Complete Guide to Dynamic Pricing
Most Europeans and Americans are used to paying one price for everything. When you go to the supermarket or shop online, you are probably going to pay the price that the merchant sets for you. Of course, you can shop around or find discount codes but generally, when the price tag says $4.99, that is the price you pay.
But all of this could soon change. Retailers and service providers are slowly adapting a pricing strategy called dynamic pricing. Dynamic pricing is not a new phenomenon. However, its popularity lately has turned it into a buzzword that some of the world’s biggest brands are talking about.
In this guide, you will learn 1) what is dynamic pricing, 2) what are the benefits of using dynamic pricing strategies, and 3) how to implement dynamic pricing in your business.
WHAT IS DYNAMIC PRICING?
Dynamic pricing is a term that is used to describe a buying experience where prices fluctuate based on different algorithms used by the merchant. Dynamic pricing is a blanket term but there are several different experiences that a customer might see.
For example, a retailer might drive prices up when an item is in demand. When the market demand falls, the retailer would then adjust its pricing to a lower figure to match that. This would capitalize on the moments when people are buying and help drive demand up again when it falls.
Another example of dynamic pricing is if a coffee shop raised the price of coffee drinks between 7:45 and 9:15 AM. Since this is the peak time of the day for coffee drinking, coffee shops can make more money off of every cup sold since the odds that customers would pay a few cents more for coffee before work are high. Alternatively, the coffee shop could also drive up the prices for drive-thru orders if is raining or snowing. This would offset the costs of losing customers because of backed up service. It would also encourage more people to come inside and be tempted by up-selling strategies.
There are several other examples of dynamic pricing that currently exists in the market. The way that airlines price flight tickets is the perfect example of the use of dynamic pricing in the current market. Airlines will price tickets differently based on customer status and based on demand. For example, a commuter flight from New York City to Chicago will be far more expensive at 6 PM on a Friday than it might be on a Wednesday afternoon. This is because there will be more people travelling home after work on a Friday afternoon. It is also because there are more business travelers on these flights who can afford to pay more for flights because the money comes out of a business expense account.
Hotels also offer a great example for dynamic pricing. Hotels will offer customers who book directly or book through the hotel’s loyalty program cheaper rates than may be found elsewhere. Some hotels will even match discount bookings by 25% in order to combat the loss of revenue to budget travel websites. However, hotels are infamous for raising prices during high demand seasons. Anyone looking for a hotel in San Francisco during a conference will pay an extortionate amount of money compared to days where there are no events on in the city.
Gas station prices also fluctuate significantly. Common wisdom suggests that it is less expensive to purchase gasoline in suburban areas or rural areas because there is less demand than in the city. Gas prices may also fluctuate based on the time of day or according to the price of oil on the market.
Financial institutions are also heavy users of the dynamic pricing system. Banks will offer preferential rates and product to customers who have good credit and a favorable number of assets. The products and services available will vary significantly between customers.
Get more insights into what dynamic pricing encompasses by reading through the following slides.
Dynamic Pricing Right Now
When you think about it, you can definitely think of a few examples of dynamic pricing in your everyday life. If you have ever checked the price of an airline ticket, only to see it skyrocket an hour later, you have encountered dynamic pricing.
Dynamic pricing is also used to draw competition away from competing retailers. This explains why you can purchase home goods and electronics at shockingly different prices even when you are shopping within the same geographic area.
Because customers now have the ability to extensively research prices in real time, retailers and service providers need to be able to remain competitive. The data that comes along with this new ability is also very valuable to merchants. For example, if a cruise line is selling a sailing date at a low price because it has not seen high demand, it can set its algorithm to put up the price for anyone who views the cruise package, navigates away from the page and then returns to it later. While this experience may be frustrating for the customer, it teaches the buyer a valuable lesson: always buy immediately or suffer the consequences of a price surge.
Beyond this, dynamic pricing is a great way to offer customers the best deals while still capitalizing on market demand. Dynamic pricing is a great way to offer an elusive deal for the bargain chasers.
THE BENEFITS OF DYNAMIC PRICING
Dynamic pricing has the ability to widen a business’s profit margins if it is used correctly. The hospitality, travel and retail sectors each have plenty to gain from this method of pricing. This is because they can raise their profit margins from pennies on the dollar to a more lucrative profit precisely when the market demand allows it most.
When the profit margin is wider, businesses can focus less on high volume sales. Instead, a business can work on developing its customers so that they become more valuable. After all, a huge number of one time buyers are not as valuable as a reliable bunch of loyal customers.
This is because it offers a way for businesses to price its products or services strategically. As businesses move online, they can collect huge amounts of data about their customers. Some of this valuable data includes past purchases, browsing history, payment methods and even the web browser that the customer is visiting the site from. Retailers can use this information to charge a price that an individual customer would be willing to pay. This price fluctuates depending on the customer. It allows businesses to target high-end customers with above-average prices while still appealing to bargain shoppers.
Dynamic pricing may sound like it only benefits merchants. However, when it is implemented correctly it can provide benefits for savvy customers, too. This is a part of its appeal for businesses. Customers love to know that they got the best deal on a product, especially compared to their neighbors. This is part of the principle that drives the increasing popularity of shopping events like Black Friday. Customers will go to incredible lengths to get a new TV at a low price. The ability to readjust prices to increase profit margins after these sales would allow retailers to run these events without suffering in the long-term.
HOW TO IMPLEMENT DYNAMIC PRICING
Different Types of Dynamic Pricing
Segmented Pricing: Segmented pricing features a pricing strategy that offers different pricing for different customers. For example, high-value customers might be offered prices that are higher because they are willing to pay more money for a faster or higher quality service.
Peak Pricing: Peak pricing is used by different industries to charge extra money for the use of services that take place during peak hours. For example, a train ticket may cost twice the price between 7 AM and 10 AM but the price will drop after the peak commuting hours.
Time Based Pricing: Businesses use a time based pricing strategy when they charge more money for faster services. Different industries will use this pricing structure to charge higher prices for same-day services. Other ways to implement this structure include charging more for orders that are processed close to the end of business hours.
Penetration Pricing: Penetration pricing is a dynamic pricing strategy that involves a business setting the initial price of a product below normal market level in order to drive demand. The low price is designed to reach a large portion of the market but can also be used to increase market share.
Changing Conditions: The changing conditions strategy involves a business using a strategy to boost profits when the conditions of the market are changing. For example, when there is a lot of uncertainty in the market or the market opportunity has only a short window of time. This strategy works by lowering the price as sales begin to fall and then raising the prices back up again.
Learn how Airbnb is using dynamic pricing to optimize its revenues.
Software and Tools
Setting up a dynamic pricing strategy requires you to sift through mountains of customer and competitor data. Almost no company has the time or resources to manually look at every single piece of data to offer the best pricing. As a result, you will almost always rely on software to do the brunt of this work for you.
This software will automate the process which allows you to set prices in real time and make decisions quickly. It helps increase profit margins and decrease the costs of getting there. The software is also heavily customizable so that prices can be adjusted according to the metrics that are most important to a business’s sales strategy.
What to Do
The most effective way to using dynamic pricing it to use it to motivate consumer behavior. Peak pricing helps widen profits during peak hours. However, it also helps even out your customers by driving more price savvy customers to off-peak hours. This helps distribute your business more evenly throughout the day rather than struggling through surges and troughs.
There are also things that you have to do if you want dynamic pricing to work for you. First, you need to be transparent about your prices. Whether it is written in a user agreement or a disclaimer, your customers need to have access to information that informs them clearly that the prices of goods and services are dependent on certain parameters. Although it seems counterintuitive to lay out you price plan, not doing so appears disingenuous and is in bad faith.
You should also be sure not to use price discrimination to discriminate against customers. Don’t prioritize consumers with disposable income and big expense accounts over those who have less disposable income. Having a few big customers who spend a lot of money is only viable when you also have a lot of smaller customers to supplement them.
For example, if you used your pricing to attract a few high paying customers and drive away low-end customers, you would find yourself in real trouble should one of the rich customers decide to defect to another brand.
Finally, you must make sure that you are using a proper value metric. Value metrics are the measurements that you use to determine what you charge and how you are charging it. You need to make sure that it fits the customer need and is easy for you to understand. You also need to make sure that your metrics can grow and change with your customer base. Carefully monitoring of changes in your customer base are essential for using dynamic pricing effectively.
What Not to Do
Dynamic pricing can be a bad thing for a brand. The key is to avoid too much price discrimination. To understand the difference between acceptable price discrimination and taking dynamic far, it is useful to look at a recent operating issue with Uber.
Uber operates a low-cost ride share service. The company implemented a ‘surge pricing’ policy during which Uber will raise the prices of its service across the geographic area. This surge pricing might include peak taxi service times such as rush hour or after a large event ends.
However, Uber has been accused of exploiting its customers by using this method. Uber implemented its surge pricing model during a snow storm in New York. Customers complained that the pricing was unfair. This damaged Uber’s reputation in a market where it is already tenuous. While it did not damage the unique value proposition offered by Uber, it did open a door for Uber’s competitors to gain a greater foothold in light of a city of upset customers.
Uber makes a great case study because it offers a valuable lesson. You should be sure to evaluate the reason for market demand before driving up prices. If market demand for a new gaming system is going up because of a new launch or a holiday, then adjusting prices is a fair way to capitalize on the market. However, if market demand for bottled water is going up because of a natural disaster, this is not the time to drive up prices on water or other necessities. Though it may not affect your business in the short-term, it will damage your brand when the disaster is over.
Ultimately, you can use dynamic pricing to raise your profits. However, you must be careful to avoid looking like a profiteer.
THE FUTURE OF DYNAMIC PRICING
Dynamic pricing is here and it is here to stay. Since it has benefits for businesses and customers, it offers a new way to price in-demand items which have the potential to boost growth.
As businesses learn to communicate the price structure in an effective way, dynamic pricing is likely to become more common place. Currently, those who use this method of pricing include large corporations and retailers like Wal-Mart and Amazon. However, it is worth noting that dynamic pricing could offer real value to the small business sector as well as large corporate chains. This is because dynamic pricing can be used to do more than manipulate customer behavior. It may be able to fine tune individual behavior as well. For the growing small and medium size business market, this could offer real opportunities to make the most of their pricing structure.
As dynamic pricing software becomes more advanced, the strategy will become more palatable to customers. Advances in this software and its applications can iron out the kinks that currently irritate customers. The more smoothly these processes are able to flow, the easier it will be to roll out on a wider scale.
Dynamic pricing is already a regular feature of the marketplace. While it is currently used to drive profit margins for large, recognizable brands, it may soon be an option for small to medium size businesses as well. While dynamic pricing is of benefit to businesses, it should also offer benefits to customers as well if it is to work effectively. Ultimately, for price discrimination methods to work the way they should, it should not discriminate against all of your customers!
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