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What Is Price Skimming?

Price skimming is a product pricing strategy by which a firm charges the highest initial price that customers will pay and then lowers it over time. As the demand of the first customers is satisfied and competition enters the market, the firm lowers the price to attract another, more price-sensitive segment of the population. The skimming strategy gets its name from "skimming" successive layers of cream, or customer segments, as prices are lowered over time.

Key Takeaways

• Price skimming is a product pricing strategy by which a firm charges the highest initial price that customers will pay and then lowers it over time.
• As the demand of the first customers is satisfied and competition enters the market, the firm lowers the price to attract another, more price-sensitive segment of the population.
• This approach contrasts with the penetration pricing model, which focuses on releasing a lower-priced product to grab as much market share as possible.

How Price Skimming Works

How Price Skimming Works

Price skimming is often used when a new type of product enters the market. The goal is to gather as much revenue as possible while consumer demand is high and competition has not entered the market.

Once those goals are met, the original product creator can lower prices to attract more cost-conscious buyers while remaining competitive toward any lower-cost copycat items entering the market. This stage generally occurs when sales volume begins to decrease at the highest price the seller is able to charge, forcing them to lower the price to meet market demand.

Skimming can encourage the entry of competitors since other firms will notice the artificially high margins available in the product, they will quickly enter.

This approach contrasts with the penetration pricing model, which focuses on releasing a lower-priced product to grab as much market share as possible. Generally, this technique is better-suited for lower-cost items, such as basic household supplies, where price may be a driving factor in most customers' production selections.

Firms often use skimming to recover the cost of development. Skimming is a useful strategy in the following contexts:

• There are enough prospective customers willing to buy the product at a high price.
• The high price does not attract competitors.
• Lowering the price would have only a minor effect on increasing sales volume and reducing unit costs.
• The high price is interpreted as a sign of high quality.

When a new product enters the market, such as a new form of home technology, the price can affect buyer perception. Often, items priced towards the higher end suggest quality and exclusivity. This may help attract early adopters who are willing to spend more for a product and can also provide useful word-of-mouth marketing campaigns.

Price Skimming Limits

Generally, the price skimming model is best used for a short period of time, allowing the early adopter market to become saturated, but not alienating price-conscious buyers over the long term. Additionally, buyers may turn to cheaper competitors if a price reduction comes about too late, leading to lost sales and most likely lost revenue.

Price skimming may also not be as effective for any competitor follow-up products. Since the initial market of early adopters has been tapped, other buyers may not purchase a competing product at a higher price without significant product improvements over the original.

What Is Peak Pricing?

Peak pricing is a form of congestion pricing where customers pay an additional fee during periods of high demand. Peak pricing is most frequently implemented by utility companies, which charge higher rates during times of the year when demand is the highest. The purpose of peak pricing is to regulate demand so that it stays within a manageable level of what can be supplied.

Peak pricing is also used among ride-sharing services and other transportation providers, where it is known as "surge pricing."

Key Takeaways

• Peak pricing is a method of raising prices during periods of high demand, commonly used by transportation providers, hospitality companies, and utility providers.
• Algorithms will often be used to estimate or predict peak vs. off-peak times and rates.
• Users of ride-sharing services, such as Uber and Lyft, are also familiar with peak or "surge" pricing, which raises fares during periods of high demand for rides and lower supply of drivers.
• During heat waves, the mismanagement of peak pricing and the supply and demand of electricity may cause blackouts or brownouts.

How Peak Pricing Works

Peak pricing is a mechanism where the price of some good or service is not firmly set; instead, it fluctuates based on changing circumstances—such as increases in demand at certain times, the type of customers being targeted, or evolving market conditions. If periods of peak demand are not well managed, demand can far outstrip supply.

In the case of utilities, this may cause brownouts. In the case of roads, it may cause traffic congestion. Brownouts and congestion are costly for all users. Using peak pricing is a way of directly charging customers for these negative effects.

The alternative is for municipalities to build up more infrastructure in order to accommodate peak demand. However, this option is often costly and is less efficient as it leaves a large amount of wasted capacity during non-peak demand. Under a dynamic pricing strategy, companies will set flexible prices for their products or services that change, according to current market demand.

Peak pricing is one element of a larger comprehensive pricing strategy called dynamic pricing.

Businesses are able to change prices based on algorithms that take into account competitor pricing, supply, and demand, and other external factors in the market. Dynamic pricing is a common practice in several industries such as hospitality, travel, entertainment, retail, electricity, and public transport. Each industry takes a slightly different approach to repricing based on its needs and the demand for the product.

Peak Pricing Examples

In public transportation and road networks, peak pricing is used to encourage more efficient use of resources or time-shifting to cheaper or free off-peak travel. For example, the San Francisco Bay Bridge charges a higher toll during rush hour and on the weekend, when drivers are more likely to be traveling. This is an effective way to boost revenue when demand is high, while also managing demand since drivers unwilling to pay the premium will avoid those times.

The London congestion charge discourages automobile travel to Central London during peak periods. The Washington Metro and Long Island Rail Road charge higher fares at peak times.

Users of home-sharing services, like Airbnb or VRBO.com, usually see prices go up during certain months of the year or during the holidays. For example, renting a home on Cape Cod via a home-share service in August is likely to be more expensive than renting the same house in the dead of winter.

Which of the following pricing strategies usually enhances the profits of firms with market power?

How is peak

What is peak

Which of the following pricing strategies does not usually enhance the profits?