Price Skimming is a strategy where companies initially price a product at the highest possible price and then lower it gradually over time.
This strategy helps companies recoup expenses incurred during the development phase of the product. However, the strategy has a limitation which is the fact that it is only effective with new products.
With no competition in the market, companies can scoop up as much revenue as they can from consumers who are willing to pay for the new product at a premium price.
This will go on for a while until there is clear reduction in sales caused by decreasing numbers of premium price buyers. At this point, the company will reduce the price of the product to win over price sensitive consumers.
Apart from helping a company recover its expenses, price skimming also gives the impression that a product is of high quality. It also discourages any competitor from following a similar approach once the price is lowered.
That is, consumers are less likely to buy a similar product at a premium price unless there is a major improvement from the original one.
On the offside, price skimming encourages another pricing strategy known as penetration pricing. Due to the high price of the original product, a competitor could enter the market with significantly lower price than what is being offered.
The competition here is aiming for the market segment that consist of buyers who would like to get the product but not at the premium price being offered. These customers could easily settle for an alternative especially if it has identical features (or in some cases) even better than the original product.
Essentially, the initial high price of a new product is helpful but also promotes competition in the market.
Price skimming is very common in the tech industry where new products are unveiled every year.