Price skimming
Price skimming is a price setting strategy that a firm can employ when launching a product or service for the first time. By following this price skimming method and capturing the extra profit a firm is able to recoup its sunk costs quicker as well as profit off of a higher price in the market before new competition enters and lowers the market price. It has become a relatively common practice for managers in new and growing market, introducing prices high and dropping them over time. Price skimming is sometimes referred to as riding down the demand curve. The objective of a price skimming strategy is to capture the consumer surplus early in the product life cycle in order to exploit a monopolistic position or the low price sensitivity of innovators. Price skimming happens when a marketer initially offers an item at a high price that consumers with the strongest desire and funds to purchase it will, and then as that demand is depleted the price gets lowered to the next layer of customer desire in the market. Therefore, the skimming strategy gets its name from skimming successive layers of "cream," or customer segments, as prices are lowered over time. There are many real world examples of price skimming, especially in the technology market. Sony's console, the Sony Playstation 3, initially launched in 2006 for 200. There are several potential problems with this strategy. It is effective only when the firm is facing an inelastic demand curve. If the long run demand curve is elastic (as in the adjacent diagram), market equilibrium will be achieved by quantity changes rather than price changes. Penetration pricing is a more suitable strategy in this case. Price changes by any one firm will be matched by other firms resulting in a rapid growth in industry volume.