What is Price Skimming?
Price skimming is a pricing strategy where the initial price is set high and then gets reduced over time. It is used in retail to get the highest margins out of the products when they are launched and make up for the loss in margin when excess inventory gets cleared at the end of the cycle.
Price Skimming Strategy in Retail
Price skimming is used in retail typically for seasonal products that are intended to go through a cycle of planned markdowns until they are cleared out of the stores.
Some types of merchandise that is not seasonal in nature or doesn’t have an expiry date will not go through a price skimming process.
The initial price will take into consideration all the future markdowns and discounts and so the intake margin will be set high enough to accommodate the loss in margins at the end of the cycle.
Selling at such intake margin, i.e full price trading, takes place for a few weeks, and then a series of markdowns start taking place, where every markdown will have a deeper discount than the one before.
Typically each markdown is intended to clear a certain percentage of inventory, as with reduced prices the quantities sold will be higher. During such process, the sell-through rates are monitored and the discount levels can be adjusted accordingly if the velocity of clearance is not going as planned.
Benefits of Price Skimming
The main benefit of price skimming is to get the most margins out of a new product from customers who are not price sensitive and want to have immediate access to fresh new merchandise.
After the demand of this customer segment is satisfied and if inventory is still available, the reduced price will then attract another segment of customers who are more price sensitive and don’t mind waiting for a while to have access to the products, even if that means that there is a risk of this product selling out or that they might not find their favorite attributes (color, size,..etc).
At the very end of the product cycle the product then gets sold at very low, or even negative, margin and is picked up by bargain hunters, who might re-sell it or buy it just because of the very low price.
At this point the retailer would have already made most of his profit at the front-end and his main goal at this stage is to clear the remaining inventory to generate cash and buy new products to go through the same cycle.
For price skimming strategy to work effectively, certain considerations should be taken into account form the start.
Supply & Price Levels
In order for the price skimming strategy to work effectively the connection between supply and price level needs to be there.
This means that, if you buy inventory in high quantities and it is obvious for customers that you have stocked a lot of that item and will have to discount it at the end to clear it, there will be no sense of urgency to rush and buy it at full price, because there will be no risk of selling out.
Another factor is your discounting strategy.
If your customers know that you go on discount every month, they will probably wait for next month to buy the new products.
If, on the other hand, you are very conservative with applying discounts, and only use them at the end of the season to clear the remaining unsold items, they will be more willing to buy at full price. They will also fear that if they wait till the end, their favorite color or style will be out of stock.
Pricing and markdowns go hand in hand, so in order for any pricing strategy to work for you, your markdown strategy will need to support it.
If you are a premium or a luxury brand and use prestige pricing to price your products, you will not be able to apply the price skimming strategy.
For your brand positioning to stay consistent, and to maintain exclusivity, you will need to be very conservative with any reduction in price, and your customers should not expect you to deeply reduce the price of the item later in the cycle.
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