Price Skimming – A pricing strategy that sets a new product at a high price and subsequently lowers them as competitors enter the market
To remember what price skimming means use the following mnemonic:
The sign with a price on was sent skimming (price skimming) across the lake. After each bounce, the price sign got lower and lower (price get lowered in time).
To launch a new product like a medical drug or a mobile phone costs a very significant amount of money.
A drug company will research and develop a new drug that solves a particular medical problem. The company will then apply for a patent which will then give them 20 years of freedom to sell the product without competition. Unfortunately, even after a patent is applied for and gained it takes 10-15 years on average from regulatory approval. There are many clinical trials and stages in order that the government’s Food and Drug Administration will approve a drug to be sold to members of the public. It usually costs over two billion dollars to get a drug to market.
Let’s say that a company finally launches their product to market after fifteen years after patent approval. This now only gives them five years before the competition will have a very similar product on the market because they are then allowed to copy the product and sell it themselves. It is therefore very important for the drug company to earn as much profit as they can to pay for the research and development. The drug company will therefore price skim and set a high price for these five years and then slowly reduce the price as the competition enters the market.
This is similar to the launch of a new phone. The price on a new phone will be price skimmed (set high) on a new release. Phone companies such as Apple and Samsung will rely on customers who value having the latest phones and who are less sensitive to high prices. This price is dropped over time to ensure each segment of customers is paying the maximum price they can afford. The price will usually be lowered further when a new model is released, as the product is no longer their latest offering. This brings in a new influx of buyers who have more limited budgets.