Definition:
Price skimming is a price strategy where firms charge high prices in the initial stage and lower their prices over time.
Explanation
Price skimming can be used when a new product is introduced. As long as the competition has not entered the market, the firm can benefit from its monopoly position and generate high revenues by setting a high price. Once customer demand is satisfied and competition enters the market, the firm has to lower its price.
What to watch out for
Competitors will recognize that the one firm is benefiting from high profit margins in the market and therefore have an incentive to enter the market to benefit as well.
Price skimming can only be used as a strategy in a market with little to no competition.
If the firm sets prices too high, consumers may not be willing to buy the product. As a consequence, the firm cannot benefit from economies of scale because sales are too low.
Further reading
Price skimming - Investopedia
Price Skimming - Corporate finance institute
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