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Price Skimming

Disciplines > Marketing > Pricing > Price Skimming

Description | Example | Discussion | See also

Description

Set the price as high as you can in order to maximize profits. As demand drops off, decrease the price so it is always at the optimum profit price. If demand increases, then increase the price accordingly.

Example

There is an oil crisis where supplies suddenly decline. Fuel retailers increase their prices sharply until they demand matches supply. As the crisis eases, they ride the curve downwards, always a little at a time and always in step with one another.

A new coffee machine that produces very pleasant coffee gets some good publicity. The manufacturer puts the price up to take advantage of the increased demand.

Discussion

Most products can be plotted on a demand curve. This is a graph of price against sales quantity where demand increases as price decreases (and vice versa, of course). This line is usually a curve, whereby halving the price results in more than a doubling of demand (and very high prices leads to extremely few sales). An important effect for price skimming is that this curve is inelastic (at least in the region of the intended price) -- in other words a small change in price results in a distinct change in demand. An understanding of this elasticity is critical for price skimming.

Customers have choice, of course, and may buy competitor products if you increase your prices too much. This means that skimming needs customer lock-in of some kind, such as by contract or monopoly. Oligopolies, where multiple companies collude on price, can also allow for skimming. Perhaps unsurprisingly, price skimming is sometimes illegal, as laws seek to protect consumers from avaricious suppliers. This and the effect of activist groups who object to your profiteering can lead to bad publicity.

A rationale for skimming is in new products which have high development costs to recoup. New products also have early adopters who typically are prepared to pay higher prices for the advantage or exclusivity that the product provides. At some point, however, particularly as the product gets into the early majority market, the demand curve changes shape, price changes can increase profit, and more competitors start appearing.

While skimming maximizes profit, this may well also attract new competitors who do not collude who may attract your customers or sell to those who are not buying because of the higher price. High margins can also make you lazy.

Price skimming can be done mathematically. This makes it very helpful for automated pricing, such as in online sales. With enough movement you can also do price experiments to draw the demand curve by which the skimming point is calculated.

See also

Diffusion