Dynamic pricing is a product pricing strategy that’s as old as civilization itself, but it declined in popularity during the Industrial Revolution (1760-1840). However, after a change in United States legislation, it reemerged in the 1980s when airlines began to change their prices based on supply and demand. After seeing how profitable this was, hotels and the travel-tourism industry in general followed suit. Consumers didn’t like it and still don’t like it, but tolerate it.
Dynamic pricing popped up again with ride hailing services, who introduced “surge pricing” during times of high demand. With ride hailing services though, the prices only go (sometimes very far) above the base price — never below — which consumers believe is unfair considering that it’s an everyday expense.
And now ticket distributors have introduced dynamic pricing, causing tickets to be priced as exorbitant as $22,700.
Is dynamic pricing inherently unfriendly to consumers, or is there a way to implement it ethically? Is it even as profitable as it seems? In this article, you’ll learn what dynamic pricing is (with examples), the pros and cons of implementing it, and how to implement it.
Dynamic pricing is a supply and demand-based product pricing strategy designed to maximize profits (not to be confused with internationalization, where product price depends on customer location). With the dynamic pricing model, the cost of a good or service increases as demand increases and can go up significantly depending on popularity.
When implementing dynamic pricing you need to be careful not to exceed the cost of what customers are willing to pay. Depending on the industry, you might also have to contend with ethical concerns regarding price gouging.
While dynamic pricing can be a successful model for your product, it isn’t always that effective. The following examples highlight cases where companies attempted to introduce dynamic pricing only to watch it backfire.
Airlines use dynamic pricing to change the price of flights depending on supply and demand. A lower supply means that there are fewer flights remaining or there weren’t many to begin with — these flights cost more. Higher demand can mean seats are selling fast or are expected to sell fast due to the time, day, or season of travel (based on historical data) — these ones also cost more.
While travel and tourism is somewhat of a luxury, the way that airlines exploit consumers’ lack of options is still unethical. Perhaps you can forgive flights to South Korea being more expensive during cherry blossom season, but what about families with children who are only able to travel during the summer holidays?
That being said, last-minute flights are cheaper, due to low demand. Even though this comes down to desperation rather than compassion (some revenue is better than no revenue), it shows that dynamic pricing isn’t always unfriendly to consumers. Additionally, savvy customers can utilize “flight hacks” to find cheaper flights by “tricking” the algorithm.
Hotels, homestays, and the travel-tourism industry in general operate in the same way, and consumers tend to tolerate it because it’s always been the norm.
Ride hailing services increase the price of rides before and after live events, and during rush hour and even bad weather. This is called “surge pricing” because the prices never really dip below the standard rate; they only surge when customers need rides the most.
This is unethical because it’s an everyday need and ride hailing services aren’t even covering car-related costs or paying the drivers upfront. These platforms just run an app that, relatively speaking, doesn’t cost much.
Ticket distributors are more akin to airlines in the way that prices are lower for events that aren’t selling. However, ticket distributors are more unethical because events in high demand are absurdly expensive; hundreds or even thousands of US dollars expensive.
Additionally, ticket distributors intentionally sell tickets to scalpers to inflate their prices, pressuring people to pay more and quickly. Newer implementations of dynamic pricing tend to be greedier and more unethical.
Although dynamic pricing might only seem like a way for companies to exploit customers for profit, there are instances where you can use it for less nefarious ways.
Amazon (to give just one example) changes the price of its first-party products, on average, every ten minutes. This boosts their profits by 25 percent. However, its prices remain fair because its products are usually inexpensive to begin with.
You probably didn’t even know that Amazon used dynamic pricing, which is a good indicator of it being used well.
The outcome for your customers can vary depending on the approach you take, but now let’s turn our attention to dynamic pricing from a product management perspective.
In addition to the extra profit that Amazon gains from dynamic pricing, Airbnb hosts are four times more likely to get bookings with “smart pricing” (dynamic pricing) turned on.
However, there’s more at play here than higher profits in the short term. Amazon and Airbnb are actually in two very different places and a huge part of that is how greedy they are with their customers and how that impacts their brand in the long term.
Dynamic pricing can also be used to sell products that would otherwise go unsold. Even selling products at-cost is beneficial because it helps businesses get their foot in the door with new customers and also prevents financial losses.
Putting aside how ethical Amazon and Airbnb are overall, their approach to dynamic pricing and how they treat customers in general is very different.
As an experiment, I tested their dynamic pricing algorithms — two products, 24 hours apart, after feigning interest in them. Airbnb went up by 122 percent and the Amazon product went up by 131 percent, which is pretty similar. The difference however, is that first-party Amazon products (e.g, USB cables) have much smaller price points than Airbnb.
You probably wouldn’t bat an eyelid at paying a dollar or so more for a cable, but over $100 more on an Airbnb?
The reality is that people are becoming less tolerant of corporate greed and it’s probably only a matter of time before dynamic pricing stops being profitable for brands that abuse it.
If you decide to pursue dynamic pricing for your product, you can follow these steps to help you get started.
First, you need to learn how sensitive your customers are to price changes. Knowing this determines how often you can change the price of your product, and more importantly, by how much.
Pricing can become a part of your brand. Want to eat cheap? McDonald’s. Want a cheap coffee? Not Starbucks. The ability to make snap decisions like this comes down to the pricing aspect of the brand’s identity.
Make sure that you set a minimum and maximum price from within your dynamic pricing software to ensure that your products reflect what your brand stands for. You can use the results of price sensitivity surveys to ensure that your product’s prices never drop below or go above what customers deem fair.
It’s worth noting that willingness to pay doesn’t necessarily mean a customer is happy to pay, so the dynamic pricing algorithm you end up with as a result of your price sensitivity surveys can still damage your brand. Proceed with caution; no brand is immune to scrutiny.
Customers don’t want to feel cheated. MediaMarkt combats this by offering partial refunds if a customer finds a lower price for the same product somewhere else. This is mostly a concern for more expensive products where the price increase is more noticeable.
Dynamic pricing algorithms take multiple factors into account — units left, units sold, inventory drain rate, price elasticity, time of day, day of week, season, how much your competitors are charging — and some industries have unique factors. For this reason, it’s impossible to compare to dynamic pricing software.
Instead, you’ll want to look towards industry-specific dynamic pricing software. For example, a quick Google search for “dynamic pricing software hotels” will reveal dozens of options and “dynamic pricing software ecommerce” will reveal dozens more. Giants like Amazon, Uber, and Ticketmaster have probably implemented their own solutions, which is another option if you have the resources to do so.
All-in-all, it’s clear from the fact that dynamic pricing still exists that it’s profitable; however, it can affect how a brand is perceived. People are becoming less tolerant of corporate greed, so using dynamic pricing too aggressively (by measure of what your customers say, not what other companies are doing) can hurt your brand, which is likely to impact your profits in the future.
Plus, dynamic pricing doesn’t have to be about charging more when demand is high — you can use it to reduce the number of unsold units when demand is low by charging less or perhaps even by selling at-cost to at least reduce losses.
Featured image source: IconScout
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