Dynamic pricing is the practice of having multiple price points based on several factors, such as customer segments, peak times of service, and time-based consumption that allow the company is applying dynamic pricing to expand its revenue generation.
Thus, wherein a static or fixed pricing a company applies the same price level to any customer and market condition, in a dynamic pricing strategy a company applies several prices based on a few critical factors for the business.
Aspect
Explanation
Definition of Dynamic Pricing
Dynamic Pricing is a pricing strategy in which the price of a product or service is continuously adjusted based on various factors, such as demand, supply, market conditions, competitor pricing, and customer behavior. This approach contrasts with static pricing, where prices remain fixed for an extended period. Dynamic pricing leverages data and technology to set prices dynamically, responding to real-time changes in the business environment. It is commonly used in e-commerce, travel, hospitality, and other industries to optimize revenue, maximize profitability, and balance supply and demand. Dynamic pricing systems often employ algorithms and machine learning to analyze data and make pricing decisions that can vary by the hour, day, or season. The goal of dynamic pricing is to set prices that reflect the current market value and capture the most revenue possible.
Key Concepts
Several key concepts define the Dynamic Pricing strategy:
– Real-Time Adjustments
Real-time adjustments are a core concept of dynamic pricing. Prices are continuously monitored and updated to reflect changing market conditions and demand. Algorithms and automation play a crucial role in making these adjustments swiftly. Real-time adjustments enable businesses to stay competitive and maximize revenue.
– Data Analysis
Data analysis is essential for dynamic pricing. Businesses gather data on customer behavior, competitor pricing, historical sales, and market trends. Analyzing this data helps identify pricing patterns and determine the factors that influence price changes. Data-driven insights drive dynamic pricing decisions.
– Personalization
Personalization involves tailoring prices to individual customers based on their past behavior, preferences, and willingness to pay. Dynamic pricing systems can offer personalized discounts, promotions, or pricing tiers. Personalization enhances customer engagement and loyalty.
– Competitive Intelligence
Monitoring competitor pricing is crucial in dynamic pricing. Businesses analyze the prices set by competitors and adjust their own prices accordingly to remain competitive. Competitive intelligence ensures that pricing decisions are aligned with market conditions.
Characteristics
Dynamic Pricing is characterized by the following attributes:
– Fluctuating Prices
Prices in a dynamic pricing strategy can change frequently, sometimes multiple times per day. These fluctuations are driven by real-time data analysis and algorithms that respond to market dynamics. Fluctuating prices reflect the current market conditions.
– Demand Sensitivity
Dynamic pricing is highly sensitive to changes in demand. Prices may increase during peak demand periods and decrease during low-demand times. Businesses aim to balance supply and demand efficiently. Demand sensitivity optimizes revenue and resource allocation.
– A/B Testing
A/B testing involves experimenting with different pricing strategies to determine which one generates the most revenue or profit. Businesses may test variations of pricing models, discounts, and promotions to identify the most effective pricing approach. A/B testing supports data-driven decision-making.
– Price Optimization
Price optimization is a key goal of dynamic pricing. Businesses seek to find the optimal price point that maximizes revenue while considering factors like customer behavior, market conditions, and competitive pricing. Price optimization enhances profitability.
Examples of Dynamic Pricing
Dynamic pricing is applied in various industries and contexts:
– Airline Tickets
Airlines frequently use dynamic pricing to adjust ticket prices based on factors such as seat availability, booking time, and demand. Prices may increase as the departure date approaches or during peak travel seasons. Dynamic pricing helps airlines optimize revenue from available seats.
– Ride-Sharing Services
Ride-sharing platforms like Uber and Lyft employ dynamic pricing during periods of high demand, such as rush hours or major events. Fares increase temporarily to encourage more drivers to be available and balance supply with demand. Dynamic pricing helps ensure ride availability during peak times.
– E-commerce Retail
Online retailers often use dynamic pricing to adjust product prices based on factors like customer browsing history, competitor prices, and inventory levels. They may offer personalized discounts or adjust prices during sales events. Dynamic pricing enhances competitiveness and revenue for e-commerce businesses.
– Hotels and Accommodations
The hospitality industry relies on dynamic pricing to set room rates based on factors like occupancy levels, seasonal demand, and local events. Hotels may adjust prices daily to maximize revenue and occupancy rates. Dynamic pricing helps hotels optimize room revenue.
Benefits and Considerations
The Dynamic Pricing strategy offers several benefits and considerations:
– Revenue Optimization
Dynamic pricing helps businesses maximize revenue by setting prices that align with current market conditions and demand fluctuations. It ensures that prices are competitive while capturing the willingness to pay of customers.
– Competitive Advantage
Businesses that effectively implement dynamic pricing can gain a competitive advantage by staying responsive to market dynamics and offering competitive prices.
– Customer Engagement
Personalized pricing and promotions can enhance customer engagement and loyalty by tailoring offers to individual preferences and behaviors. However, businesses must be transparent in their pricing practices to build trust with customers.
– Complex Implementation
Implementing dynamic pricing requires robust data analytics and pricing algorithms, which can be complex and resource-intensive. Businesses must invest in technology and expertise to effectively execute dynamic pricing strategies.
Table of Contents
When price tags didn’t even exist
Today we go to any store find a price tag and assume that is the value of that item we’re purchasing. There’s no question asked, nor interaction in many cases with the clerk. Yet there was a time when price tags didn’t exist.
Finding the origin of things is always hard. Before the 19th-century price tags didn’t exist. In other words, before buying anything you needed to bargain and haggle with the clerk to finalize the purchase.
When price tags got introduced, they did represent an incredible innovation.
Indeed, stores could finally manage more inventories with fewer clerks. That’s because clients needed to walk to the clerk to ask for the price and after haggling, a bit agree on the purchase.
This might have been time-consuming in terms of the clerks required to manage the inventories, the training needed to have clerks know the price ranges, and what was allowed. And the time it could take for customers to bargain the price.
As price tags have become the norm, where the same prices are applied to anyone, we find it odd when on the web the same thing changes in price.
In many cases, we look for a flight ticket, which price is different, or an item on a popular e-commerce platform that according to where and when we browse shows us a slightly different price.
This makes us wonder whether the era of price tags is over in favor of what is called dynamic pricing.
Also, many dynamic pricing strategies are already used in many of the products or services you might buy. It’s just that you don’t realize that.
What is dynamic pricing?
Dynamic pricing is the practice where prices for goods or services change based on several factors.
Think of the case in which there is a surge in demand for a service (Uber for example), and the price of it rises accordingly.
Uber is a two-sided marketplace, a platform business model that connects drivers and riders, with an interface that has elements of gamification, that makes it easy for two sides to connect and transact. Uber makes money by collecting fees from the platform’s gross bookings.
Therefore, there are certain times of the day or certain periods where the same service or item can be sold for more. Also, at a certain interval of time, the demand for a service might be higher. Think of the case of more people trying to purchase a ticket for a concert which might drive the price up.
Is dynamic pricing legal?
As fixed prices have become the norm after the 19th century, people often wonder whether dynamic pricing is legal.
Yet it is when price discrimination depends on economic factors that are affected by demand and offer. In other cases, if price discrimination might be based on gender, race, or religion that becomes illegal.
Technological changes are enabling dynamic pricing
Think of the case in which you enter a store to purchase a coffee and pay $2. Yet a person enters the same coffee shop and purchases the same coffee for $1.
Would you feel good about it? Chances are you’d feel ripped and perceive the so-called dynamic pricing as a fraud.
Think of a different scenario. If you’re purchasing an item on e-commerce, that item price is set according to several factors.
The algorithm that drives the offering on the e-commerce platform has quite some data about your behavior, and spending habits, it knows your location, and it knows the time of purchase.
Based on all those variables it determines the price of the good you’re buying. You would perceive it as all done algorithmically and automatically by a machine, which is not thinking. You might perceive it as technological advancement.
Besides, if you don’t feel like buying, you can see quite the e-commerce and get back when and if prices are lower.
The fact that technology nowadays allows platforms to embed algorithms makes it easy for those companies to leverage dynamic prices and makes it easier for consumers to accept this practice.
How can you apply dynamic pricing to your business?
If you’re evaluating dynamic pricing for your business, then it makes sense to understand whether your business model might be better off with this approach.
For instance, do you serve several segments that have entirely different budget levels?
Think of a company that serves both consumers and business clients. The former will have a budget that is way lower compared to the latter. In that case, you can achieve higher revenue by simply repackaging your product or service in a different format.
Therefore, for the customer segment with the highest budget, it might make sense to have your service at a certain time of the day. Thus the price for that segment will be higher. In other cases, your product or service might have peaked.
Think of the case of more people consuming electricity at a certain time of the day. Based on simple demand and offer electricity will cost more.
Think also of a coffee shop for which customers purchasing from the early hours of the morning are willing to pay more. You can create a fast track that makes the price higher for those customers.
Think also of the case of e-commerce that does business around the world. In certain countries (like the US and Canada) the value of the service is higher and the spending ability as well.
Therefore, based on the IP of the user accessing your store prices will change to reflect local spending habits.
In short, there are several ways in which you can apply dynamic pricing to your business, and it boils down to a few scenarios:
Peak or surge pricing: based on peak hours or periods where the service gets charged more.
Segmented pricing: based on the spending ability of some customers compared to others.
Changing conditions: applied for instance when sales start to slow down due to macroeconomic factors, to keep up with the trend and adjust them upward again when the market gets better.
Time-based pricing: offer faster service for a higher charge.
Penetration pricing: lower the price of service as a sort of marketing expense to penetrate a markets
Other dynamic pricing examples
To better understand why prices fluctuate in response to various factors, we’ve mentioned some dynamic pricing examples below.
In the current online e-commerce industry, there are many examples of dynamic pricing.
Indeed, as most of the interactions happen without a salesperson in the way of finalizing the transactions, digital platforms experiment as much as possible with pricing dynamics that match users’ journeys with the final product price.
Let’s see some of them.
Booking.com dynamic pricing
One example is Booking’s Occupancy-Based Pricing. As Booking explains:
Occupancy Based Pricing allows you to maximize the occupation rate of your more spacious (but, usually harder to book) and most valuable rooms by offering a tailored price depending on the number of people staying in each room.
The occupancy-based pricing works in this way. If perhaps a room can fit up to 4 people, instead of offering a single option, for 4 people, the property owner can offer the room for groups of 3, 2, or even to a single guest. Each group will have different pricing.
Example with Occupancy-Based Pricing, for a Quadruple Room:
Price for 4 people: 100$
Price for 3 people: 90$
Price for 2 people: 80$
Price for 1 person: 60$
This enables the owner to fill the room more easily while matching the proper price with the potential customer’s needs.
Amazon dynamic pricing
Amazon has a diversified businessmodel. In 2021 Amazon posted over $469 billion in revenues and over $33 billion in net profits. Online stores contributed to over 47% of Amazon revenues, Third-party Seller Services, Amazon AWS, Subscription Services, Advertising revenues, and Physical Stores.
One of the digital platforms that are able to leverage dynamic pricing is definitely Amazon. Indeed, on Amazon, also a product like the Kindle might change in price throughout the year:
Kindle price chance tracked by Keepa
The price chance will depend on multiple factors, including seasons, the ability of third-party sellers to run their own campaigns on the platform, and Amazon’s experimentation with pricing to enable more convenience compared to retail prices.
Airbnb smart pricing
Airbnb is a platform business model making money by charging guests a service fee between 5% and 15% of the reservation, while the commission from hosts is generally 3%. For instance, on a $100 booking per night set by a host, Airbnb might make as much as $15, split between host and guest fees.
When you have Smart Pricing turned on, your pricing suggestions reflect the controls you’ve set, combined with a lot of data. In fact, Smart Pricing takes into account over 70 different factors that could change your price.
What are some of the factors taken into account? As Airbnb points out, some of those factors might comprise:
Lead-time or how close is the booking to the check-in date.
Market popularity or how many people are looking for the same home (of course, the price will go up for more popular locations).
Seasonality, as the high season comes close the prices will go up.
Listing popularity or the pricing increase as the listing gets more and more views.
Listing details or the more amenities you add to the listing the more the price might increase or vary.
Bookings history or when the host closes higher booking rates compared to what the algorithm suggested, the pricing will adjust to that new pricing, so enable the host to earn more.
Review history or as the listing gets more positive reviews the price will adjust upward, based on those reviews.
In 2021, Airbnb generated enabled $46.9 Billion in Gross Booking Value, and it generated $6 Billion in service fee revenues. In 2021, there were $300.6 Million Nights and Experiences Booked, ad an average service fee of 12.78%, at an Average Value per Booking, of $155.94.In Q3 2022, Airbnb recorded its most profitable quarter ever. With revenues of $2.89 billion in Q3 2022, Airbnb posted a record of $1.21 in net income. The first nine months of 2022 posted revenues of $6.5 billion and a net income of $1.64 billion. Thus Airbnb will be profitable in 2022.
Airline ticketing
Like the vast majority of airlines, American carrier Delta Airlines utilizes dynamic pricing in its airfares to maximize profit. How does this play out in practice?
Higher prices if there is less competition – Delta adjusts its prices according to the level of competition on certain routes. Industry analyst AI Multiple found that Delta charged around $200 more for its Minneapolis-St Paul (MSP) to Detroit Wayne County (DTW) route than a flight from MSP to Lansing. Both routes are around 650 miles, but since Delta was the only airline flying between MSP to DTW, it could charge a higher price.
Higher prices for frequent flyers – according to a piece published in Time Magazine, Delta was at one point charging its frequent flyers $300 more than an economy seat on the same flight. Experts believe Delta was able to use dynamic pricing because frequent flyers were often businesspeople who needed to travel frequently.
Event ticketing
Dynamic pricing is also used to sell more tickets at major sporting events. In 2011, baseball team the San Francisco Giants initiated a project to become the first pro sports team to use the approach.
Team management identified that consumer demand was ultimately determined by:
The time and day of the match.
Who was pitching, and
Whether there were any special promotions.
Based on this information, they introduced the SaaS application Qcue into their ticketing system.
The app, which analyzes dozens of factors to provide price recommendations, was trialed on 2,000 seats in the outfield and upper deck which were usually the last to sell.
Qcue’s algorithm was fine-tuned in the months after, with ticket prices rising in value in response to factors such as Friday night fireworks or the rock-star-esque appeal of pitcher Tim Lincecum.
In 2010, Qcue was rolled out park-wide with daily price recommendations increasing club revenue by $7 million.
Utility consumption
While most households in the United States pay a flat, per-kilowatt-hour fee for their electricity, dynamic pricing and smart meters are now seen as a way to foster sustainable energy use.
In this context, consumers pay a higher price for electricity when storms or heat waves reduce the supply of available energy.
Smart meters then alert consumers via text or SMS that the price of power will be increasing over a set period, which encourages consumers to turn off appliances on standby and reduce discretionary power use.
Dynamic pricing has already been rolled out in Washington, D.C., where consumers reduced energy consumption in response to price increases during peak demand.
Aside from the environmental benefits of sustainable energy use, dynamic pricing when applied on a broader scale is seen as an effective way to reduce the risk of system-wide blackouts.
Pricing Strategy Examples
A pricing strategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricing strategy aligns the customer with the company’s long term financial sustainability to build a solid business model.
From the FourWeekMBA research, we identified 14 pricing example formulas that you can borrow for your business:
AppSumoed: transforming subscriptions in lifetime deals
This implies a pricing formula, where to launch your product (especially for software products) you move (temporary) to a one-time deal. This enables the product to quickly gain traction.
Auction: the winner takes it all
In an auction pricing strategy, two or more people bid on a product, and the product gets sold to the bidder who offers the most.
Bundled: more for less
Bundling consists of grouping a set of products and services, more conveniently priced if they were priced singularly.
Consumption-based: pay what you consume
In a consumption-based model, customers only pay when the product gets used. This is usually well suited for those services or products that require continuous usage.
Couponized: discounted as default
In a “couponized” scenario, the platform acts as a deal platform where you can find default continuous discounts.
Fixed-price: the safe price
In a fixed-pricing pricing strategy, the company “promises” to keep the same pricing level forever, thus assuring customers about the potential future market fluctuations.
Pay-as-you-go: charge it up and go
In a pay-as-you-go pricing strategy, you can enable customers to prepay for a certain level of service to be used at their discretion.
Pay as you want: customer-made pricing
In a pay-as-you-want model, customers make the price.
Platformed: get a cut on one or both sides
In a platform business model, you can make money by charging a single side of the platform (LinkedIn charges recruiters) or by collecting a fee from both (Airbnb earns a commission from both hosts and guests).
Psychological pricing: change the product’s perception
In a psychological pricing strategy, rather than changing the physical nature of the product offered, you can leverage on psychological elements to carve the perception around your product.
SaaSified: transform a product into a service
In the SaaS industry, most software is sold as subscription services.
Subsidized: let the rich pay for the poor
In a subsidized pricing strategy, a set of customers pay for everything else. This pricing strategy makes the product free for most customers while the premium for others.
Uberized: dynamic pricing
Dynamic pricing is the practice of having multiple price points based on several factors, such as customer segments, peak times of service, and time-based consumption, that allows the company to apply dynamic pricing to make the transactions on the platform more scalable.
Unbundled: let them get what they want
In an unbundled scenario, rather than trying to lock in with a higher-priced product bundle, the company can make available the only product people want the most.
Key Takeaways
Origin of Price Tags: Price tags became commonplace in the 19th century, replacing the need for bargaining and haggling with clerks when making purchases.
Benefits of Price Tags: The introduction of price tags allowed stores to manage inventory more efficiently, reducing the need for numerous clerks and streamlining the purchasing process.
Dynamic Pricing Definition: Dynamic pricing is a strategy where prices for goods or services change based on various factors, adapting to market conditions and demand fluctuations.
Examples of Dynamic Pricing: Dynamic pricing is seen in various industries, such as Uber adjusting prices during peak demand or concert tickets varying based on popularity and timing.
Legality of Dynamic Pricing: Dynamic pricing is legal when it’s based on economic factors influenced by demand and supply. Illegal price discrimination based on factors like gender, race, or religion is not allowed.
Technological Advancements: Technological advancements enable platforms to use algorithms for dynamic pricing, which is perceived as less fraudulent than manual adjustments by salespeople.
Applying Dynamic Pricing: Businesses can apply dynamic pricing by considering factors like peak times, customer segments, segmented pricing, changing market conditions, and regional spending habits.
Dynamic Pricing Examples: Dynamic pricing examples include Booking.com’s occupancy-based pricing, Amazon’s price fluctuations for products, Airbnb’s smart pricing, and airlines adjusting fares based on competition.
Impact on Airline Tickets: Airlines use dynamic pricing to adjust fares based on competition and customer types, such as frequent flyers paying more for the same seat.
Event Ticketing: Dynamic pricing is used in selling event tickets, with factors like time, day, and special promotions influencing ticket prices.
Utility Consumption: Smart meters and dynamic pricing are employed in utilities to encourage energy conservation during peak demand, reducing the risk of blackouts.
Pricing Strategy Examples: Various pricing strategies can be used based on business models, including bundled pricing, fixed pricing, pay-as-you-go, psychological pricing, and more.
Dynamic Pricing in the Digital Age: Dynamic pricing is a common practice in e-commerce, with algorithms adjusting prices based on user behavior, spending habits, location, and other variables.
Unbundled Strategy: Offering products or services separately, catering to specific customer preferences instead of bundling them together.
Why do companies use dynamic pricing?
Dynamic pricing can be used for several reasons. In some cases, it can help gain market shares or tackle demand and supply in a network. Take the case of how Uber used dynamic pricing to make some routes more interesting to drivers in specific areas and times of the day. Or how dynamic pricing helped Uber make rides more convenient for riders, thus gaining market shares.
What factors affect dynamic pricing?
The structure of the market, network, demand, and supply dynamics are all factors that influence dynamic pricing. Dynamic pricing, if adequately rolled out, can help improve the value of a network by regulating demand and supply, thus making the network more fluid.
Is dynamic pricing fair to customers?
In some instances, dynamic pricing can enhance a service. Take the Uber rides that are unavailable at specific times or areas. While dynamic pricing might make these rides more expensive, it also enables an additional service to be available to customers. In other cases where demand is scarce, dynamic pricing might make the price lower for customers, in order to incentivize the market’s demand.
Price skimming is primarily used to maximize profits when a new product or service is released. Price skimming is a product pricing strategy where a company charges the highest initial price a customer is willing to pay and then lowers the price over time.
Productized services are services that are sold with clearly defined parameters and pricing. In short, that is about taking any product and transforming it into a service. This trend has been strong as the subscription-based economy developed.
Menu costs describe any cost that a business must absorb when it decides to change its prices. The term itself references restaurants that must incur the cost of reprinting their menus every time they want to increase the price of an item. In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.
A price floor is a control placed on a good, service, or commodity to stop its price from falling below a certain limit. Therefore, a price floor is the lowest legal price a good, service, or commodity can sell for in the market. One of the best-known examples of a price floor is the minimum wage, a control set by the government to ensure employees receive an income that affords them a basic standard of living.
Predatory pricing is the act of setting prices low to eliminate competition. Industry dominant firms use predatory pricing to undercut the prices of their competitors to the point where they are making a loss in the short term. Predatory prices help incumbents keep a monopolistic position, by forcing new entrants out of the market.
A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors.
The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.
The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.
A price maker is a player who sets the price, independently from what the market does. The price setter is the firm with the influence, market power, and differentiation to be able to set the price for the whole market, thus charging more and yet still driving substantial sales without losing market shares.
Revenue model patterns are a way for companies to monetize their business models. A revenue model pattern is a crucial building block of a business model because it informs how the company will generate short-term financial resources to invest back into the business. Thus, the way a company makes money will also influence its overall business model.
Geographical pricing is the process of adjusting the sale price of a product or service according to the location of the buyer. Therefore, geographical pricing is a strategy where the business adjusts the sale price of an item according to the geographic region where the item is sold. The strategy helps the business maximize revenue by reducing the cost of transporting goods to different markets. However, geographical pricing can also be used to create an impression of regional scarcity, novelty, or prestige.
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors.
Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organizationscale further.
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
Kindle price chance tracked by Keepa
