Price skimming

This article describes a pricing strategy used by sellers, typically in markets that suffer from imperfect competition, significant transaction costs or imperfect information.
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Definition

Price skimming is a pricing strategy whereby the seller reduces the price of a good with time. This strategy is also often termed riding down the demand curve.

Price skimming is a particular type of periodic discounting, and is thus a form of price discrimination (more specifically, it is third-degree price discrimination).

Motivation behind price skimming

Price discrimination in markets where early adopters are willing to pay more

Price skimming makes sense as a price discrimination strategy in markets where the early adopters are the ones who are willing to pay more. Some reasons why early adopters might be willing to pay more include:

• For durable goods that provide value throughout their lifetime, early adopters are paying more for the convenience of having the good for a longer period of time. This is particularly true when buying the good earlier does not make it more likely that the good will die earlier.
• For certain kinds of information goods, there is value in having the good as early as possible, so that the information can be acted upon (an example is financial news).
• Fans of an author or artist may be willing to spend more money in order to have access to the latest works of art as soon as possible.

Price skimming as caution

By keeping a high price in the beginning, sellers ensure that not too many people buy their product in the beginning. This allows them to get an understanding of the nature of demand for the product, determine problems, and incorporate user feedback, before releasing their product to the larger market at a lower price.

Alternatives to apparent price skimming

What appears to be price skimming may be due to many other factors.

Decreasing cost due to technological improvements

One possibility is that a combination of user feedback and further technological innovation helps sellers reduce the costs of production further to the point where it is more profitable to enlarge the market by reducing the price.

Lower cost due to entry of competing firms

When a product is initially introduced, the seller may be able to charge a high price because there is no competing seller offering a similar good or service. However, the high profitability of the first seller may entice other competitors to sell the same good or a close substitute. This competition drives the price of the good down.

Relation with other pricing strategies

Similar strategies

• Periodic discounting refers to a more general strategy of varying the price predictably over time.

Opposite strategies

• Penetration pricing refers to a strategy of maintaining a low price in the beginning in order to achieve good market penetration, and then raising the price.
• Predatory pricing refers to a strategy of selling at a low price in order to drive competition out of the market, and then raising prices to monopoly levels. (There is not much evidence in the economic literature of successful predatory pricing strategies).

References

Online encyclopedia/dictionary references

• The Wikipedia entry on price skimming

Textbook references

• Pricing policies for new products by Joel Dean, Harvard Business Review, Volume 28, Page 45 - 53(November 1950): ^{More info}
• Beyond the many faces of price: an integration of pricing strategies by Gerard J. Tellis, Volume 50,Number 4, Page 146 - 160(October 1986): ^{JSTOR linkMore info}