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, and 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.
What is dynamic pricing?
Dynamic pricing is a pricing strategy in which companies apply variable pricing instead of traditional, fixed pricing. Prices are set in accordance with current market demands, and as data is analyzed, the right prices are calculated. In dynamic pricing, different users can be charged a different amount for similar goods.
Dynamic pricing is a must for e-commerce retailers to increase sales and generate more profit. With machine learning, companies can monitor and adjust prices more effectively. Algorithms analyze historical and competitive data to make accurate pricing recommendations and sales predictions. Dynamic pricing can boost profits by 25% on average.
And how does it work? A good example is dynamic pricing in airlines. When you’re buying a flight ticket online, you can sometimes notice that the price of the ticket changes, the very same ticket, same plane, same time, same seat. It can go up or down, depending on various factors. Airlines price tickets differently based on customer status and demand. It’s now obvious that some time is more expensive for travel, so flight tickets will cost more around Christmas, or even on a Friday evening than Wednesday morning. We’ve already learned that this is how it goes, but sometimes the price can change instantly, like when you add the ticket to the cart. But airlines are not the only segment making more profit with the use of this strategy; dynamic pricing is popular in retail, in the hotel industry, financial institutions, and fuel industry. Dynamic pricing allows businesses to remain competitive while still capitalizing on market demand.
What are the types of dynamic pricing?
There are different types of dynamic pricing based on different factors.
Segmented pricing is a pricing strategy that offers different prices for different customers, for example, in different geographical regions.
Competition-based pricing is a process of selecting appropriate price points in reference to the prices charged by the competition. This strategy is often used by companies selling similar products.
That’s a pricing strategy often used by airlines or hotels. The prices change depending on the availability of products or services.
Peak pricing is a strategy where customers pay more during a period of higher demand. Peak pricing is most frequently implemented by utility companies.
Penetration pricing is a strategy used to attract customers to a new product or service. It means setting a low initial price for a product or service, often below the market rate. This strategy relies on the concept of low prices attracting a large portion of customers.
Dynamic pricing can analyze a number of factors that you consider important to your pricing strategy. For some companies, analyzing just one aspect like the supply, demand, or competitors’ prices is sufficient, but in other cases, pricing may rely on a number of factors to set the best possible price.
Dynamic pricing – dos and don’ts
There are good and bad reasons to increase prices, and sometimes higher demand is not the only factor that should influence the decision to make prices higher.
What to do?
Stay competitive. Dynamic pricing helps you be competitive 24/7. If you want to make sure you’ve got the best offer in town, you don’t have to spend hours going through your competition’s offers.
Motivate customer behavior. You can encourage more customers to use your service during off-peak hours. This way, you can distribute the activity more evenly throughout the day and help avoid experiencing heavy surges.
Be transparent about your pricing. Don’t use your pricing strategy against your customers. Make sure you let them know that the prices may change. You may be afraid of saying, “the price may go up if …” – and sure, users can wonder why they may be paying more than someone else. But in this case, they know the rules, and they accept them while keeping people in the dark would be much like lying. And imagine your customers finding out that they’re charged differently for the same product or service without knowing it. They may get angry.
What not to do?
Avoid too much price discrimination. It may be hard to tell where the line is, especially when the prices are calculated based on the current demand. However, you need to make sure that your pricing strategy doesn’t hurt your customers and ruin your company’s image. And it can if it’s unfair.
Is dynamic pricing legal?
We’ve grown used to the fact that every passenger on a plane may have paid a different price for the same standard. As shoppers, we may experience moments of frustration when we see that prices go up just when we’ve made up our mind to buy something or that the price drops just a day after we’ve bought it. “Can they even do that?”, we may ask, and that’s a reasonable question – to which the answer is… that depends.
Price discrimination can be illegal if it’s based on impermissible factors such as race, gender, nationality, or religion. No company is allowed to offer a higher price for the exact same product based on these factors. Dynamic pricing can also be illegal if it violates antitrust law. However, good dynamic pricing strategies analyze factors such as location, demand, customer profile, and competition to generate price recommendations – and in such a case, it’s perfectly legal. However, not everything that’s legal is acceptable for consumers. When designing a dynamic pricing strategy, it’s good to consult experts – other companies using this solution, business professionals, or a lawyer. Make sure that your pricing strategy is transparent and doesn’t hurt your customers. As long as it works for them, it works for you, too.
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.
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. 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?
As I already mentioned in the “dos and don’ts” above, 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.
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 somewhere else. 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 a tech partner) 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, and 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. The risks are there, but you can minimize them. 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. 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 investing 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?
Dynamic prices make sense if there’s a limited number of things, say seats on a plane. 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.
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 it. You may say, 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 that 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 dynamic pricing
Amazon uses dynamic pricing and updates the prices of products 2.5 million times a day. On average, 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 them to the cart. Or they may see the price of an item go down right after they’ve bought it.
Uber dynamic pricing
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 are 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. A few years ago, there was a snowstorm in New York, and taking an Uber, for many, was 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.
Airbnb dynamic pricing
Another well-known brand that leverages a dynamic pricing strategy is Airbnb. This popular home rental marketplace base the prices of the accommodation available on their platform on several various conditions, such as seasonality, demand and availability, special events (like festivals, local holidays, etc.), time of booking (how much in advance the booking is made), day of the week and a few more.
Within the Airbnb dynamic pricing model, the hosts sharing their properties on the platform can use Airbnb’s “Smart Pricing” tool. It helps the hosts automate their listings’ pricing to allow them to get the biggest profit while keeping their offers attractive to the clients. Also, Airbnb provides the hosts with pricing recommendations to help them set the optimal price.
Read also: Famous apps built with Node.js
Why use dynamic pricing?
More and more companies implement dynamic pricing, so there needs to be a reason, right? And naturally, there is: other pricing strategies fail. The most common pricing strategy, still, is fixed pricing. It can mean low or high prices, depending on the company and the product or service, but it’s often fixed – you set a static price based on your costs and desired profit margin. However, there’s an important assumption there: your sales volume should be big enough to generate the right profit margin and cover the costs. This way, you can’t use your pricing strategy to influence customer behavior and sales volume. And remember, your customers are dynamic, too. They’re well aware of acceptable prices, they choose from too many options. You need to adjust – or you’re out. To keep up with the competition, demand, and other factors, you need a dynamic approach. A good dynamic pricing system will consider all the data points relevant to your business and make data-driven decisions. As always, a strategic approach and the right data play a key role in the process, so you make sure you’re turning towards being a data-driven organization and not basing your actions on unverified assumptions.
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! 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.