Skimming Pricing Strategy

We all know what price means in terms of commercial goods and services – it is the value we pay in exchange for receiving such goods and services. On the consumer’s side, the process of such a receipt of goods/services in exchange of a price paid is what we know as purchase or buying. On the manufacturer’s/service provider’s/seller’s side, the process of parting with such goods/services in exchange for the price received is known as sale or selling. Have you ever wondered on what basis the prices of commercial goods and services are fixed? Well, the price is the sum total of all the costs incurred in producing/procuring the goods/services plus a profit percentage which can be calculated either on the cost price or the selling price.

What is Market Skimming Policy?
As the name suggests, the market skimming strategy seeks to skim away or churn out all those customers from the market who are willing to pay a higher price just to get access to the marketer’s products or services before anyone else does. This customer segment is considered as the creme-de-la-creme, the premium segment that has a very high consumer’s surplus in terms of their demand for the product or service and are willing to pay a higher price for outstripping their contemporaries in owning such a product. Market skimming is a variant of discriminatory pricing strategy. The strategy of market skimming is to charge a higher price for a product during its initial launch in the market. Once the premium paying customer segment has been optimally exploited, the price of the product is, then, gradually lowered in order to exploit the other, lower paying consumer segments.

Adopting a skimming pricing strategy is a good way for firms, that have incurred sunk costs, to recover these before competitors enter the market and target the common customer segment. This way, while the competitors are busy planning and manufacturing similar and alternative products and services, the original marketer churns the profits out of the premium paying market segment. Sometimes, the reverse of this happens. Sometimes, when a company launches a new, novelty product/service range at a high price, the entrance of competitors soon after compels it to lower its prices to survive competition and remain in the market.

Besides recovering sunk costs, another reason for following a skimming pricing strategy is to cover up for the product life cycle by earning excess in the initial stages of the product life cycle to cover up for the stagnating market demands during its maturity stage.

Examples of Market Skimming Strategy
Most prominent instances of market skimming can be seen in the electronics and computer technology markets because upgrades come up every 6-8 months, pushing previous technology versions towards the maturity stage of the product life cycle. One such prominent example is the Sony PlayStation 3. When launched, it was priced approximately USD 600 but these days, it is available at around USD 300. Laptops and mobile phone handsets are other prominent examples of market skimming.

Skimming strategy may be profitable in the following instances:-

– The R&D costs involved in an innovative product or technology tends to be very high. Skimming serves to recover such cost before competitors get a chance to barge in on the scene.
– Once the cream customer segment is optimally exploited, the product gets established in the market. Also, being the first to introduce such a product to the market, the market skimmer becomes the market leader in that product/service.
– Skimming often helps the marketer to identify different segments for future discriminatory pricing.
– High prices mean high dealer markups and following a skimming strategy may be beneficial where third-party distributors and dealers are involved. This creates a win-win situation for both the supplier as well as the dealer.

Following are the limitations of this pricing strategy:-

– Products for whom a shift in price results in a shift in demand should not be priced under market skimming strategy as higher prices would mean lesser buyers.
– Discriminatory pricing is subject to many legal implications and as such, a marketer considering using this pricing strategy must make sure he is doing so within the scope of law.
– Stock clearance may become a problem as the premium paying segment is usually always smaller than the mainstream/lower paying segments. Manufacturers must keep this in mind while planning production volume.
– A high-priced market entrant is more likely than others to attract competitors sooner. This is due to the fact that competitors would be tempted to earn high margins as well.
– Subsequent lowering of price may tarnish the premium image of the product and marketer and people may view such a price switch as evidence of lowering of quality standards.

Types of Pricing Strategy
As mentioned previously, the price is the sum total of all the costs incurred in producing/procuring the goods/services plus a profit percentage which can be calculated either on the cost price or the selling price. Besides these, a lot of other economic and financial considerations also go into pricing such as consumer’s surplus, indifference curve analysis, margins claimed by the channels of distribution, etc. There are, in totality, eighteen types of prices and pricing strategies:-

1. Competitive Pricing
2. Cost-plus Pricing
3. Market Skimming
4. Loss Leader Pricing
5. Limit Pricing
6. Penetrative Pricing
7. Market-oriented Pricing
8. Contribution-margin-based Pricing
9. Predatory Pricing
10. Flexible Pricing
11. Psychological Pricing
12. Target Pricing
13. Leadership Pricing
14. Marginal Cost Pricing
15. High-low pricing
16. Absorption Pricing
17. Premium Pricing
18. Discriminatory Pricing

Like any other micro-economic policy, the various policies and strategies of pricing have various justifications and different benefits and limitations. What pricing strategy one marketer chooses may differ from others based upon the product/service he offers, the life cycle of such product and service and the frequency of upgrades that occur in that product segment.

What is Price Gouging?

The simple and straight definition of this concept is pricing and selling at a price level, that is substantially higher than the fair price level.

Price Fixation and Cost Fixation

The concept of market is made up 4 important factions. Firstly, there is the product or the commodity that is sold by the supplier/producer. Next, there is the supply, that is number of units that are supplied into the market. Third, there is the demand for the supplied commodity or unit, which is of course backed by the ability of the consumer to pay for the same. Last, there is the price of the product.

There are two basic ways in which price of any commodity is ascertained.

– Costing is the primary, or initial method with the help of which price is set. Costing is a technique where the price of the commodity/product is derived at the factory level. In such a case, cost of production plus overheads, plus taxes, plus transportation cost, plus profit margin, determine the cost of the commodity.
– Once this commodity enters the market, a certain demand for it gets generated. The basic rule of thumb that is observed is that more the demand, for lesser units, the more is the price of the commodity. The less the demand the lesser the price. The same principle works the other way round also. That is, the more the units supplied, the less is the cost, and the less the supply the greater is the price. This principle is known as the demand and supply analysis.

Now, based upon these two principles, the suppliers/producers can also manipulate and escalate, or even inflate, the price levels in an unethical manner. Here’s an explanation on how it is done, or why it is deemed to be unethical.

About Price Gouging

All of us have heard of gouging of gas price. In this phenomenon, the actual calculated cost price of gas is much lower, and the price for which it is sold is much higher. Now, the unethical part comes in where sellers, increase their profit margin, overprice their production cost and finally send lesser units into the market.

In such instances the price escalates, drastically, or unnaturally. A method which escalate the prices, which is commonly used, is where the number of units sent into the market is very less and at the same time, a substantial number of units that are sold are stored away, creating a higher demand, boosting the price levels. When the levels go up, the stored away units are sold off. This phenomenon is known as artificial scarcity.

The gouging phenomena comes under the scanner of governments, when the general public gets affected by it. Auctions, costly and luxury goods, cannot be deemed to have gouging effects. However, fuel, medicines, food, clothing and other things that are required to survive, or even live properly, cannot be priced over a certain limit. If the prices exceed the fair price, then anti-gouging policies are adopted by the government. Gouging of prices is a felony in some nations and states.

Gouging of prices is something that is to be frowned upon, as it is almost as good as robbing of basic needs. Socialist and communist nations deal with such phenomena in a very harsh manner. There are some basic necessities of every human being on which a price tag cannot be added on, simple things like water or air or medicines or even a few morsels of food, are not be sold or measured in monetary terms, they are to be shared properly, and justly by all humanity.