Price Skimming

What is price skimming?

Price skimming is a price strategy where firms charge high prices initially and lower their prices over time. 

Explanation

Companies can use price skimming when they introduce a new product. As long as competition has not entered the market, the firm can benefit from its monopoly position and generate high revenues by setting a high price.

However, the firm should lower its cost once customer demand is satisfied and competition enters the market.

What are the disadvantages of price skimming?

1. Competitors will recognize that one firm is benefiting from high profit margins in the market and, therefore, have the incentive to enter the market to help as well.
2. Price skimming can only be used as a strategy in a market with little to no competition.
3. If the firm sets prices too high, consumers may not be willing to buy the product. Consequently, the firm cannot benefit from economies of scale because sales are too low.

Further reading

Price skimming - Investopedia
Price Skimming - Corporate Finance Institute