Pricing - Skimming & Penetration
Business: Cambridge International GCSE (2027 Exams), topic 3.3.7
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.
Increase market share
- When these goods or services enter the market, a business can attract customers from established competitors.
- Penetration pricing was used by Apple when they entered the market for activity trackers by launching the Apple Watch.
- The Apple Watch competed with products by businesses like Fitbit.
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.
Test yourself on Pricing - Skimming & Penetration
Why can price skimming be good?
What is a disadvantage of price skimming?
When Apple first released their Apple watch it was sold at a low price to compete with products from companies like Fitbit. What is this an example of?