Price skimming is a pricing strategy in which a marketer sets a relatively high initial 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. The objective of a price skimming strategy is to capture the consumer surplus early in the product life cycle in order to exploit a monopolistic position or the low price sensitivity of innovators.
Therefore, the skimming strategy gets its name from skimming successive layers of "cream," or customer segments, as prices are lowered over time.
There are several potential problems with this strategy.
Price skimming occurs in mostly technological markets as firms set a high price during the first stage of the product life cycle. The top segment of the market which are willing to pay the highest price are skimmed off first. When the product enters maturity the price is then gradually lowered.
Price skimming is only used when a new product just entered the market, the business may be able to charge high prices as some customers would want to be first to buy the product. Business usually start with a high price and it will lower over time so this strategy is mostly used by technology products.
Price skimming occurs for example in the luxury car and consumer electronics markets. In consumer electronics, there is a confounding factor that there is typically high price deflation due to continual reductions in manufacturing cost and improvements in product quality - for example, a printer priced at $200 today would have sold for a far higher price a decade ago.
The book market often combines price skimming with product versioning in the following way: a new book is published in hardback at a high price; if the book sells well it is subsequently published in paperback at a much reduced price (far lower than the difference in cost of the binding) to more price-sensitive customers. The hardback usually continues to be sold in parallel, to those consumers and libraries that have a strong preference for hardbacks. The skimming policy also affect the customer through the relative higher price of the product or services. This policy deals with the cross demand in the com-petite market.
In an empirical study, Martin Spann, Marc Fischer and Gerard Tellis analyze the prevalence and choice of dynamic pricing strategies in a highly complex branded market, consisting of 663 products under 79 brand names of digital cameras. They find that, despite numerous recommendations in the literature for skimming or penetration pricing, market pricing dominates in practice. In particular, the authors find five patterns: skimming (20% frequency), penetration (20% frequency), and three variants of market-pricing patterns (60% frequency), where new products are launched at market prices. Skimming pricing launches the new product 16% above the market price and subsequently lowers the price relative to the market price. Penetration pricing launches the new product 18% below the market price and subsequently increases the price relative to the market price. Firms exhibit a mix of these pricing paths across their portfolios. The specific pricing paths correlate with market, firm, and brand characteristics such as competitive intensity, market pioneering, brand reputation, and experience effects.