Dynamic Pricing Model
How to Implement a Dynamic Pricing Strategy
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Recently I was interviewed about dynamic pricing by Tixboo, a dynamic ticket pricing company out of the UK. Interestingly enough, that same week I encountered an intoxicated gentleman on a Boston bus openly complaining about the New England Patriots’s new dynamic pricing policy for ticket prices.
Whenever pricing strategy becomes worthy of a drunken rant; you know it’s a big deal — and a great opportunity to explore a concept that can boost revenue.
Yet, over the past few years companies utilizing dynamic pricing have come under fire from consumers. While the push for fatter margins through pricing is admirable, these implementations fell short of a few tests to ensure customers and the business were ready for such a dynamic and variable step.
To ensure you don’t make the same mistake(s), let’s take a dive into what exactly constitutes dynamic pricing, review some pros and cons, and then present some ways to make your pricing dynamic – without the backlash.
What is dynamic pricing?
At its core, the dynamic pricing model is the concept of selling the same product at different prices to different groups of people. Technically, this is the same definition as “price discrimination”, an illegal practice with roots in the Robinson-Patman Act of 1936.
Yet, that Act has more holes than a wheel of swiss cheese, which makes any legal basis of a price discrimination lawsuit incredibly grey, especially when dealing with non-commodity goods online. In fact, US Courts and the Federal Trade Commission have repeatedly shot down dynamic price discrimination cases unless the discrimination took place on the bases of a suspect category (gender, race, sexual orientation, etc. and is incredibly difficult to prove) or was anti-competitive, which is highly unlikely to occur in an online market.
As a result, business have taken it upon themselves to institute dynamic pricing in two forms:
1. Dynamic pricing based on groups
In this scenario, companies are using machine learning algorithms or just statistical splicing to offer different prices to different groups. This can be as simple as a split A/B test or more sophisticated by predicting a higher willingness to pay based on machine type, location, demographic information, etc. and showing a different price to a particular group. Most lawsuits and consumer backlash involves this form of dynamic pricing (although, few of these lawsuits have been won by consumers).
2. Dynamic pricing based on time
My drunken subway friend was complaining about this form of dynamic pricing – having a price go up or down based on time. In its most basic form you’ll see this purely in a car lot – at the end of the month prices are lower as salespeople push for quotas. In a highly sophisticated method, individuals will use something like Tixboo to make these decisions on the fly to maximize revenue for events and meet different levels of demand.
Is dynamic pricing fair?
In its purest form, we all should theoretically be perfectly ok with dynamic pricing, because we, the consumers, ultimately have a decision of whether we’re going to purchase the product or not. The onus is on the producer to make sure the price presented meets our willingness to pay to ensure a purchase — aligning to our own personal equilibrium price with real-time pricing.
If you’re not willing to pay for the product, you’ll leave and maybe come back when there’s a sale or a cheaper version. If you’re willing to pay for the product, then your utility is met and you’re none the wiser about your friend getting a cheaper price. It’s perfect pricing and harmony in the free market.
Consumers don’t think so
Unfortunately, like most economic theories, reality is a bit more complicated. When blatant dynamic pricing is revealed to a consumer, it appears more like price discrimination than the fluffy world I illustrated above, because we feel like we were just lied to and that we didn’t get as good of a deal as someone else. Years of travel commercials have taught us that we can only hope that the person sitting next to us on the plane paid more than us. Ironically, some how we’re ok with this scenario, but assume everything is nefarious if it occurs with a book on Amazon.
This isn’t a huge deal if your customer never finds out or you’re in a “dynamic industry” – travel, tickets, etc. Yet, for most SaaS products (and I would argue most retail products, as well), we’re awful at tracking and measuring the different equilibrium prices for our customer groups. Most dynamic pricing engines out there don’t get enough real-time data to truly differentiate. Even then, tracking technology hasn’t gotten to the point where we can ensure that an individual who received a price on Tuesday gets the same price on Friday or even shows the same price to their business or family member in a different time zone.
The result means that if you have a product where the sales cycle is more than 24 hours or involves multiple people, the risk that your secret gets out increases exponentially with each day and individual involved in the buying process.
How to implement dynamic pricing
This doesn’t mean you can’t institute some aspects of dynamic pricing successfully. After all, not all of your customers are the same, therefore you should be able to extract more revenue from some than others. You just need to implement them in the proper manner:
1. Price Differentiation – Two prices are better than one
One of the bedrock concepts in pricing strategy is to quantify your customer personas and then align your packaging and pricing to those personas. Typically, you’ll find your personas aren’t all created equal, and if you do, then you probably aren’t thinking about your personas properly. You can then offer lower and higher prices on different versions of your product to bring in dynamic revenue from customers of different sizes. For more on product and feature differentiation check out this post.
2. Ensure you’re using a proper value metric
Hand in hand with price differentiation is pricing along a value metric, which is what you’re physically charging for in terms of a product (per user, per GB, etc. ). This is difficult for a retail product, because you’re charging for a physical item, but in the software world, you can split your pricing up based on number of users, amount of storage, number of views, etc. or a combination of multiple metrics. The impact here is every customer is paying you a different among – accounting for dynamism and less cash being left on the table. For more on value metrics, take a look at this break down of value metrics and how to properly use them.
3. Utilize Time in an auction type model
Similar to what many sports teams and concerts are doing with ticket prices, you can make sure your price goes up or down based on time. Airlines and travel booking sites do this all the time. There’s no reason someone launching a software beta or releasing a new widget can’t use dynamism in their pricing.
4. Couponing and Discounts
We’re not a huge fan of discounts, because of their negative impact on future sales and your brand, but they can be used effectively in discretely providing a dynamic price to a subset of prospects or customers. Keep in mind that with social products you’ll want to ensure the coupon doesn’t spread, but this is typically less likely compared to a public site having different prices and is more socially acceptable. For more on discounts and the right way to push for them, check out our discount pricing post.
Be upfront and transparent
Most proponents of dynamic pricing say you should just be transparent that you’re employing dynamic pricing on your site. This is great, but it still doesn’t solve for the cognitive dissonance of, “am I truly getting the right deal? ”
You’ll notice that all of the above suggestions solve for both being transparent and eliminating the feeling of missing out. That being said, although you probably won’t get into legal trouble with dynamic pricing, you need to be careful about your brand, image, and any PR backlash that can leave a long lasting impact. We’ve found price transparency is key and will definitely continue to advocate for more, rather than less.
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pricing strategy
The Ultimate Guide to Dynamic Pricing | Omnia Retail
Dynamic pricing is when a company or store continuously adjusts its prices throughout the day. The goal of these price changes is two fold: on one hand, companies want to optimize for margins, and on the other they want to increase their chances of sales.
Dynamic pricing is a pricing strategy that applies variable prices instead of fixed prices. Instead of deciding on a set price for a season, retailers can update their prices multiple times per day to capitalize on the ever-changing market.
Dynamic pricing often gets confused with personalized pricing. But these two different types of pricing are extremely different from one another.
To put it simply, dynamic pricing looks at your products and and their relative value in relation to the rest of the market. Personalized pricing, on the other hand, looks at individual consumer behaviors and gauges (and changes) a product’s value based on past shopping experience.
Personalized pricing is controversial because it uses individual data and shopping formation that many consumers consider private and personal. It’s also somewhat risky in an age where consumers can interact with and talk to each other like never before. If Consumer A finds out they paid more for the exact same product than their best friend, their trust in a company will erode.
Dynamic pricing, on the other hand, allows you to capture extra sales and take advantage of a changing market without invading consumer privacy or trust.
Dynamic pricing in e-commerce
Dynamic pricing and e-commerce co-evolved together. As the internet became more sophisticated and online shopping grew, so has the need for dynamic pricing.
Consumer electronics was one of the forerunners in the retail landscape in terms of the trend towards online. As a category of elastic products that are sensitive to price changes, it makes sense. Retailers need dynamic pricing to stay on top of the market and continue to offer competitive prices.
But as consumer spending rises in this category (and with it the online market share), two developments that affect dynamic pricing have emerged:
1. Increased price transparency
As more people shop for consumer electronics online, the amount of comparison shopping also increased. Consumers are now far more likely to evaluate a retailer’s prices against the company’s competition.
This shines a spotlight on your product price and makes it the most important part of each sale. Since consumer electronics are typically highly elastic, a 5%-10% difference between your price and your competitor’s could be the deciding factor for a consumer.
2. More frequent price changes
Because of this increased demand for price transparency and matching, the number of price changes every day has increased dramatically since the dawn of e-commerce. Traditionally, the supplier or the manufacturer would determine the price of a product with a consumer advised price (CAP). However, this CAP quickly became irrelevant with the growth of comparison shopping online.
Today, prices are determined by the retailer instead of a supplier, and are based on a variety of variables, including general market trends, competition prices, and stock levels.
A variety of other categories, such as Toys and Games, for example, follow the same pattern: when online spending rises, so does the demand for price transparency. This, in turn, leads to an increased frequency of price changes and the use of dynamic prices.
This trend often also attracts new players on the market without physical stores, which makes it difficult for traditional retailers.
Although the traditional retailers have the first mover advantage, they are generally less flexible in adapting their (pricing) strategy. However, the retailers that do capitalize on their omnichannel advantage can move ahead of the pack.
Dynamic pricing software
Most retailers practice a most basic form of dynamic pricing by discounting items at the end of a season or using a clearance sale to get rid of extra stock.
However, dynamic pricing can go much further than a discount at the end of a season. When you use a dynamic pricing software, you can wield the power of data to capture more sales and take control of your assortment.
Today, almost all major retailers will use some sort of dynamic pricing software.
Dynamic pricing online
Dynamic pricing has obvious benefits online: you can follow the competition, adjust prices instantly, and easily capture quantitative metrics about your store to improve your performance.
Dynamic pricing offline
Dynamic Pricing is also useful offline. Through the use of electronic shelf labels (ESLs), you can easily apply dynamic pricing practices to your physical store. This helps you keep your prices up-to-date with what you present online, and makes pricing management easier.
What are some dynamic pricing strategies?
Traditionally, there are three basic ways retailers set their prices: the cost-plus method, the competitor-based method, and the value based method.
The cost-plus method is the most simple out of all three. All you need to do is take the cost of your product and add the desired margin on top of that cost.
The competitor-based method follows your competition. If your competitor changes their price, you’ll change your price as a result, whether that’s to be lower or higher than your competition.
The value-based pricing method follows the price elasticity of a product. Different consumers value items differently, so everyone has a certain threshold that they are willing to pay for a product. A value-based pricing method capitalizes on the public’s perception of the value of a product and charge accordingly.
Dynamic pricing software allows you to combine different pricing methods at the same time. Some softwares also allow you to incorporate other useful information, such as your stock levels, popularity score, and even the weather forecast.
How to implement dynamic pricing
Implementing dynamic pricing is a journey, one that has a lot of twists and turns. And it does create a big change in your organization. That’s why you should view the adoption of dynamic pricing as an opportunity to improve your overall pricing strategy and internal systems, as well as your overall margin.
Is it hard to get started with dynamic pricing?
After hundreds of implementation projects, we’ve come up with a five-step process to successfully implement dynamic pricing:
Define your commercial objective: Your commercial objective is like your company’s compass: it’ll help you navigate any institutional changes and keep you heading in the right direction. The commercial objective applies to more than just pricing and marketing, but it’s the first step for a successful dynamic pricing strategy. Learn more about how to define your commercial objective here.
Build a pricing strategy: Your pricing strategy takes your commercial objective, then translates it into strategy that your team will use to sell products. An example? Say your overall commercial objective is to be known as the cheapest retailer on the market. Your pricing strategy would then be to make sure every product in your store is cheaper than the competition’s offering. Learn how to build a pricing strategy here.
Choose your pricing method(s): Your pricing strategy tells you what you want to do. Your methods are how you’ll achieve those pricing goals. Your pricing methods are more specific than your pricing strategy.
Establish pricing rules: Pricing rules tell your dynamic pricing software what to do. You should set a rule for every product that the software needs to track and change.
Test and monitor: The final step for getting started with dynamic pricing is to test and monitor your software’s changes. Learn more about testing the effectiveness of your online pricing.
Dynamic pricing: What it is and how you can you use it
Dynamic pricing refers to charging different prices for a product or service, depending on who is buying it or when it sells. Dynamic pricing is sometimes called demand pricing, surge pricing, or time-based pricing. And it’s a reaction to changes in competition, supply, demand, and other market forces.
In 2020, dynamic pricing made headlines when the prices of everyday goods such as toilet paper and hand sanitizer changed dramatically. More common examples are happy hours at your local bar, airline pricing on travel websites, and rideshare surge pricing.
In this article, we’ll explore whether dynamic pricing is an effective strategy for your business.
What is dynamic pricing?
Dynamic pricing is a strategy that involves setting flexible prices for goods or services based on real-time demand. Algorithms and machine learning help facilitate this real-time pricing strategy. Companies can factor in things like supply and demand changes, competitor pricing, and other market conditions to help set product prices.
Dynamic pricing decisions won’t work for every business or industry. But industries that often use dynamic prices include
Hospitality
Travel, including the airline industry
Entertainment
E-commerce businesses
Retail
Electricity
Public transportation
Generally, dynamic pricing favors wealthier consumers. Wealthier consumers have the means to handle price adjustments. Consumers with more limited funds may find themselves priced out of the market when prices increase. They may wait for lower prices or sales to purchase goods or services.
What is an example of dynamic pricing?
Sometimes, dynamic pricing results in unintended consequences for business owners. Let’s take a look at a recent example of how real-time price changes impacted a small business selling on Amazon.
Dynamic pricing e-commerce case study: Amazon
In May 2017, a BuzzFeed article recommended Remodeez shoe deodorizers on a list of popular foot remedies. The increased exposure and the ensuing increase in sales would’ve been great news for any retailer. But the article listed the price at $9. 99.
At the time, would-be buyers went to Amazon to see the price was closer to $15 because Amazon uses dynamic pricing. The Amazon price-tracking website camelcamelcamel shows the price increased in 2017 each time Remodeez got media coverage. And that’s had an impact on the business.
“Consumers think they’re getting gouged—and they think it’s me, ” Remodeez founder Jason Jacobs told CBS News. He said there was no benefit to the price increases, as he lost out on sales volume.
The force that drives dynamic pricing is one of perceived value—the worth a customer assigns to your product. There are several variations of these advanced pricing models to consider when determining prices for your products.
Types of dynamic pricing
Each of the following dynamic pricing strategies relies on supply and demand. However, there are a couple of other variations that you’ll want to consider, as each method has its own characteristics. Below, we’ll detail popular dynamic pricing variations.
Price discrimination
Price discrimination (also called variable pricing) occurs when a business sells the same products at different prices through different channels. There are three degrees of price discrimination.
First-degree price discrimination: Also known as perfect price discrimination, this is when a business prices each product at its maximum value.
Second-degree price discrimination: This is when a business charges different prices based on quantity sold—think discounts for bulk purchases.
Third-degree price discrimination: This is when a business charges different prices to different types of consumers. An example of this would be senior discounts or lower prices for children.
You can justify price discrimination if it presents a customer benefit. Take online versus offline sales, for example. You might offer free shipping on your website but charge more for products purchased online than you do in the store, or vice versa. Some customers will pay a little more for the convenience of ordering online.
However, Canada’s largest bookstore chain, Indigo, does the opposite. The retailer charges less for orders they ship from their warehouse because it costs less to process the request.
Price discrimination also works when you have a captive audience. Airlines use price discrimination when they use demand-based pricing to change the price of airline tickets. People who need to fly a particular route will have to pay more during peak times.
Advantages and disadvantages of price discrimination
Price discrimination can ensure your products are profitable across all channels. Product costs vary, depending on the channel, like in the Indigo example. If you use a third-party e-commerce site to sell, consider that they charge a fee and increase your price accordingly.
And because not all customers are willing to pay the same price for your product, you can segment to optimize sales. For example, many college students have tight budgets, so they’re often overlooked as a market. Offering student pricing for movie tickets ensures a movie theater fills seats, even if it’s at a lower price.
The drawback to price discrimination is some people may find the periods when prices rise to be unfair. And they may go to your competition for a better price.
Price skimming
If you have a new-to-market product, you’ll need to attract customers who will see the value-based pricing of your product and tell others. With price skimming, pricing starts high to attract early adopters and people who see more value in your product because of its price.
Think of every piece of technology you have ever purchased: a VCR, DVD player, MP3 player, mobile phone, tablet, computer. If you bought it shortly after it hit the market, chances are you paid more than those who bought it later.
Advantages and disadvantages of price skimming
The clear advantage of price skimming is that your initial price can help you see a hefty profit margin. In terms of disadvantages, price skimming usually doesn’t work long-term. Before long, your competition will flood the marketplace with lower-priced alternatives to your product.
Yield management
Also known as revenue management, you might see yield management as a price and market discovery tool. It’s the process of lowering prices, based on low demand, that can attract new customers.
For example, hotels use yield management to manage their inventory of unsold rooms. A room might be listed for $200 a night several months out. But if no one books the room, the hotel might release it to a third-party travel site to sell at a steep discount. Selling the room at a lower profit margin is better than letting it go vacant.
Advantages and disadvantages of yield management
Selling a product or service at a reduced price keeps revenue flowing and helps provide an ROI for time-sensitive items. It also offers an opportunity to turn a one-time buyer swayed by price into a loyal customer.
A disadvantage develops if customers wait for those last-minute deals instead of buying early at full price. You may recoup losses in the short-term. But you’re also training customers to expect a discounted rate, making them more reluctant to pay the standard price in the long-term.
How to use dynamic pricing
If dynamic pricing is compatible with your business model, it can be an effective strategy to boost revenue. It’s even more effective if your products or services are in high demand. Here are four steps to get the most out of dynamic pricing.
1. Define your goals
Before you price your products or services, define your goals. That includes defining why your business exists, what it stands for, and what your customers can expect from you. Implementing dynamic pricing without first addressing these questions can confuse your team, your audience, and your stakeholders.
2. Establish your pricing strategy
No two businesses are alike, so their pricing strategies shouldn’t be either. Before you dive into the tactics of dynamic pricing, consider your overarching strategy to attract and retain customers through pricing.
For example, if your goal is to capture as much traffic as possible while also making a good margin, you could follow the “high-runner” strategy. With the “high-runner” strategy, you price most of your products cheaper than the competition but price a few items higher to capture profits. The rationale behind this strategy is that once a visitor shops with you once, they’re less likely to look elsewhere for similar products.
Choosing the best pricing strategy for your small businesses serves as a compass for decision-making and sets you up for success.
3. Choose and implement your dynamic pricing strategies
Once you’ve established a pricing strategy, you need to implement the tactics to bring it to life. This is where the dynamic pricing strategies—price discrimination, price skimming, and yield management—come in. But these strategies aren’t mutually exclusive. You may want to use a combination to align pricing with your goals.
4. Test your dynamic pricing strategies
You can’t improve what you can’t measure. Before you put your dynamic pricing strategy into effect, it’s vital to have systems in place that monitor sales. Without monitoring sales, you can’t ensure that your strategy is accomplishing what you want. If you’re not seeing the results you want, consider reevaluating your strategy.
Using artificial intelligence (AI) for dynamic pricing
Not every business can use dynamic pricing as frequently as Amazon or eBay. For example, it would be difficult for a brick-and-mortar store to change prices every hour, given the task of manually changing price tags. However, some physical retail brands are using AI to come up with dynamic pricing that they can implement through promotions and discounts.
Here’s how it works: Cloud software tests a subset of products at various stores, tracking factors like competitor pricing and customers’ shopping history. After about a week of evaluating a price’s impact on sales, the AI makes a suggestion. If the stores sell more of a product after a price change, AI prompts the store manager to make a permanent price change. The AI-manufactured price is then released to all customers.
Pros and cons of dynamic pricing
Depending on your industry, dynamic pricing could help you grow your business. That said, you should understand the pros and cons of the strategy before you go all in. There is no catch-all answer to how implementing dynamic pricing will impact your business. Ultimately, your decision comes down to whether you’re confident that the potential benefits outweigh the risks.
Dynamic pricing pros
Dynamic pricing allows you to set real-time prices based on the trends that impact your business the most. With dynamic pricing, you can remain competitive and maximize revenue.
A dynamic price can save your company money in the long run. Since software determines prices, you won’t need to allocate funds for market research or pricing strategies.
Dynamic pricing can grow your business. Dynamic pricing strategies can help you see 2-5% sales growth and a 5-10% increase in profit margins, according to McKinsey.
Dynamic pricing cons
Customers may become frustrated with inconsistent prices.
Businesses trying to stay competitive can start price wars where prices drop to unsustainable levels.
Customers may consider dynamic pricing unfair, particularly if prices fluctuate based on shoppers’ demographics.
Is dynamic pricing legal?
Yes, dynamic pricing is legal. But some organizations challenge its legality. The advocacy group Consumer Watchdog called attention to Amazon in 2017, and the FTC is investigating Amazon for deceptive pricing.
Businesses can adjust prices based on internal metrics or market. But it is illegal for businesses to adjust prices based on impermissible factors such as race, gender, religion, or nationality.
Is dynamic pricing fair?
In theory, one could make a case for pricing to match rising demand and prevent a supply shortage. In practice, it’s a controversial topic.
Consumers may feel as though businesses lied to them if they paid more for shoes, concert tickets, or airline tickets than their neighbors. However, proponents of dynamic pricing argue that it’s the consumer’s responsibility to find the best price.
Despite some negative feedback, Amazon optimization company Feedvisor reported that dynamic pricing software has grown more popular with Amazon sellers. Between 2017 and 2018, 15% more vendors selling between $250, 000 and $2 million per year used repricing software.
If you implement dynamic pricing in your business, it’s in your best interest to always be upfront and transparent with consumers about your practices.
What’s the difference between dynamic pricing and price discrimination?
Price discrimination refers to price changes that are based on individual shopper demographics. Dynamic pricing is the practice of making prices flexible based on fluctuations like internal metrics, market factors, and competitor pricing.
Price discrimination is a subset of dynamic pricing, but one key difference separates the two concepts. Price discrimination provides different shoppers with different prices. Dynamic pricing changes the price for all shoppers.
One example of price discrimination would be an e-commerce brand creating two prices for the same product to see how shoppers respond. With dynamic pricing, an e-commerce brand adjusts the price of that same product for all shoppers to increase traffic.
Why is dynamic pricing important?
Although there may be a stigma around dynamic pricing, the reality is that it can maximize profits and track expenses. Using algorithms and machine learning, you’ll employ price optimization, ensuring you set your goods and services at the best price.
If supply and demand impact your product significantly, dynamic pricing may be the best strategy to ensure a steady flow of sales. What’s more, the data you gather after implementing dynamic pricing can reveal your products’ perceived value during times of atypical demand.
With insightful strategy and attention to detail, you’ll find that a dynamic pricing model can help take your business to the next level.
Frequently Asked Questions about dynamic pricing model
What is dynamic pricing model?
Dynamic pricing is a pricing strategy that applies variable prices instead of fixed prices. Instead of deciding on a set price for a season, retailers can update their prices multiple times per day to capitalize on the ever-changing market.
What is an example of dynamic pricing?
In 2020, dynamic pricing made headlines when the prices of everyday goods such as toilet paper and hand sanitizer changed dramatically. More common examples are happy hours at your local bar, airline pricing on travel websites, and rideshare surge pricing.Jun 1, 2020
How do you create a dynamic pricing model?
A successful dynamic pricing setup relies on 5 core steps:Define your commercial objective.Build a pricing strategy.Choose your pricing method.Establish pricing rules.Implement, test, and evaluate the strategy.May 8, 2018
