Price Skimming
Price skimming is sometimes referred to
as riding down the demand curve. This can be seen in the series of diagrams
on the right. The first diagram shows the demand schedule, price, and
quantity demanded at time. Price skimming is a pricing strategy in which
a marketer sets a relatively high 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.
The objective of a price skimming strategy is to capture the consumer
surplus and the highest price charged. If this is done successfully,
then theoretically no customer will pay less for the product than the
maximum they are willing to pay. In practice it is impossible for a
firm to capture all of this surplus.
Price skimming must be
careful with the law. Price discrimination is illegal in many jurisdictions,
but yield management is not. Price skimming can be considered either
a form of price discrimination or a form of yield management. Price
discrimination uses market characteristics (such as price elasticity)
to adjust prices, whereas yield management uses product characteristics.
Marketers see this legal
distinction as quaint since in almost all cases market characteristics
correlate highly with product characteristics. If using a price skimming
strategy, a marketer must speak and think in terms of product characteristics
in order to stay on the right side of the law.
The inventory turn rate
can be very low for skimmed products. This could cause problems for
the manufacturer's distribution chain. It may be necessary to give retailers
higher margins to convince them to enthusiastically handle the product.
Price Skimming encourages
the entry of competitors. When other firms see the high margins available
in the industry, they will quickly enter.
Price Skimming results
in a slow rate of diffusion and adaptation. This results in a high level
of untapped demand. This gives competitors time to either imitate the
product or leap frog it with a new innovation. If competitors do this,
the window of opportunity will have been lost.
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