When someone talks about price skimming, what exactly are they referring to? Are they referring to a pricing strategy, or about focusing on a particular type of customer, or both? In order to answer these questions, think of how some companies are able to get a higher price for their product by focusing in on a couple of unique customer segments. They have a product offering whose cost-per-use benefits are clearly ahead of their competition's offering. However, because they operate in a price sensitive market, they focus on a specific customer segment in order to get the highest possible return on sales. Therefore, it’s a pricing strategy that is predicated on appealing to the needs of specific customer segments. So, how does this work?
Understanding Customer Segmentation
Segmenting your customer base simply implies that you define the different types of customers within your industry. In B2B industries, these customers can be classified by their size, their geographical location, their business model, their own customer base and ultimately, by their distinct business strategies.
For B2C markets, classifying the customer base would involve identifying unique characteristics of consumers in terms of their age, education level, ethnicity, country, cultural influences and sex. Companies understand that since no two customer segments are the same, the reason for and against buying a particular product are different from one group to the next.
Price skimming simply includes identifying which customer group is most likely to value cost-per-use and longevity benefits. It’s these customers that value quality over price, service over convenience, and value over quick solutions. Finding these customers isn’t predicated on cold-calling. It isn’t based on using a shotgun approach to defining your market. Instead, it involves segmenting your customer base into specific groups and identifying which one is most likely to value a higher quality product.
The graph and video above are taken from the post: Product Life Cycle Management: Steal Market Share in the 4th Phase
Skimming Isn’t Correlated to Product Launches
Like all business strategies, there are varying opinions as to how price skimming works. Some adhere to a strategy of using the same price for all customers and flooding the market with proposals, in the hopes of taking only the best the market has to offer. Others believe that price skimming includes the high prices that are so much a part of a product’s initial launch phase. This then lends credence to the idea that being first to market guarantees higher prices. Unfortunately, both are inaccurate. Flooding the market in the hopes of finding customer that value product quality is often difficult, if not problematic. It’s an inaccurate approach to finding specific customers.
Don't get me wrong. There are customers who will pay a higher price, but this "all or nothing" approach is long and tedious. In terms of a product’s launch, the pricing is often high simply because production volumes are so low. The company lacks the economies of scale to offer lower pricing and can only offer a lower price once the market has fully adopted the product. That only happens when customers buy, competitors enter and production volumes increase.
An Example of Price Skimming
Let’s assume your enterprise woks in the Telecom sector and sells to OEM (Original Equipment Manufacturers), Distributors, VARS (Value-Added Resellers), Sales firms, System Integrators and End-User customers. To date, most of your sales have been through distribution, sales firms, system integrators and VARS. However, these business models are predicated on offering extremely competitive pricing for high volumes. Their success depends upon providing immediate, quick-turn products with very thin profit margins. Most importantly, they add an extra layer of cost to your product line before they ultimately make that sale to individual equipment manufacturers, integrators or end-users. After all, they’re middlemen and to make a profit involves squeezing you on pricing. However, what if you focused instead on selling direct to the End-User and to larger, more established Original Equipment Manufacturers? Could you secure a better price with these customer segments than what you’re currently selling to? You could, but it involves the following three steps.
Step 1: Segment Your Market
Define your customer segments by their likes, dislikes, business models, their strategies, their own customer base or any other important indicators that would distinguish how these customers differ from one another. What are the overriding factors that influence their decision to purchase? What makes them decide to move forward with an order? Most importantly, how are they unique from one another and do any of them value quality above all else?
Step 2: Define Their Relationship in the Value Chain
Where do these current customers sit along the value chain? Do they add an extra layer of cost to your product before it reaches the end-user or consumer? Focus on their role in the big picture. It will point to why you’re being squeezed so often on pricing. Is it simply the nature of the market or because of the type of customers you’re servicing?
Step 3: Identify Price Skimming Targets
The third step involves identifying price skimming targets and removing levels in the value chain that do nothing more than erode your margins. In our example of the Telecom sector, it would include bypassing VARS, Distributors and Integrators and instead, focusing on OEM’s and End-Users. Doing this allows you to remove one level of pricing – a level you could use to increase your return on sales. By no means am I implying that you stop selling to your current customer base. What I am implying is that you identify which customer segments are more likely to provide you with higher returns. You can sell to both without any issues.
Granted, the Telecom example is fairly straightforward, and there are industries where companies must sell through distribution, or at the very least, must at some time deal with VARS or other middlemen. In other industries, pricing is the overriding factor among non-differentiating products. This is often the case in sales of raw material. However, if your company doesn’t currently operate in such an industry, isn’t it best to focus on those customers who value quality over price? Isn’t it best to focus on identifying those customers most likely to pay a higher price for your product? These are the customers your company should focus on.
To better understand the approaches involved in cost-per-use and longevity sales, please read: Sales Negotiation Training: Cost-Per-Use Product Sales Strategies
The above video is from the post: Your Value Chain Defines Your Value Assertion: B2B Marketing Essentials
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