Skimming and Penetration Pricing
Skimming and Penetration Pricing
It is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time. The purpose of such strategy is to make higher profits within the short run period in order to recover the costs incurred in product researching, manufacturing, marketing etc. because such costs associated with the product are high.
However this strategy carries with it the risk of acceptance of the product in the market as other competitors may tend to lower their price range of the same product thereby forfeiting a large part of the market share. Then they lower the cost to attract other customers, more price-sensitive segment.
Therefore, the skimming strategy gets its name from skimming successive layers of customer segments, as prices are lowered over time.
When Sony introduced the world’s first high definition television to the Japanese market in 1990, the high-tech sets cost $43,000. These televisions were purchased only by customer who could afford to pay a high price for the new technology. Over the next several years, Sony rapidly reduced the price to attract new buyers. By 1993, a 28-inch HDTV cost a Japanese buyer just over $6,000. In 2001, a Japanese consumer could buy a 40-inch HDTV for about $2000, a price that many more customers could afford. In this way, Sony skimmed the maximum amount of revenue from the various segments of the market.
You can generally divide price skimming into three distinct phases.
During the first phase, the product is set at its highest price. This usually occurs during the product’s initial launch when the company is targeting early adopters – those people that just have to have the latest and greatest thing, like the latest smart phone, and price isn’t too much of a concern. The company’s profit margins will be as high as they ever will be.
The second phase occurs when the early adopters have made their purchases and it’s time to increase your market share by getting a larger cross-section of your target market. You do this by decreasing the price sufficiently to induce a reasonable percentage of your target market to consider the purchase of your product. Your profit margin will decrease, but your sales volume and market share will increase.
Finally, when sales have started to decline, it’s time for the third phase where the price is reduced even further to attract discount shoppers. Again, the profit margin will decrease.
The product is probably near the end of its life cycle as it enters this phase of pricing.
APPLE’S twist to the Skimming
Apple has added a twist to the skimming strategy. Rather than introducing their products at a high price and then lowering their prices later, Apple ventures out a price and then maintains and defends that price by significantly increasing the value of their products in future lines. For example, over the past six years, the average sales price of the iPhone has remained remarkably stable with the subsidized price (a price for a product that is reduced because the government has paid part of the cost of producing it) remaining at $200 and the unsubsidized price (price that is paid by the customer and not partly paid by government) hovering around $650.
The argument against Apple’s price skimming strategy is that the competition has caught up with the iPhone and Apple is no longer able to compete unless they lower their prices. But do the facts support this argument?
First, the iPhone has received 9 awards for customer satisfaction Second, in 2012, Apple gained 69% of all mobile phone profits. Further, they did it with only 8% of the total market share. That’s price skimming at its finest.
Apple has some 70% market share in iPods and around 50% market share in iPads. Yet they are doing this while still maintaining their price skimming strategy. Price skimming is neither the only strategy nor is it the only superior strategy. It is just one of many marketing strategies. However, Apple is executing the strategy of price skimming brilliantly.
A famous example of this was the initial release of the Apple iPhone. Apple released the iPhone on Sept. 5, 2007, for $599. Apple fans rushed out to purchase the iPhone. Two months later, Apple lowered the price to $399 to capture even more customers. The earliest adopters paid $200 more for the privilege of being first. In this case, though, Apple got a black eye. The huge price decrease was too much too soon according to the early adopters as these early adopters were big fans and Apple risked losing significant customer goodwill from their best customers. Apple eventually gave each of the early adopters a $100 store credit. Skimming as a market entry strategy only works when you have a monopolistic position (the iPhone was unique). The lesson from Apple’s case is to bring your price down slowly. The news articles at the time didn’t criticize Apple for lowering the price, but they criticized it for lowering the price too soon.
A marketing strategy used by firms to attract customers to a new product or service. Penetration pricing is the practice of offering a low price for a new product or service during its initial offering in order to attract customers away from competitors. The reasoning behind this marketing strategy is that customers will buy and become aware of the new product due to its lower price in the marketplace relative to rivals.
The product does not have a particular price-market segment. (company sets more than one price for a product without experiencing significant differences in the costs of producing or distributing the product) It has elasticity of demand (buyers are price sensitive).
The market is large enough to sustain relatively low profit margins. The competitors too will soon lower their prices.
Lay’s Stax: The Lay’s Stax were introduced in late 2003 by Frito-Lay. Being a close substitute for Pringles, Stax were aggressively priced well below $1 at launch to lure customers who previously purchased Pringles. Pringles totally had the market cornered on stackable potato chips until Lays came out with Stax. The curved shape and texture of the chip were virtually the same. The tall, cylinder-shaped can was nearly identical, too. During the first few months of the product launch, cans of Stax were available for $0.69 in grocery stores. People even preferred Stax over Pringles for its gluten free taste rather than the price solely. After the initial penetration strategy to draw customers, the common supermarket price rose above $1 after few months.