Price skimming is a business technique which involves charging a high price for a product when it is released initially, and gradually lowering the price over time. The goal of this practice is to ensure that the price matches consumer willingness to pay, generating profits for the company both over time and in the short term. The “skimming” is a reference to a stage in milk processing in which the cream is repeatedly skimmed from the top, yielding milk with a steadily lower butterfat content, much as price skimming creates a steadily cheaper product.
There are a number of reasons for companies to utilize price skimming, beyond the simple desire for profits. One of the most basic motivations is the desire to recoup the investment involved in product development before competitors hit the market and make high prices unsustainable. For example, if a company develops a totally new and innovative product, it may spend a great deal of money in the process of designing and marketing the product, and it wants to recover this money quickly to make the product profitable.
Another reason involves consumer psychology. Many people attach certain values to high priced products, including luxury, exclusivity, and quality. By releasing a product with a high price, the manufacturer sends a message to prestige-conscious consumers, ensuring that they will flock to buy their product. Even as the price drops, people will continue to associate these values with the product, creating a steady demand for it.
Price skimming relies heavily on early adopters who are willing to pay a high price to be the first to have a new product. As the product spreads among these early adopters, the producer can slowly lower the price as people become less willing to pay top dollar for the product. Ideally, the producer will remain competitive with the inevitable rival products released by other companies. Supply and demand for the product will also remain stable over time.
Manipulation of pricing is a delicate business, because a company must be able to balance evidence about consumer psychology and the direction of the market when they set a price for a new product. Companies must also comply with laws which generally restrict price manipulation for reason of consumer protection. However, many nations recognize that companies have a right to attempt to recoup investments, and therefore price skimming may be tolerated as a legitimate business practice.