Cream skimming

Cream skimming is a pejorative term used to refer to the perceived business practice of a company providing a product or a service to only the high-value or low-cost customers of that product or service.

Whether or not the perceived negative effects of cream skimming actually do occur - or only occur in limited circumstances - is a matter of debate. This article is not intended to make any argument as to whether the practice can or does happen in any circumstance, but simply to identify the term in order that the reader may understand the general context in which it is used.

The term derives from the practice of extracting cream from fresh milk at a dairy, in which a device called a "separator" draws off the cream (which is lighter, and floats) from fresh or raw milk. The cream has now been "skimmed" or captured separately from the fresh milk.

The idea behind the concept of cream skimming in business is that the "cream" - high value or low-cost customers, who are more profitable to serve - would be captured by some suppliers (typically by charging less than the previous higher prices, but still making a profit), leaving the more expensive or harder to service customers without the desired product or service at all or "dumping" them on some default provider, who is left with less of the higher value customers whom, in some cases, would have provided extra revenue to subsidize or reduce the cost to service the higher-cost customers, and the loss of the higher value customers might actually require the default provider to have to raise prices to cover the lost revenue, thus making things worse.

The term has also been used in relation to the concept of school vouchers in which it is claimed that the vouchers could be used by parents of "better" students to move them out of lower performing or substandard public schools and into less-crowded private ones, leaving the more disruptive and harder to teach ones behind in the public schools, making the situation worse.

For example, it was believed that MCI and Sprint long distance telephone companies would end up taking away very high value business and some residential accounts from AT&T, leaving AT&T primarily with higher-cost to service accounts or ones producing less revenue (such as customers in less-densely populated or rural areas), meaning all customers of AT&T would end up paying more.^[1] This could conceivably lead to a vicious circle as more customers leave the high-price carrier for the lower priced carrier, thus forcing still more price increases to cover the upward spiraling costs of providing service to a shrinking revenue base. This scenario did not occur, as various technological changes (spurred in part by the availability of competition) eventually lowered the net cost for most long-distance telephone calls.^[2]

The United States Postal Service has a monopoly on the delivery of "non-urgent" first-class mail, where delivery is not time-sensitive. It also has the exclusive right to use customer-owned mail boxes for placing the customer's mail for delivery. This means that, even though mail boxes, such as those in the door of a house, or on the curb, or in the front lobby of the customer's building, are owned by the customer, and not owned by the Postal Service, by law only the Postal Service may use them to deliver mail. This law is in effect because it is believed that were the Postal Service to not have this monopoly, other competing mail carriers would take over the most lucrative parts of the business (e.g. local delivery of bills in dense urban areas), leaving the Postal Service with more expensive urban deliveries and rural service.^[3]

References

1. ^ An example of how it is believed competitors may take advantage of cream skimming off the carrier of last resort in telecommunications, who otherwise would be making monopoly profits, is given by Peter Smith, "Subscribing to Monopoly" in Public Policy for the Private Sector, The World Bank, September, 1995, available at http://rru.worldbank.org/documents/publicpolicyjournal/053smith.pdf, (179K, retrieved March 11, 2008)
2. ^ Examples of how extreme competition in telephone service drove prices down and cream skimming did not occur are given in Martin Ostermayer, Christian Nobs and Darrell Gualco, Business: Local Service Market including ILEC and CLEC, 17 February 1999 at http://www.ehrlichorg.com/s99ibm/b0217-02.doc (Microsoft Word Document, 172K, retrieved 11 March 2008)
3. ^ An analysis of this particular factor is given in Michael A. Crew and Paul R. Kleindorfer Emerging Competition in Postal and Delivery Services, in Chapter 10, "An Analysis of the Potential of Cream Skimming in the United States Residential Delivery Market" by Robert H. Cohen, William W. Ferguson, John D. Walker and Spyros X. Xenakis. A sample from this chapter is available from Google Book Search at this link (Retrieved 11 March 2008) The same article also appears as a web page on the website of the Postal Regulatory Commission at http://www.prc.gov/prc-docs/library/refdesk/techpapers/prcstaff/cohen.pdf (Retrieved 14 April 2011)

See also

• Redlining