What is Price Skimming?
In one of our posts earlier, we mentioned that the pricing structure is at the heart of any SaaS product: it is the pillar that ensures repeatable sales processes and recurring profits.
Pricing a product is one of the trickiest things, however. How do you price your product in such a way it appeals to a wide enough spectrum of audience. You price it too high and people won’t see the value, and there won’t be any takers. You price it a bit too low and it might come across as cheap and poor quality.
Price skimming is one of the pricing techniques that you should consider when you are scratching your head and wondering what’s the right way to price your product. But what exactly is price skimming? Let us try to understand.
In its simplest term, price skimming is a pricing strategy where a marketer first sets a fairly high starting price for a good or service, then reduces the price over time to draw in more consumers who are price sensitive. A first mover in the market, facing little to no competition typically uses the price strategy.
As per Wikipedia,
“Price skimming is sometimes referred to as riding down the demand curve. The objective of a price skimming strategy is to capture the consumer surplus early in the product life cycle in order to exploit a monopolistic position or the low price sensitivity of innovators.”
The theory behind this pricing is that at the launch stage when your product is freshest, you try to "skim" off the top customer segment to which you appeal the most, thus boosting your initial income. It is a complex and challenging strategy and one that is not for just any business. But if implemented right, price skimming can lead to an enormous competitive edge in the market and a huge boost in both sales and brand awareness of your product and business.
Taking into account the diffusion of innovation theory which explains the rate at which a product spreads across a social system, innovators are the ones that want to be the first to receive a new product or service. They are price-insensitive and risk-takers. Skim pricing strategy is aimed at these innovators, it is aimed to get the maximum benefit from such innovators and early adopters. When demand from these two segments increases and touches their full capacity the product 's price is brought down to target price-sensitive customers including early majority and late majority users.
Examples of price skimming
Let’s see how does it look like in real life when we examine the strategy with some examples. We will consider some popular product categories.
No price skimming example list can be complete without mentioning Apple. Apple is a classic example of employing this pricing strategy in just about all its products. Remember the time when the iPod was launched for the very first time or maybe that time when the iPhone was launched. They were both products of novelty with expensive pricing. But the older generation of the product saw a massive price cut making way for the newer generation. Circling back to the same Diffusion of Innovation theory the price cut made it approachable to so many more people who now saw an immense value that some time ago was an exorbitant piece of electronics.
On its smartphone lineup, Apple's pricing strategy follows the price skimming strategy religiously. Every year, Apple launches new iPhone models and new iPhone prices are pretty high, usually much higher than the rest of the market. Meanwhile, the lineup of its previous year gets a price cut as they are no longer considered to be tech's cutting-edge pieces.
We can also consider the example of Sony’s Playstation. The PS3 was priced at $599 when launched a few years ago but now it costs $200 or even lesser in online retail stores. PS3 effectively had no competition and was bound to be successful because its previous console, PlayStation 2, was a big success. Even though the PS2 was priced conservatively, the company realized there were plenty of potential customers for the PS3, setting a higher initial launch price. The PS3 's price was then lowered every year and eventually sold at less than $200.
4K TVs were first launched by Sony in the US in 2012 at an eye-watering price tag of $20,000. A year later the price was about $7,000. Today's prices fall below $1,000.
Part of the price drop might've been attributed to advanced technologies and lower production costs. Initial sales did not have the same economies of scale, either. There 's definitely price skimming there, though. Only very few people are prepared to shell out $10,000 + for a TV. Only the early adopters may be the first to get a special category of TV – if they are willing to pay a premium.
The longer consumers are able to wait, the more likelihood of the discounted prices.
Price skimming in SaaS
Price skimming is predominantly seen in consumer electronics industry and not many SaaS companies have been able to pull price skimming off that successfully as Salesforce did years ago when it launched a truly cloud-based CRM system in a day and age when it was completely unheard of. Salesforce made the most of it by setting the prices really high. That went on for a substantial period of time until it decided to expand its customer base by lowering the prices and extend the CRM to smaller businesses too.
If you have a SaaS product and giving serious thoughts about price skimming, I’d advise you to tread your path cautiously. If not done properly it can backfire mightily and the path to recovery could be long and tedious.
If it’s a B2B SaaS product, my answer is going to be plain and simple. Just don’t do it. It’s not feasible. It’s not beneficial for neither the customer nor you. For a B2C SaaS, it might work, considering it is an immensely novel product. Something that’s so unique and useful that simplifies people’s lives by orders of magnitude. And people are more than willing to pay a premium price to use it. Do thorough customer research still.
Always ask yourself, is the product or idea fresh or revolutionary enough to justify market skimming? Can you accurately measure the real value your SaaS product adds to customer business processes?
Advantages of price skimming
Superior profit margins
A product priced at its upper limit is going to help the company generate higher profits. It helps them make the most of the specific market segment that is created from selling at high prices, and then reach the rest by lowering the price as time goes by.
Price skimming helps businesses change their product prices by market situation, brand perception, customer response, product features, and competition. Price skimming helps businesses better control their product pricing.
Quicker real-time monitoring
Early adopters and enthusiasts are the two main target audiences during the original product launch – as they are the ones who buy the product at the higher launch price and are usually well informed and eager to give feedback to the company. These early adopters and enthusiasts help a business gain insight into their products' performance and position.
Helps create buzz
High prices attract news and media attention, helping to get easier product exposure and advertising. The higher price also helps consumers build a better brand identity if properly implemented.
This is an important advantage of proper price skimming implementation. By setting the initial price high, businesses tend to segment the market into various categories – early adopters, brand loyalists, and regular consumers. This also helps to maintain inventory and test the waters when entering new markets or introducing new products.
Quicker cost recovery
A relatively high initial price right from the launch helps quickly and easily recover the money invested in product research and development. This also helps quickly recover advertising and marketing costs.
Downsides of price skimming
Can affect the brand negatively
Customers who purchased early can feel 'ripped off' when the same product is offered at a reduced price. This can create a negative image. Some early Sony Playstation 3 adopters feel they've been cheated. Companies engaged in price skimming could be considered greedy or manipulative, highlighting the fact that all companies or all products should not use price skimming.
Competition takes advantage
Selling at a steep price means the company will only sell small quantities early. This could make it prone to losing to a cheaper rival. Android phones, for example, increasingly took market share from Apple.
The product must have an inelastic demand
Skim pricing strategy is appropriate when the product follows an inelastic demand curve – a demand curve where the product quantity is not significantly affected by the price change. If a product does not follow the inelastic demand curve, it eventually leads to sales fluctuations where it may cause increased demand when prices are lowered and vice versa. This makes keeping their production and inventory incredibly hard for businesses.
Short term advantages
While the skim pricing technique helps increase the company's profit margins, it's only for a limited period. It doesn't last long since the market starts to gain a few competitors and it will be harder to hold on to its products' high price tags. It also leads to loss of sales and user base if the business can not justify the long-term higher price.
Thorough implementation mandatory
Price skimming can only be implemented after thorough market conditions research and analysis, customer feelings, and brand-perception. There are many factors that come into play if done wrong – most of which adversely impact the brand.
Price skimming and penetration pricing
Pricing penetration is the opposite. When a company enters a competitive market by setting very low prices and then with enough market share, it gradually raises the price. In India, Reliance Jio, a new entrant in the Telecom sector did just that. In just a couple of years, it managed to turn out to be the largest telecom company in the Indian subcontinent. Another example is Android which has been slowly and gradually eating up market share from Apple in the premium range smartphone segment.
Penetration price is a bottom-up strategy. Price low to reduce adoption pressure, expand rapidly, then switch up-market after broad adoption. In the SaaS domain, Netsuite, New Relic, Slack follow this model. Penetration emphasizes market share.
Should you or should you not?
Well, like most of the good things, it depends.
If you have credentials and a product capable of disrupting an industry then just go for it, it can be an instant path to massive success. Be careful when setting high introductory prices and lowering them quickly as a PR backlash will definitely arise from the sudden price drops. Analyzing and knowing what your consumer values in your product can help you discover the true essence of the demand curve and along with it, the feasibility of executing a price skimming strategy. So long as there are only a few rivals in the market and you articulate price cuts effectively, skimming will produce the revenue you need to rapidly recover costs, keep upgrading the product, and ensure your company's survival.