Bikaner Technical University

Managerial Economics and Financial Accounting

Market Structure and Pricing Theory
Unit IV
MARKET

Market is a place where buyer and seller meet, goods and services are offered for the sale and transfer of
ownership occurs. Economists describe a market as a collection of buyers and sellers who transact over a
particular product or product class (the housing market, the clothing market, the grain market etc.). For
business purpose we define a market as people or organizations with wants (needs) to satisfy, money to
spend, and the willingness to spend it.

Definition:

According to Philip Kotler “Market is a societal process by which individuals and groups obtain what they
need and want through creating, offering and freely exchanging products and services of value with others”.

In economics, market structures can be understood well by closely examining an array of factors or features
exhibited by different players. It is common to differentiate these markets across the following seven distinct
features.

 The industry’s buyer structure

 The turnover of customers
 The extent of product differentiation
 The nature of costs of inputs
 The number of players in the market
 Vertical integration extent in the same industry
 The largest player’s market share
Characteristics of a market:
 Existence of buyers and sellers of the commodity.
 The establishment of contact between the buyers and sellers. Distance is of no consideration if
buyers and sellers could contact each other through the available communication system like
telephone, agents, letter correspondence and Internet.
 Buyers and sellers deal with the same commodity or variety. Since the market in economics is
identified on the basis of the commodity, similarity of the product is very essential.
 There should be a price for the commodity bought and sold in the market

Classification of Markets
Markets classified into three main categories according to Area, time, and competition. Each category has
subdivisions as we will see.
 Market according to Area
 Market according to time
 Market according to competition
1. Market according to Area

Based on the extent of the market for any product, markets can be classified into local regional, national and
international markets.

Local Market

A local market for a product exists when buyers and sellers of commodity carry on business in a
particular locality or village or area where the demand and supply conditions are influenced by local
conditions only. E.g. Perishable goods like milk and vegetables and bulky articles like bricks and
stones.

National Market

When commodities are demanded and supplied throughout the country, there is national market
e.g. wheat, rice or cotton

Regional Market

Commodities that are demanded and supplied over a region have regional market.

Global Market

When demand and supply conditions are influenced at the global level, we have international
market. e.g. gold, silver, cell phone etc. On the basis of demand and supply, this geographical
classification is made. With improved transport facilities and communications, even goods of local
markets can become international goods.

2. Market according to time

Marshall classified market based on the time element. In economics “time” does not mean clock time. It
means only the division of time based on extent of adjustability of supply of a commodity for a given change
in its demand. The major divisions are very short period, short period and long period.

Very Short Period

Very short period refers to the type of competitive market in which the supply of commodities
cannot be changed at all. So, in a very short period, the market supply is perfectly inelastic. The price
of the commodity depends on the demand for the product alone. The perishable commodities like
flowers are the best example.

Short-period

Short period refers to that period in which supply can be adjusted to a limited extent by varying the
variable factors alone. The short period supply curve is relatively elastic. The short period price is
determined by the interaction of the short-run supply and demand curves.

Long Period

Long period is the time period during which the supply conditions are fully able to meet the new
demand conditions. In the long run, all (both fixed as well as variable) factors are variable. Thus, the
supply curve in the long run is perfectly elastic. Therefore, it is the demand that influences price in
the long period.

3. Market according to competition

These markets are classified according to the number of sellers in the market and the nature of the
commodity. The classification of market according to competition is as follows
Types of Competition

The market can be divided into two types.,

 Perfect Competition
 Imperfect Competition

Market Structure

Market structure describes the competitive environment in the market for any good or service. A market
consists of all firms and individuals who are willing and able to buy or sell a particular product. This includes
firms and individuals currently engaged in buying and selling a particular product, as well as potential
entrants. These are the main areas in the market, they are

 Seller contribution
 Buyer contribution
 Product differentiation
 Conditions of entry into the market (competition)

Perfect competition refers to a market structure where competition among the sellers and buyers prevails in
its most perfect form. In a perfectly competitive market, a single market price prevails for the commodity,
which is determined by the forces of total demand and total supply in the market. Perfect Competition
Examples Foreign exchange markets, Agricultural markets, Internet-related industries.

Characteristics/Features of Perfect Competition

The following features characterize a perfectly competitive market:

1. A large number of buyers and sellers: The number of buyers and sellers is large and the share of
each one of them in the market is so small that none has any influence on the market price.

2. Homogeneous product: The product of each seller is totally undifferentiated from those of the
others.

3. Free entry and exit: Any buyer and seller is free to enter or leave the market of the commodity.

4. Perfect knowledge: All buyers and sellers have perfect knowledge about the market for the
commodity.
 5. Indifference: No buyer has a preference to buy from a particular seller and no seller to sell to a
particular buyer.

6. Non-existence of transport costs: Perfectly competitive market also assumes the nonexistence of
transport costs.

7. Perfect mobility of factors of production: Factors of production must be in a position to move

freely into or out of industry and from one firm to the other.

Under such a market no single buyer or seller plays a significant role in price determination.

Imperfect competition

A competition is said to be imperfect when it is not perfect. Based on the number of buyers and sellers, the
structure of market varies as outlined below: “poly” refers to seller and “psony” refers to buyer. Imperfect
competition has three types, they are,

1. Monopoly

2. Monopolistic competition

3. Oligopoly

Monopoly

The word monopoly is made up of two syllables, Mono and poly. Mono means single while poly implies
selling. Thus monopoly is a form of market organization in which there is only one seller of the commodity.
There are no close substitutes for the commodity sold by the seller. Pure monopoly is a market situation in
which a single firm sells a product for which there is no good substitute. Monopoly Competition Examples
Microsoft and Windows DeBeers and diamonds.

Features of monopoly

The following are the features of monopoly.

1. Single person or a firm: A single person or a firm controls the total supply of the commodity. There
will be no competition for monopoly firm. The monopolist firm is the only firm in the whole industry.

2. No close substitute: The goods sold by the monopolist shall not have closely competition
substitutes. Even if price of monopoly product increase people will not go in far substitute. For
example: If the price of electric bulb increase slightly, consumer will not go in for kerosene lamp.

3. Large number of Buyers: Under monopoly, there may be a large number of buyers in the market
who compete among themselves.

4. Price Maker: Since the monopolist controls the whole supply of a commodity, he is a pricemaker,
and then he can alter the price.

5. Supply and Price: The monopolist can fix either the supply or the price. He cannot fix both. If he
charges a very high price, he can sell a small amount. If he wants to sell more, he has to charge a low
price. He cannot sell as much as he wishes for any price he pleases.

6. Downward Sloping Demand Curve: The demand curve (average revenue curve) of monopolist
slopes downward from left to right. It means that he can sell more only by lowering price.

Methods of Controlling Monopoly

1. Legislative Method: Government can control monopolies by legal actions. Antimonopoly

legislation has been enacted to check the growth of monopoly. In India, the Monopolies and
Restrictive Trade Practices Act was passed in 1969. The objective of this Act is to prevent the
unwanted growth of private monopolies and concentration of economic power in the hands of a
small number of individuals and families.
 2. Controlling Price and Output: This method can be applied in the case of natural monopolies.
Government would fix either price or output or both. 3. Taxation: Taxation is another method by
which the monopolistic power can be prevented or restricted. Government can impose a lump-sum
tax on a monopoly firm, irrespective of its level of output. Consequently, its total profit will fall.

4. Nationalization: Nationalizing big companies is one of the solutions. Government may take over
such monopolistic companies, which are exploiting the consumers.

5. Consumer’s Association: The growth of monopoly power can also be controlled by encouraging
the formation of consumers associations to improve the bargaining power of consumers.

Perfect Competition Monopoly

1. Average revenue curve is a horizontal straight line 1. Both average revenue curve and marginal revenue
parallel to X axis. Marginal revenue is equal to average curve are downward falling curves. Marginal revenue
revenue and price is less than average revenue and price.

2. At the equilibrium, MC = MR = AR. That is price 2. At the equilibrium, MC = MR < AR that is price
charged is equal to marginal cost of production charged is above marginal cost.

3. The firm in the long run comes to equilibrium at the
minimum point or the lowest point of the long run
average cost curve. The firm tends to be of optimum
size operating at the minimum
average cost.
4. Equilibrium can be conceived only under increasing
cost and not under decreasing or constant cost
conditions
3. Even in the long run equilibrium the firm will be
operating at a higher level of
average cost. The firm stops short of optimum size.
4. Equilibrium situation is possible at increasing,
decreasing or constant cost conditions.
5.But monopoly firm earns super normal profit both in
short run and long run.

5. The firm can earn only normal profit in the long run 6. Price is higher and the output will be smaller
and may earn super profit in the short run

6. Price will be lower and the output is larger

Monopolistic competition

When large number of sellers produce differentiated products, monopolistic competition is said to exist. A
product is said to be differentiated when its important features vary. Monopolistic Competition Examples
Restaurants Hairdressers Clothing TV programs.

Characteristics of Monopolistic Competition

The important characteristics of monopolistic competition are:

1. Existence of Many firms: Industry consists of a large number of sellers, each one of whom does not feel
dependent upon others. Every firm acts independently without bothering about the reactions of its rivals.
The size is so large that an individual firm has only a relatively small part in the total market, so that each firm
has very limited control over the price of the product.

2. Product Differentiation: Product differentiation means that products are different in some ways, but not
altogether so. These products are relatively close substitute for each other but not perfect substitutes.
Consumers have definite preferences for the particular verities or brands of products offered for sale by
various sellers. Advertisement, packing, trademarks, brand names etc. help differentiation of products even if
they are physically identical.
3. Large Number of Buyers: There are large number buyers in the market. But the buyers have their own
brand preferences. So the sellers are able to exercise a certain degree of monopoly over them. Each seller
has to plan various incentive schemes to retain the customers who patronize his products.

4. Free Entry and Exist of Firms: As in the perfect competition, in the monopolistic competition too, there is
freedom of entry and exit. That is, there is no barrier as found under monopoly.

5. Selling costs: Since the products are close substitute much effort is needed to retain the existing
consumers and to create new demand. So each firm has to spend a lot on selling cost, which includes cost on
advertising and other sale promotion activities.

6. Imperfect Knowledge: Imperfect knowledge about the product leads to monopolistic competition. If the
buyers are fully aware of the quality of the product they cannot be influenced much by advertisement or
other sales promotion techniques. But in the business world we can see that thought the quality of certain
products is the same, effective advertisement and sales promotion techniques make certain brands
monopolistic

Wastages of Monopolistic competition

1. Unemployment: Under monopolistic competition, the firms produce less than optimum output. As a
result, the productive capacity is not used to the fullest extent. This will lead to unemployment of resources.

2. Excess capacity: Excess capacity is the difference between the optimum output that can be produced and
the actual output produced by the firm. In the long run, a monopolistic firm produces an output which is less
than the optimum output that is the output corresponding to the minimum average cost. This leads to excess
capacity which is regarded as waste in monopolistic competition.

3. Advertisement: There is a lot of waste in competitive advertisements under monopolistic competition. The
wasteful and competitive advertisements lead to high cost to consumers.

4. Too Many Varieties of Goods: Introducing too many varieties of a good is another waste of monopolistic
competition. The goods differ in size, shape, style and colour. A reasonable number of varieties would be
desirable. Cost per unit can be reduced if only a few are produced.

5. Inefficient Firms: Under monopolistic competition, inefficient firms charge prices higher than their
marginal cost. Such type of inefficient firms should be kept out of the industry. But, the buyers„ preference
for such products enables the inefficient firms to continue to exist. Efficient firms cannot drive out the
inefficient firms because the former may not be able to attract the customers of the latter.

Oligopoly

Oligopoly refers to a form of imperfect competition where there will be only a few sellers producing either
homogenous or differentiated products. Oligopoly Competition Examples Steel industry Aluminium Film
Television Cell phone Gas

Characteristics of Oligopoly

1. Interdependence: The most important feature of oligopoly is interdependence in decision -making. Since
there are a few firms, each firm closely watches the activities of the other firm. Any change in price, output,
product, etc., by a firm will have a direct effect on the fortune of its rivals. So an oligopolistic firm must
consider not only the market demand for its product, but also the possible moves of other firms in the
industry.

2. Group Behavior: Firms may realize the importance of mutual co-operation. Then they will have a tendency
of collusion. At the same time, the desire of each firm to earn maximum profit may encourage competitive
spirit. Thus, co-operative and collusive trend as well as competitive trend would prevail in an oligopolistic
market.

3. Price Rigidity: Another important feature of oligopoly is price rigidity. Price is sticky or rigid at the
prevailing level due to the fear of reaction from the rival firms. If an oligopolistic firm lowers its price, the
price reduction will be followed by the rival firms. As a result, the firm loses its profit. Expecting the same
kind of reaction, if the oligopolistic firm raises the price, the rival firms will not follow. This would result in
losing customers. In both ways the firm would face difficulties. Hence the price is rigid.
Full cost pricing is a price-setting method under which you add together the direct material cost, direct labor
cost, selling and administrative costs, and overhead costs for a product, and add to it a markup percentage
(to create a profit margin) in order to derive the price of the product. The pricing formula is:

(Total production costs + Selling and administration costs + Markup) ÷

Number of units expected to sell = Full cost price

This method is most commonly used in situations where products and services are provided based on the
specific requirements of the customer; thus, there is reduced competitive pressure and no standardized
product being provided. The method may also be used to set long-term prices that are sufficiently high to
ensure a profit after all costs have been incurred.

Advantages of Full Cost Pricing: The following are advantages to using the full cost plus pricing method:

 Simple. It is quite easy to derive a product price using this method, since it is based on a simple
formula. Given the use of a standard formula, it can be derived at almost any level of an
organization.

 Likely profit. As long as the budget assumptions used to derive the price turn out to be correct, a
company is very likely going to earn a profit on sales if it uses this method to calculate prices.

 Justifiable. In cases where the supplier must persuade its customers of the need for a price increase,
the supplier can show that its prices are based on costs, and that those costs have increased.

Disadvantages of Full Cost Pricing: The following are disadvantages of using the full cost pricing method

 Ignores competition. A company may set a product price based on the full cost formula and then be
surprised when it finds that competitors are charging substantially different prices.

 Ignores price elasticity. The company may be pricing too high or too low in comparison to what
buyers are willing to pay. Thus, it either ends up pricing too low and giving away potential profits, or
pricing too high and achieving reduced sales.

 Product cost overruns. Under this method, the engineering department has no incentive to
prudently design a product that has the appropriate feature set and design characteristics for its
target market. Instead, the department simply designs what it wants and launches the product.

 Budgeting basis. The pricing formula is based on budget estimates of costs and sales volume, both of
which may be incorrect.

 Too simplistic. The formula is designed to calculate the price of only a single product. If there are
multiple

Cost-plus pricing

In Cost plus pricing method, a fixed percentage/profit margin is added to unit production cost which includes
material cost, labour cost, overheads cost, manufacturing overheads etc. to get selling price.

This type is more suitable, where there is no uniform production or each order is different.

Formula

The formula for cost plus pricing method is as follows −

S.P. = PC (1+ PM)

Here, S.P. = Selling price, PC = Unit production cost, PM = profit margin/fixed percentage
Advantages

The advantages of cost plus pricing method are as follows −

 Simple to calculate.
 Increase in price can be justified.
 Price can be determined, if there is no market price.

Disadvantages

The disadvantages of cost plus pricing method are as follows −

 High prices.
 Replacement costs are ignored.
 Market competitions are ignored.
 No contract cost.

Advantages and Disadvantages

 Building up the selling price of a product: It's simple using this method, with one caveat. You need
to have a consistent method for allocating overhead costs each accounting period going forward to
maintain integrity with the cost buildup.

 Locking revenues in with a contract: Any supplier would like to have a contract with cost-plus pricing
because it essentially guarantees sales with a certain profit percentage and coverage of all
production costs with no risk of having a loss.

 A way for suppliers to justify and explain a price increase: With cost-plus pricing, price increases are
easier to roll out because companies can simply inform clients that the costs to produce the product
have risen.

The cost-plus model comes with its share of disadvantages, including the following:

 Pricing doesn't consider the competition: The product could be priced too high, which would cost
the company in terms of lost sales and market share. The pricing could also be lower than the
competition's, causing the company to lose potential profits because of not charging the market rate
for its goods.

 Suppliers have little incentive to control or reduce costs: When they've entered into a cost-plus
pricing arrangement, companies end up producing what they want, regardless of what it costs to
produce or how it sells in the market.

 Runaway costs from suppliers hired on a cost-plus basis: Suppliers have the incentive to include
every possible cost in a cost-plus contract, rather than looking for ways to cut costs and streamline.

 Doesn't consider most recent replacement costs. The cost-plus method is based on historical costs
and doesn't factor in any recent changes in the amount of costs incurred.

Example

Consider an example given below wherein the cost plus pricing method is used.

If a power plant company generates 90000 units, which consumes 25000 litres diesel (costs 1/lit). Through
this, the company earns35000/month and management fee 23000. During the contracting period of eight
years,it depreciates at 23000. 10000/month.

(Assume profit margin = 25%, sales = 23%).

Solution
The profit with the help of cost plus pricing method is calculated as shown below −
Total cost = diesel cost + labour cost + management fee + depreciation
= 25000 + 35000 + 23000 + 10000
= $93000
Invoice = total cost (1+ profit margin)
= 93000 (1+ 0.25)
= $116250
Profit = 116250 – 93000 => $ 23250
Sales invoice = 93000/ (1-23%)
= 120779 (approximately)
Profit = 120779 – 93000 = $ 27779

Marginal Cost Pricing

Marginal cost pricing is the practice of setting the price of a product at or slightly above the variable cost to
produce it.

Advantages of Marginal Cost Pricing: The following are advantages to using the marginal cost pricing
method:-

Increases Profits: There will be customers who are extremely sensitive to prices. This group might not
otherwise buy from a company unless it were willing to engage in marginal cost pricing. If so, a company can
earn some incremental profits from these customers.

Gain Entry to Markets: If a company is willing to forego profits in the short term, it can use marginal cost
pricing to gain entry into a market. However, it is more likely to acquire the more price-sensitive customers
by doing so, who are more inclined to leave it if price points increase.

Increase Sales of Accessories: If customers are willing to buy product accessories or services at a robust
margin, it may make sense to use marginal cost pricing to sell a product on an ongoing basis, and then earn
profits from these later sales.

Disadvantages of Marginal Cost Pricing

The following are disadvantages of using the marginal cost pricing method:

Not Useful for Long-Term Pricing: The method is completely unacceptable for long-term price setting, since
it will result in prices that do not capture a company's fixed costs.

Ignores Market Prices: Marginal cost pricing sets prices at their absolute minimum. Any company routinely
using this methodology to determine its prices may be giving away an enormous amount of margin that it
could have earned if it had instead set prices at or near the market rate.

Encourages Marginal Customers: If a company routinely engages in marginal cost pricing and then attempts
to raise its prices, it may find that it was selling to customers who are extremely sensitive to price changes,
and who will abandon it at once.

Focuses on Costs: A company that routinely engages in this pricing strategy will find that it must continually
hold down costs in order to generate a profit, which does not work well if the company wants to transition
into a high-service, higher-quality market niche.
Going rate pricing

Going rate pricing is a pricing strategy where firms examine the prices of their competitors and then set their
own prices broadly in line with these. A going rate pricing strategy is most often used to price products or
services that are homogenous and don't vary in design.

Sealed bid pricing

It is a competitive pricing method, in which prices are decided based on quotation/estimated price or in
sealed bids. This method is generally used in construction/contract business.

In this, a tender notice is printed in the newspaper. Work proposals, type of job, quality, duration of project
etc. are printed in the newspaper. In reply to the notice, interested parties send their sealed bid stating their
price, particulars before deadline.

On the due date, submitted sealed bids are opened and allocated to bid at a lower price with satisfaction
conditions. Company sets the price based on how competitors' costs the product.

Advantages: The advantages of the sealed bid pricing method are as follows −

 Quick processes.

 Evaluation time is less.

 Several bidders.

 Clear product specifications.

Disadvantages: The disadvantages of the sealed bid pricing method are as follows −

 Suppliers are given less preferences.

 Less clarification about suppliers to meet specifications.

 Lack of flexibility.

 Sometimes the speed of the process can prove costlier.

Perceived Costs

Perceived value pricing is that value which customers are willing to pay for a particular product or service
based on their perception about the product. Perceived value pricing is an important marketing strategy
which helps firms to price a particular product in the markets. Generally, marketers position the product in
such a way that it will make the product unique.

Factors

#1 – Outer Appearance

Seeing is believing; outer appearance creates a decisive first impression among customers. Thus, paint
quality, fit-and-finish, packaging, labeling, and design dictate perceived value.

But the aesthetic angle goes beyond the product; it applies to pamphlets, brochures, store design, etc. For
example, a product that offers premium functionality can fail to create a value perception if it looks
unappealing.

#2 – Utility

Aesthetics have a bigger impact on first-time purchases. It cannot generate repeat customers. If a product
offers functionality and fails to look appealing, it can still score well in customer retention.

Further, not all customers need a particular product. Marketing and pricing decisions depend on the market
size of the product. Further, if a customer finds a product unaffordable, its utility vanishes. Thus, perceived
value is high when a product can justify its price.
#3 -Availability

Common and high-volume goods are available everywhere. But some products have a smaller market size. In
such a scenario, the manufacturer cannot hold a large stock. Also, the manufacturer limits their distribution
network to relatively high-volume areas. When a brand is missing from supermarkets and vendor machines,
its perceived value falls.

#4 – Emotions

Surprisingly, psychology plays a huge role in buying decisions. Such goods are called aspirational products.
Here, the product becomes a status symbol, no longer about functionality. Watches and automobiles are
some examples.

Even with cheaper goods, emotions can play a role. For example, Coca-Cola markets itself as a lifestyle, as a
feeling. Owing to its popularity, the product’s perceived value increases.

#5 – Brand Value

Branding also plays a vital role in deciding the product’s price. In simple terms, brand value is about
popularity, brand awareness, and perception. Customers assume lower value if they have never heard about
a brand. As a result, popular brands impose high prices and still manage to justify them.

Advantages Disadvantages

Perception is subjective; customers can be very

If a customer perceives a high
individualistic. As a result, aA business can miscalculate
value within the price range.
perceived value.

It leads to high-profit margins as

The business needs to justify its price; if not, sales can
customers are willing to pay a set
plummet.
price.

For large firms, brand value plays a bigger role.

CLV (Customer Lifetime Value) or
Customers end up paying a premium if they consider the
customer loyalty increases with
product aspirational. In such scenarios, the perceived
time.
value is not relevant.

This method considers

customers’ purchasing power The perceived value goes out of the window when a
and ability to afford a particular competitor offers lower prices.
product.

Differential pricing
The Differential Pricing is a method of charging different prices for the same type of a product, and for the
same number of quantities from different customers based on the product form, payment terms, time of
delivery, customer segment, etc.

The companies can charge different amounts from different customers considering the following basis:

 Customer-Segment pricing: Different group of people pays different prices for the same kind of a
product on the basis of a segment they belong to.
E.g., In any government examination, the form fee varies for the general category people and the
other backward class people.

 Image pricing: The companies can charge different prices for the same kind of a product on the basis
of an image, a product enjoys in a market.
E.g., cosmetics and clothing brands are the best examples.

 Product-form Pricing: Different prices charged for different variants of the same product.
E.g., The price of the same type of a car may vary because of different color and add-on features.

 Location Pricing: The companies charge different prices for the same product on the basis of
different locations where it is offered.
E.g., In movie theaters the customer pays different amounts for the different locations from where
they can watch movies.

 Time pricing: The price of a product varies with the time, such as the price charged is less in the off-
season as compared to the season time. Also, the movie tickets for the matinee show is less as
compared to other show timings.

Penetration Pricing

Penetration pricing is a pricing strategy that is used to quickly gain market share by setting an initially low
price to entice customers to purchase. This pricing strategy is generally used by new entrants into a market.
An extreme form of penetration pricing is called predatory pricing.

It is common for a new entrant to use a penetration pricing strategy to quickly obtain a substantial amount
of market share. Price is one of the easiest ways to differentiate new entrants from existing market players.
The overarching goal of this pricing strategy is to:

 Capture market share

 Create brand loyalty

 Switch customers from competitors

 Generate significant demand, looking to utilize economies of scale

 Drive competitors out of the market

Situations where penetration pricing works effectively:

  When there is little product differentiation

 Demand is price-elastic

 Where the product is suitable for a mass market (and, therefore, for utilizing economies of scale)

Skimming pricing

Price skimming, also known as skim pricing, is a pricing strategy in which a firm charges a high initial price
and then gradually lowers the price to attract more price-sensitive customers. The pricing strategy is usually
used by a first mover who faces little to no competition. Price skimming is not a viable long-term pricing
strategy.

Advantages of Price Skimming

 Perceived quality: Price skimming helps build a high-quality image and perception of the product.

 Cost recuperation: It helps a firm quickly recover its costs of development.

 High profitability: It generates a high profit margin for the company.

 Vertical supply chain benefits: It helps distributors earn a higher percentage.

Disadvantages

 Deterrence: If the firm is unable to justify its high price, then consumers may not be willing to
purchase the product.

 Limitation of sales volume: A firm may not be able to utilize economies of scale if a skim price
generates too few sales.

 Inefficient long-term strategy: Price skimming is not a viable long-term pricing strategy, as
competitors will eventually enter the market with rival products and exert downward pricing
pressure.

 Consumer loyalty: If a product that costs $1,000 at launch has a follow-on price of $200 in a couple
of months, innovators and early adopters may feel ripped off. Therefore, if the firm has a history of
price skimming, consumers may wait a couple of months before purchasing the product.