Skimming the market: Pricing of new products and services.

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Whether you’re thinking about starting a business or are already a marketing professional, choosing the right pricing strategy is a fundamental pillar for the successful launch of a new product or service, because the decision you make at this moment will mark its destiny from here on. Among the multiple tactics available, two stand out for their efficacy and popularity: skimming prices and penetration prices. Each of these strategies responds to different market objectives and contexts, setting the initial course that can determine success or failure in the market.

The skimming price strategy, or “skimming,” involves initially setting a high price for a new product, capturing the maximum value from consumer segments less sensitive to price. This tactic aims not only to maximize the initial profits from early adopters but also to quickly recover research and development costs, effectively managing the product’s life cycle. On the other hand, penetration pricing seeks to attract a broad base of consumers by setting low prices from the launch, quickly seeking a high market share and discouraging the entry of competitors. In this post, I will focus on skimming prices, and in a following one, I will address penetration prices.

The selection between these pricing strategies is not trivial; it requires a detailed analysis of the product’s characteristics, the dynamics of the target market, the company’s cost structure, and the price sensitivity of potential consumers. The skimming price strategy, in particular, is based on the premise that there is a market segment willing to pay a premium price for novelty, exclusivity, or innovative features of the product. This strategy is ideal for products that present significant innovation and have a clear and defendable competitive advantage over time. A skimming pricing strategy is not the same as a luxury pricing strategy. Although they share the fact of targeting less price-sensitive segments, luxury pricing strategy demands different conditions to be successful.

In the following sections, I delve into the advantages and challenges of implementing a skimming pricing strategy and summarize the ideal conditions where this strategy has a greater chance of success and the fundamental role of continuous innovation for this strategy.

Advantages of launching a product or service with skimming prices

A skimming pricing strategy, when applied correctly, can offer significant benefits, allowing companies not only to quickly recover their investments but also to firmly establish the product’s perception in the market. Below, I detail these and other advantages of this pricing strategy.

  1. Maximization of initial profits: The skimming pricing strategy allows companies to maximize profits in the early stages of a product’s life cycle by setting high prices. This is especially beneficial for innovative or high-tech products, where early adopters are willing to pay a premium to access the novelty first. For example, Apple frequently employs this tactic with the launch of new iPhone models, capturing the maximum value from technologically advanced and brand-loyal consumers as described in this article.
  2. Quick investment recovery: Initial premium prices help quickly recover research and development costs. This is crucial in industries such as pharmaceuticals or technology, where product development can be extremely costly. Pharmaceutical companies, for example, use skimming prices to recover the costs associated with the long and expensive phase of development and clinical trials of new drugs.
  3. Market segmentation: Through the skimming pricing strategy, companies can effectively segment the market, initially targeting consumers less sensitive to price. This allows a clear differentiation between consumers willing to pay more for added value and those more sensitive to price, to whom price reductions can later be directed. Video game console manufacturers, like Sony with its PlayStation, apply this strategy by launching new products at high prices, initially capturing the most enthusiastic gamers.
  4. Product positioning as premium: By establishing a high price, companies can position their product as high quality. This positioning attracts consumers looking for status or the best quality available. Brands like Asics (running shoes) and Tesla (electric vehicles) have used skimming prices to reinforce the perception of superior innovation and technological leadership, respectively.
  5. Production capacity management: For new and innovative products, production capacities may initially be limited. Skimming prices help manage demand, ensuring that only the most willing consumers can purchase the product, thus avoiding over-demand and potential scarcity issues. This approach was evident in the launch of technologically advanced products like the Tesla Roadster, the brand’s first vehicle where the initially limited production was balanced with a high price to effectively manage demand.

Disadvantages of launching a product or service with skimming prices

Despite the evident advantages mentioned above, a skimming pricing strategy also has disadvantages that underscore the importance of careful planning and market analysis for its implementation. In this sense, brands must be prepared to adapt to market responses and consider how the strategy fits within a broader approach to product positioning and brand management. Below are the main disadvantages of this strategy:

  1. Risk of competitor entry: An initial high price may be an invitation for competitors to enter the market with more economical alternatives, capturing those price-sensitive consumers who cannot or do not want to pay the premium. For example, after the launch of a high-end smartphone by a leading brand, it is common to see competitors offering devices with similar features at a lower price.
  2. Negative perception due to price reduction: Consumers who purchase the product at the initial price may feel defrauded or misled when the price is reduced. This can damage the long-term relationship with customers and negatively affect the brand’s perception as discussed recently in this post.
  3. Dependence on a small market segment: By focusing on consumers willing to pay a high price, companies run the risk of depending too much on a relatively small market segment. If this segment is not as large as anticipated or if its loyalty changes, the strategy may result in sales below expectations.
  4. Barriers to mass adoption: Skimming prices can create barriers to the mass adoption of the product, especially in price-sensitive markets. This can delay the achievement of economies of scale and allow competitors to establish a dominant market position in broader segments. An example is the high-definition (HD) television market in its early days, where the initial high prices limited acquisition by the mass market.
  5. Difficult adjustment to changes in demand: The skimming pricing strategy can make it difficult to quickly adjust to unexpected changes in demand. If the market evolves in such a way that consumers become more price-sensitive or if a disruptive innovation emerges at a lower cost, companies may find themselves trapped in an inflexible pricing structure. This was evident in the case of some high-end digital cameras, where rapid technological advances introduced by smartphones and the entry of new competitors pressured prices to drop faster than anticipated.

Ideal conditions for the success of the skimming strategy

To determine whether a product or service meets the necessary conditions to apply a skimming pricing strategy, the marketing manager or entrepreneur must evaluate several key factors that influence the viability and potential success of this strategy. These factors include:

  1. Significant innovation: The product or service must offer unique features, functionalities, or technological advancements that are not available in existing products or services in the market. The innovation must be sufficiently significant to justify a premium price, at least temporarily.
  2. High Perceived Value: There must be a market segment that perceives the high value of the product or service and is willing to pay a premium price to be among the first to acquire it. This segment is usually made up of so-called early adopters, who value innovation and the status associated with owning the product or service before others.
  3. Competitive protection capability: The company must have means to protect its product or service from rapid competition, at least during the initial phase of high prices. This can be achieved through patents, copyrights, or a strong brand and reputation that act as barriers of entry for potential competitors.
  4. Quick investment recovery: If the development of the product or service involved a significant investment in research and development (R&D), the skimming pricing strategy may be ideal for quickly recovering those costs. This is especially relevant in industries with short product life cycles or where constant innovation is critical.
  5. Market with little or no initial competition: The strategy is more effective in markets where there are few direct alternatives or competition, allowing the company to establish and maintain high prices without immediate pressure to reduce them.
  6. Flexibility and segmentation capacity: The company must have the ability to adjust prices over time and possibly segment the market to target different groups of consumers with different versions of the product or price levels, thus maximizing profitability throughout the product’s life cycle. Use these criteria as a checklist to evaluate whether your product or service is a good candidate for a skimming pricing strategy. However, it is important to conduct a detailed market analysis and consider factors such as the price sensitivity of target consumers, the existence and strength of potential competitors, and general industry trends that could influence the effectiveness of the selected pricing strategy.

Role of innovation in the success of the skimming strategy

 The degree of innovation of a product or service plays a critical role in the possibilities of carrying out a successful skimming pricing strategy. Innovation, in this context, refers not only to technological novelty but also to the perceived value and differentiation that the product or service offers in the market. Below, I detail several ways in which the degree of innovation affects the viability and success of a skimming pricing strategy:

  1. Perceived value and differentiation: A high degree of innovation increases the perceived value of the product or service among consumers, especially among early adopters, who are willing to pay a premium price to have access to the latest technologies or exclusive benefits. The clear differentiation from existing products justifies the initial high price and can protect against early competition.
  2. Lower price sensitivity in target segments: Highly innovative products attract market segments that value innovation and the status associated with being pioneers in adopting new products. These consumers tend to be less sensitive to price, facilitating the implementation of skimming prices without significantly affecting initial demand.
  3. Barriers to entry for competitors: Significant innovation can create natural barriers to entry for potential competitors, whether through technological complexity, patents, or the exclusivity of the product’s features. This provides the company with a temporary monopoly period or a sustained competitive advantage, during which it can capitalize on high prices before competition intensifies.
  4. Quick recovery of R&D investments: Products that require considerable investment in research and development (R&D) benefit especially from the skimming pricing strategy, as initial premium prices help recover R&D costs more quickly. This is crucial for maintaining financial viability and encouraging continuous innovation.
  5. Adaptation to the market acceptance curve: The degree of innovation affects the speed and pattern of market adoption. A highly innovative product may experience slow but steady initial adoption, followed by accelerated growth as market awareness and acceptance increase. Skimming prices allow capitalizing on the different stages of adoption, adjusting prices as the product moves from early adopters to the mass market. In summary, the degree of innovation is fundamental to determining not only the feasibility but also the success of a skimming pricing strategy. However, it is crucial that innovation is effectively communicated to the market and that the company is prepared to adjust its strategy in response to evolving market conditions and consumer behavior.

Conclusion

The decision between skimming or penetrating the market is fundamental to the success of new products or services. The skimming strategy, which involves high initial prices to maximize profits from less price-sensitive segments, offers advantages such as quick investment recovery and premium positioning. However, it presents challenges such as the risk of competitor entry and the possible negative perception due to price reductions. Its success depends on the product’s significant innovation, high perceived value, competitive protection, and the ability to quickly recover R&D costs. Additionally, it is crucial that there is little initial competition and flexibility to adjust prices. The effectiveness of this strategy lies in the product’s differentiation and perceived value, as well as the company’s ability to navigate the market and adapt to its changes. The selection of this tactic should be based on a detailed analysis of these elements, ensuring the product’s long-term viability in a competitive and changing market environment.

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