Dynamic pricing in practice: Is it for everyone?

Dynamic pricing has been around for as long as we’ve known commerce. Prices vary depending on a number of factors: customer status, location, supply, demand, time. We’re witnessing more on more online sellers adopt this pricing strategy too and it seems like it’s working. It’s an easy way to stay competitive and squeeze out more profit. So it works. Right? The thing is, dynamic pricing is not for everyone. And just like I always say in the case of adopting any type of AI technology, you should start with the strategy first.

Is dynamic pricing right for your business?

Looking at the examples from giants like Amazon or Uber (which I will cover later on in this article), it may be tempting to follow their lead and implement dynamic pricing. It’s a great solution for many e-commerce retailers, hotels or airlines but many companies stay away from this solution because of the risk of disadvantages outweighing the benefits. Let’s have a closer look at some of the disadvantages and analyze whether there’s an actual risk.

Customer alienation

What if your customer thinks they got a bad deal? Dynamic pricing will often help customers pay less but at times, they might get frustrated that they paid more than someone else for the exact same product or service. And aren’t flight ticket prices a taboo while you’re on a plane? Nobody wants to learn that they’ve overpaid. So customers can get frustrated and this may lead to complaints, bad reviews, and even returns. If you’re making your customers ask for their money back, you’re doing it wrong.

Ultimately, you want new technologies to fit into your overall business strategy and help you achieve your goals – one of them being customer retention. Losing customers is an expensive issue, so you need to steer clear of anything that can make retention drop. How?

I’ve discussed the “dos and don’ts” of dynamic pricing in the previous article in this series: What’s the use of dynamic pricing. Long story short: make sure you’re transparent about your pricing strategy. When your customers understand why prices change, they’re more likely to accept it.

Lower customer loyalty

This is a natural result of customer alienation. When customers feel that you’re tricking them into paying more, they will explore other options. They shop around and know how to get the best deals, and they can always use price comparison tools. You can use this in your favor by adjusting your prices to remain competitive, but this can also work against you when customers feel that the prices they are charged are unfair.

Customer shopping

Even more competition

It’s a competitive world out there, you know it too well. And, perhaps not surprisingly, this is still connected to how your customers see your pricing strategy. As a company, you should offer some unique value: you may be the store that has it all, you may deliver in 24 hours, you may have the most affordable products, or you sell one-of-a-kind items. However, when your prices are “unfair”, your customers lose sight of this unique value and go shop around. Why would they stick to a company that makes them overpay? In some cases, your use of dynamic pricing might drive customers towards competing companies.

The tech has to be good

The thing is that AI-driven technologies have to be implemented strategically and well-built. That’s just how it is. You don’t need a data scientist who’s not interested in how the solution will affect your business, you need a provider (be it in-house or outsourced) who understands your business, matches the right technology to your requirements, and helps you make sense of your newly-made AI solution. You need your dynamic pricing model to be tailor-made, so it answers your needs: the prices can’t be lower than you can afford, and can’t be higher than the customers are willing to pay. The optimal price can be calculated considering various factors, and not every factor will be important to your business. You might base your prices on limited supply, higher demand, timing, competition prices. Whatever works for you. As always: keep your business strategy in mind when adding tech to it. It’s there to work for you. Period.

Is it too risky?

No. Don’t be surprised: the risks are there but when you create a strategy for adopting the model, make sure that your data science team understands your needs and requirements, and that you understand the limitations there are, you can make it work. For many companies, dynamic pricing is a must to remain competitive as they wouldn’t be able to analyze and adjust prices manually. There are far too many data points, and while people don’t deal well with too many numbers (or data points), AI rocks in this area. Dynamic pricing, used right, helps companies maximize profit, stay competitive, and works well with your sales and discounts strategy. Customers are used to the fact that various companies price the same products differently, so they may be willing to pay a couple of dollars more for that book on quantum physics since you’ve got that great deal on accessories.

How do I know I should use dynamic pricing?

That’s a good question, dear reader. The first question is:
Why do you want to use it?

If you want to use it because Amazon does, please talk to an expert before you invest in something blindly.

If you know your “why”, that’s a great first step. Tell me all about it! 

Or in case you don’t want to talk just yet, let’s answer a few more questions together:

Is your inventory limited?

If there’s a limited number of something, say seats on a plane, dynamic prices make sense. When you’ve got a lot of seats, you can charge lower prices, but they will go up once there are just a few seats left.

Does demand change over time?

You can use dynamic pricing to encourage customers to buy given products. You can also influence customer behavior, e.g. to drive more traffic at unpopular times. You can’t have total control over demand, but you can influence it to make more profit.

Changing demand

Will your customers accept dynamic pricing?

Remember the risks up there? Just don’t risk. You need to be sure your customers are OK with your pricing strategy, and you need to make them aware of the fact that your pricing is dynamic. You may be worried that telling them “you can pay more than your annoying friend” will make them angry. You are not wrong. Instead, tell them why prices change. For example: our prices are dynamic – this means that the price of a product may change depending on a number of factors like limited supply or competitors’ prices. Makes sense?

Examples of dynamic pricing

Now that you already know if dynamic pricing is for you, let’s have a look at two companies who already use it. They do it well, however, they fail sometimes, too. But you can learn your lessons from their mistakes and not make the same ones in the future.

Amazon

Amazon uses dynamic pricing and updates the prices of products 2.5 million times a day, which means that a product’s price changes about every 10 minutes as reported by Business Insider. How do they do it?

As described in the excerpt from “Swipe to Unlock: The Primer on Technology and Business Strategy”:

Amazon analyzes customers’ shopping patterns, competitors’ prices, profit margins, inventory, and a dizzying array of other factors every 10 minutes to choose new prices for its products. This way they can ensure their prices are always competitive and squeeze out ever more profit.

What’s the result of this? Amazon often attracts customers with great deals on popular products, let’s say bestselling books. The price they offer will be lower than that of their competitors but they then increase prices on unpopular products. The idea behind this is that if consumers see discounted prices on the most popular items, they will assume that Amazon generally has the best deals. And even if a user realizes that it’s not the best price they can get for some item, they may be willing to pay slightly more since they’re already shopping there. Why would you go to another platform to buy another book if you can get all you need in one place?

The prices at Amazon change so often that they sometimes make shoppers feel frustrated – the price may differ in the morning when they browse the products and in the afternoon when they add it to cart. Or they may see the price of an item go down right after they’ve bought it.

Uber

Uber uses a surge pricing model in their business. When demand for rides increases, prices go up. When you order an Uber on a Saturday night, you may notice that the price is higher than it was a few days earlier – that’s because a Saturday is a popular time for Uber, meaning that demand is higher. And since more people need an Uber, prices go up. This is an encouragement for more drivers to go on the road.  Riders wanting to order an Uber know about can see a multiplier to the standard rates in the app, so they know that they will have to pay more. It’s all fair and logical, and to make sure the rules 100% clear, Uber explains its pricing strategy on its blog

However, Uber sometimes misses a “human touch”. They rely on the algorithms and while in most cases it’s not a mistake, there are situations where machine judgment is simply not enough. Remember the situation I described in the previous article? A few years ago, there was a snowstorm in New York, and taking an Uber was for many the only option to get back home. The surges were reportedly around the level of 4x, which is expensive but given the circumstances – acceptable. Unfortunately, with the demand increasing, prices were changing more dynamically than expected. Uber’s prices are calculated based on real-time demand, so they can change anytime. While users were informed that they would pay about 4x the standard rate, the actual price they were charged was even higher. Many riders requested refunds and Uber was largely criticized for making an unfair profit off people in a difficult situation. Lesson to learn: don’t forget your customers are human. Be a little sensitive.

What are your thoughts?

I tried to answer some of the important questions considering why you should, or shouldn’t, adopt dynamic pricing. If there’s more you need to know – ask. It’s good to ask questions (just look how many I’ve asked here! – and I even made you ask questions to yourself) and finding answers will also make it easier to make sense of how you see the technology working in your organization. Whether it’s dynamic pricing or any other tech that you’re looking to implement, make sure that it aligns with your business and you’ll know how to use it right.

Predictive analytics for your business
Share the article with your friends!

Written by:

Kaja Polachowska

Communication specialist in love with the English language, a translator who also translates from tech to human. Follow at Quora

Leave a comment

Host: Buyun Zhao, Board Member to 5 AI startups



Learn how your startup can use AI to innovate and get a competitive advantage on the market!

Join our AI workshop this Thursday, 3pm Paris time!