set amount of each style, price skimming works perfectly here. It is the ideal model for continuously adjusting price until you’ve sold all of your inventory – with each piece of clothing being sold at its highest potential price.
Doesn’t make sense: products with tough competition
If you’re entering a heavily saturated market with an undifferentiated product, it’s probably not the wisest idea to come out with a high-priced markup. Essentially, you’re not displaying any competitive advantage or reason for buyers to choose you.
Like clothing stores, new car dealers are always turning over new inventory and trying to sell each year’s model before the next year’s comes along.
During the first month of that new car’s availability – demand is high, and you can justifiably keep the price high as well. However, as months 11 and 12 approach, car dealers and their buyers know the selling price will be substantially lower.
Dealers can use this strategy to provide buyers with a brand new car at a lower cost and account for that sacrificed markup in their earlier sales.
Doesn’t make sense: contracting, consulting, and professional services
Professional services such as medical, legal, or consulting services are more demand-inelastic than the products that would benefit from price skimming. On top of that, it doesn’t make much sense for these types of workers or businesses to lower the costs of their services as they advance in their careers.
Instead, these businesses might benefit the most from project-based or hourly pricing models.
Is Price Skimming Right for Your Business?
Still unsure if price skimming is the best approach for your pricing strategy? Download HubSpot’s Sales Pricing Strategy Calculator to forecast how much revenue and profit you’ll earn by employing nine different pricing strategies – including price skimming.
Originally published Oct 28, 2019 6:30:00 AM, updated October 28 2019