Dynamic pricing is a delicate topic for businesses. Its development is tied to the emergence of new e-Commerce trends. Over the past few years customers have complained about companies using dynamic pricing. While dynamic pricing can increase your margin, you also run the risk of losing your business completely. There’s a fine line between dynamic pricing model and price discrimination. To make sure you don’t fall into the same pitfalls, we’ll discuss exactly what dynamic pricing is and review some pros and cons. By the end of this post you’ll understand how to use dynamic pricing—without the backlash.
Let’s get started.
Defining Dynamic Pricing
At its core, dynamic pricing is a business strategy that adjusts prices based on the present market conditions. The change of prices can happen within minutes, hours, or days. It solely depends on the type of market. Dynamic pricing is also referred to as time-based pricing, surge pricing, or demand pricing.
Dynamic Pricing Vs. Pricing Discrimination
Dynamic pricing involves selling an identical product at different prices. This is technically the exact definition of price discrimination. It is the illegal practice outlined in the Robinson-Patman Act of 1936.
The price discrimination act has several legal loopholes. The act is especially gray when it comes to dealing with non-commodity goods sold online.
The Federal Trade Commission is known to shoot down dynamic price discrimination lawsuits. A dynamic price discrimination lawsuit is permissible under the following circumstances:
- Based on suspect categories such as race, gender, or sexual orientation. It is very difficult to prove this kind of discrimination.
- If the pricing is anti-competitive, this is not likely to occur in an online marketplace.
Dynamic Pricing Strategies
There are different ways that businesses apply dynamic pricing. Each of these strategies is intended to achieve different outcomes.
Here, you’ll find different prices offered to different customers. Their segments distinguish the customers. For example, high-value customers who prefer speed and quality get higher prices. These clients do not mind the higher price tag as long as the service is quick and excellent.
Time-based Dynamic Pricing
Some companies use this strategy to charge more for speedy services. For example, if you need a same-day service. Sometimes businesses will charge you more near the closing time.
Market situations change due to the influence of various external factors. Businesses have to adjust according to these changes if they want to make any profits. If the market change induces a fall in sales, the company will adjust its pricing strategy. They will offer lower prices.
This strategy is a favorite of many industries. These places charge more during peak hours.
Penetration Pricing: Businesses using this strategy are trying to create a wider reach into the market.
To get a more significant market share, companies price their products lower than the market price. As more customers get familiar with the product, the business gradually increases the cost of the product.
Is Dynamic Pricing Okay to Use?
Theoretically, we should all be okay with dynamic pricing. As consumers, we ultimately have the power to decide whether we want to purchase a product or not.
The company has the responsibility to have competitive prices that people are willing to pay. The right price aligns with the individual equilibrium price.
If you are not willing to purchase the product, you leave it. You may consider coming back when there is a sale, or you find a cheaper alternative.
If you are willing to pay the quoted business price, then your need is fulfilled.
It is a free market, existing in perfect pricing and harmony.
What do Consumers Think?
Reality tends to deviate from the point of view of economic theories. Dynamic pricing is one of them.
When the truth of dynamic pricing is revealed to a consumer, it appears like price discrimination stripped off its sheep’s clothing. It feels like you have just been lied to and did not get a deal as good as the next person.
Passengers who use commercial airlines know that most people paid different prices for their flight. This scenario is the most accepted form of dynamic pricing. No one will create a fuss if they realize that they spent more than their seatmate.
If you bought a book online and paid more than your neighbor, you will undoubtedly suspect that you got a raw deal. The book customers wouldn’t feel bad if they didn’t find out that the product pricing is variable with the same vendor.
The biggest challenge for online retail is finding the equilibrium price. Dynamic price engines do not get enough real-time information to differentiate honestly.
Tracking technology on which dynamic pricing engines rely is not developed to the point that a person who shopped on Monday will get the same price on Sunday.
If you are a company that has sales cycles longer than 42 hours or involves multiple buyers, there is a higher risk that your pricing secret will get out.
How To Implement Dynamic Pricing
The shortcomings of dynamic pricing engines and tracking software do not mean that you cannot use dynamic pricing.
In the end, you inevitably end up with different types of customers. You can obtain more revenue from one group compared to the other.
The only catch is that you need to execute your implementation flawlessly.
1. Price differentiation
One of the core concepts of pricing strategies is to evaluate the persona of your customer base. Then go ahead to package and price the products according to the personas.
The personas will always be different. If you find no differences, then you are indeed using the wrong approach.
After you make the distinction, you can offer lower and higher prices—this way, the product earns dynamic revenue of different amounts from your customer base.
2. Value Metric
Using the correct value metric to price your product complements price differentiation.
The value metric refers to the amount you will charge, for example, per GB consumed or per number of users.
In the physical retail world, this isn’t easy to achieve. But in the software market, you can easily split up the pricing. You can base this on a premium version of the product, or the number of users supported, and so on.
Every customer will pay a different amount based on the package they chose.
3. Timed Auction Pricing
Use the time to dictate when your prices rise or fall. This is similar to the strategy used in ticket sales for concerts, travel, and sports matches.
New software releases have different prices for their Betaware before a stable release.
4. Coupons and Discounts
Well, for a lot of businesses, discounts are a necessary evil. Discounts reel in a subset of customers.
You must be careful in offering discounts. They can create a negative impact on subsequent sales when prices revert.
You can offer coupons discreetly to a select group of people.
Is Dynamic Pricing Right for Your Business?
Three things can help your business successfully adopt dynamic pricing. First, you must be transparent to the customers concerning your pricing.
Your customers should always be aware of the factors that inform the price of your product.
Another way is to understand what motivates your customers’ shopping habits.
People who argue in favor of dynamic pricing think transparency makes the application justified.
Transparency is excellent, and we are all for it. However, it still doesn’t take away the biggest customer dilemma in transparent dynamic pricing, i.e., “Am I getting the best deal?”
All these suggestions solve the problem of transparency and the fear of missing out.
You are likely to stay out of legal trouble with dynamic pricing. But you need to know that the brand image and PR backlash may cause some lasting problems.
About that popular example… Let’s talk about why airplane tickets vary so much to illustrate an application of dynamic pricing principles.
Why do airfares fluctuate so much?
- Airlines thoroughly study the habits of their passengers. There are business travelers and leisure fliers. While both groups behave distinctly, they both need to fly on the plane.
- Leisure travelers are known to plan their trips as they are more flexible with dates. However, business travelers often have to travel on a fixed date at a set time.
- Leisure fliers generally book their tickets in advance, looking for the best deals. On the other hand, business fliers are often compelled to purchase last-minute tickets. They are willing to pay more airfare to secure a seat on that flight.
- There are seasons of the year when the demand for airplane tickets stays high, and so do the prices, for example, during holidays.
Airfare prices also fluctuate independently of customer behavior. Sometimes it solely depends on the time of day or the airline company. To get a deeper insight into how airlines set their prices, read here.
Should You Adopt Dynamic Pricing?
If you have an ecommerce business, you should consider adopting a dynamic pricing model. It creates a lot of good effects on a company.
We have listed a couple of the benefits of dynamic pricing below.
1. More control over your pricing strategy
At a glance, it appears that companies that apply dynamic pricing lose control over a product’s prices.
The reality of this is the opposite of losing control.
As a retailer, you will have access to the live pricing trends of the products in the same industry as yours.
You will be able to see how your competitors price their products using pricing intelligence software. This information provides an idea of the demand and supply of the products.
Knowing your competitor pricing and the pricing trends will help you to set better prices on your items. This way, you can maximize your revenue.
2. Price flexibility without a PR nightmare
Again, when the concept of dynamic pricing is not understood correctly, retailers tend to shy away.
It has the potential to deviate from the brand value and negatively impact customer trust. The assumption is that customers might mistake the changing prices for manipulation. This couldn’t be further from the truth.
You can use dynamic pricing to strengthen brand awareness and protect the company. You can achieve this by setting a commodity price floor that reflects the value of your brand. It allows for flexibility and increases your earning potential.
Profitable brands launch seasonal and promotional offers using dynamic pricing to create more brand awareness. These prices are flexible enough for profitability. It is much more difficult to stay profitable with the flat pricing model.
3. Dynamic pricing is a money-saving venture
Dynamic pricing software and apps use real-time data in the fluctuations of the product supply and demand chain. They also monitor competitor activity, price fluctuations, and your supply and demand. As a result, your e-commerce business gets the correct data to set optimal prices and still earn a profit despite the regular changes in price.
In the long run, the use of dynamic pricing software and engines saves you money. All the calculations are done online. There is no need for manual data collections and administrative activities.
The fewer overheads you churn up, the more profitable your business is.
4. Efficiently managed with the right software
Dynamic pricing involves monitoring products averaging in their hundreds of thousands. At the same time, it consists of an analysis of live trends of demand and supply. Both of these applications are complex and highly challenging tasks. Most e-Commerce businesses would be unable to shoulder these functions.
However, using the right e-commerce software, businesses can do all this in a matter of seconds. It automates the entire process, eliminates guesswork, and provides data to help the company set an optimal price.
5. It‘s not perfect
Systems that depend on technology-led forecasts risk the possibility of errors. The dynamic pricing algorithms are no exception.
However, the good news is, the algorithm does not automatically set the price for you. So if there is an arrow, the price presented is just a proposal at the end of the day. If you disagree with it, you can adjust.
This way, you will always be in control over this software’s price suggestions.
Potential errors in dynamic pricing software and applications are easy to manage. If it slips through the cracks, the effects are not as devastating as one would imagine. They do not significantly impact the overall profits because price resets happen frequently.
Downsides of Dynamic Pricing
We have painted a wonderful picture of dynamic pricing. However, like everything created by humans, there are downsides.
The disadvantages of dynamic pricing should help you decide if it’s the right strategy for your business. It should also determine how often you should employ it.
1. Potential to alter customer behavior
The mechanisms of dynamic pricing will affect customers’ behaviors.
On the positive side, dynamic pricing will encourage sales, especially when prices drop. On the other hand, it could also impede sales when prices go up.
If customers are convinced that prices will go down shortly, some of them will delay a purchase. A delayed sale could transform into a purchase that never happens or one that happens somewhere else.
2. Algorithm errors
You are unlikely to receive a flash crash from bad algorithms Wall Street style. Mishaps arising from algorithm errors in dynamic pricing have been minimized.
However, when they happen, they will still have an impact on your profits, though minimal. Mistakes happen when customers can purchase a product at meager prices.
The number of eCommerce retailers has multiplied dramatically in the past few years. This has led to more and stiffer competition. The biggest challenge most online retailers face is how to keep competitive prices and still maximize their profits.
The solution to this problem lies in dynamic pricing. The pricing strategy takes into account real-time data on supply and demand to recommend the best pricing. Dynamic pricing used consistently can significantly boost your revenue.