Pricing - Skimming & Penetration

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Setting Pricing - Price Skimming

Price skimming is a pricing method where a business sets a relatively high initial price and then gradually lowers it over time. This is often used before a business faces competition in the market. Once competition arrives, there will be downward pressure on the price to fall.

Maximise revenue

Price skimming is used to try and maximise revenue.
Consumers who buy early on are willing to pay a higher price but the business can still attract other customers who can pay a lower price later on in the product’s lifecycle.

Cover fixed costs (research and development)

Price skimming can help to recover the costs of research and development, which can be expensive for technology products.
For example, the Apple iPhone X reportedly cost over $1bn in research and development costs.

Slower unit sales growth

A disadvantage of price skimming is that it can slow down the growth of a product and this can give competitors more time to launch a competing product or service.
A company does not maximise the number of sales at the start so competitors can get more of a chance to enter the market.

Example

Tesla also used price skimming when it first launched the Model S.
- Charging a premium price before gradually lowering it as competition increased and production scaled.

Pricing Methods - Penetration Pricing

Penetration pricing is where a business tries to increase market share by offering a low initial price. Loss leaders work in a similar way to penetration pricing.

Lower short-term profits

In the short term, penetration pricing can lead to lower average profits than would be earned with a higher price.
However, market share may be more important for the long-term profitability of a business.

Loss leaders

Loss leaders are products or services that are sold by a business at a price where the business makes a loss (average revenue < average cost).
Loss leaders can attract new customers or sell to existing customers, in the hope that they make extra (incidental) purchases.

Loss leaders: examples

Dollar Shave Club offered to deliver a razor and new razor blades to your house for $1 every month.
This was loss making, but it attracted customers who bought extra products.
Another example is ALDI, which often offers weekly special products at a loss.
- Hoping that customers also do their main weekly shopping in-store.

Recommending and justifying pricing methods

Businesses must choose pricing methods based on their objectives, the level of competition, and customer demand.
Penetration pricing may be recommended when a business wants to quickly attract customers and gain market share.
Price skimming may be recommended when a business wants to recover high research and development costs and target customers willing to pay more.
The justification should always link to the business situation.
- Such as competition level, product type, and long-term growth aims.