The phrase “dynamic pricing” often sparks heated debates in eCommerce and retail, and it’s not hard to see why.
If you’ve ever booked a hotel, ordered an Uber, or shopped on Amazon, you’ve experienced the effects of dynamic pricing in real-time. Prices may shift down or up at a moment’s notice.
But if dynamic pricing adds complexity to the customer experience, why have so many industries embraced it? What makes this pricing strategy so appealing to businesses?
Dynamic pricing based on various factors such as market demands, target groups, and time periods enables businesses to capture the highest possible value for a product or service at any time of day, week, or year. But the benefits of dynamic pricing aren’t restricted to price optimization. Dynamic pricing models allow businesses to be highly adaptable to changes in demand or competitor activities—and if executed well, actually increase customer loyalty and satisfaction.
So, how does dynamic pricing work, and what do businesses need to be aware of when implementing it?
TL;DR
- Dynamic pricing refers to prices that fluctuate based on factors like demand, supply, customer behavior, and seasonality.
- Dynamic pricing is calculated through the use of data collection and machine learning algorithms to analyze market conditions and make appropriate pricing decisions.
- There are some serious ethical considerations involved with dynamic pricing, namely price discrimination and regulatory concerns related to consumer rights and data privacy.
What is Dynamic Pricing?
Dynamic pricing systems refer to pricing models where the price of goods and services fluctuates based on a range of factors. This differs from a fixed price approach, where prices are reviewed and adjusted in regular installments.
Dynamic pricing models make it possible for businesses to align their pricing to current market conditions, helping to increase profit margins and offset operational expenses. Factors that influence price changes in dynamic pricing systems include:
- Market demand
- Availability
- Supplier costs
- Customer behavior
- Competitor pricing
- Time of day/year
Dynamic pricing is an evolution of older variable pricing tactics such as segmented pricing, where different prices are set for different customer segments, and yield management, where prices are adjusted based on demand and capacity.
Together, these strategies have paved the way for more sophisticated and responsive dynamic pricing systems, which use machine learning to make thousands of pricing decisions per minute. This is thanks to advances in automation and data analytics, making it possible for businesses to adjust real-time pricing.
The use of dynamic pricing methods is most common in industries where the demand for goods and services fluctuates. Food delivery and ride-sharing services, for example, levy peak pricing when the supply of drivers is low to rebalance demand. The travel industry also relies on dynamic pricing to accommodate peaks and troughs, with lower prices typically offered during the off-season to fill bookings.
How Dynamic Pricing Works
Dynamic pricing models use a range of variable conditions to offer different product prices at different times, and potentially to different groups of customers. To do this, businesses need to gather data to understand what influences pricing decisions.
Data can include anything from historical sales data to competitor pricing, product availability, and more. This makes it possible to set prices and a baseline for dynamic fluctuations based on customer demand or any factors deemed relevant.
Most businesses rely on algorithms to analyze data in real-time and identify trends in customer behavior or market demand. For example, if high demand peaks during the holiday season for certain products, an algorithm will take this into account when adjusting prices during November-December.
Benefits of Dynamic Pricing
For businesses: Increased revenue, better inventory management
Being able to adjust prices based on market conditions enables businesses to maximize revenue. Considering factors like demand or seasonality makes it easier to assess the actual value of their offerings. Ongoing data collection and analysis of consumer behavior makes it possible to gauge their level of interest, turning value-based pricing and adjustments into a real science.
Moreover, tying dynamic pricing to real-time supply chain management provides storefronts and eCommerce businesses with a more streamlined way of managing excess inventory. It’s also easier to avoid stockouts by removing discounts and driving buyer urgency via messaging such as “limited stock” or “5 or fewer units left!”
For consumers: Deals and price optimization
While discussions about dynamic pricing usually focus on high prices, consumers also benefit from low prices if they’re willing to buy when demand is less. With dynamic pricing, it’s flexibility (or the lack of it) that determines pricing. If consumers are willing and able to let prices dictate the times/days they are using certain services, this can result in significant cost savings.
Challenges and Criticisms about Dynamic Pricing
Ethical considerations
One of the biggest critiques of dynamic pricing models is a lack of transparency with consumers, who may not understand how pricing algorithms work. Because customer behavior plays a key role in setting prices, this can result in price increases being levied against some consumers but not others.
For example, a customer looking for urgent airline tickets to travel to a funeral may log several online searches for specific travel dates—data that can then be factored into price adjustments. This raises ethical concerns over whether businesses can exploit a lack of consumer flexibility to set higher price points.
Potential for consumer backlash
Consumers like to know the price of a product or a service upfront, so they can compare options and make informed purchasing decisions. However, one of the biggest problems with dynamic pricing is that it often works against these frictionless customer experiences.
For example, a person might check the price of an Uber ahead of time for a specific journey. But if demand is higher at the time of ordering, this causes surge pricing to kick in. Unexpected higher prices lower customer satisfaction, and may cause some consumers to choose alternative options where static pricing is available.
In sum, while flexible pricing can work in consumers’ favor, they’re far more likely to remember the occasions where dynamic pricing has conspired against them.
Regulatory concerns
Most of the concerns surrounding dynamic pricing focus on whether businesses using dynamic pricing models are ensuring that consumer rights and data privacy are being respected.
Price discrimination based on demographics such as race and gender is outlawed. However, pricing algorithms can still exhibit these biases. Businesses must be careful that their pricing tools do not use any of these indicators, as regulators can require businesses to disclose how price fluctuations are calculated.
Dynamic or not, any pricing practices that are considered unfair or deceptive may be subject to disciplinary action. If consumers are being misled about the reasons for price changes, for example, this may be considered illegal and subject businesses to penalties.
Implementing Dynamic Pricing with Technology
Data analytics plays a pivotal role in dynamic pricing. Without regular data collection and analysis, businesses cannot assess market conditions and align their pricing with what is happening on the ground.
Traditionally, dynamic pricing has relied on historical data to make predictions about demand. As well as predictive analytics, advances in AI and machine learning allow competitive pricing to be implemented at an extremely granular level. There has been widespread coverage about flight and hotel prices skyrocketing around concert dates for Taylor Swift’s Eras tour—a perfect example of how the growing sophistication of dynamic pricing has implications for consumers.
But as segmentation down to the individual consumer becomes easier to implement, metrics like customer loyalty and repeat purchase rates can be taken into account. Consumers will benefit more often from tailored offers from online retailers, creating better customer experiences.
Dynamic Pricing Strategies
There are several types of dynamic pricing that businesses can use, depending on the nature of their product or service.
Each pricing method, whether it be cost-plus pricing, price skimming, or dynamic pricing, involves setting prices based on different factors to maximize revenue and profitability. Here are some different types of dynamic price setting.
Segment-based pricing
Segment-based pricing is where a business separates its customers into different purchasing groups based on certain characteristics. This could be location, browsing behavior i.e. visiting the site or searching for specific routes/dates, or whether they are an existing or new customer. The business can then change prices for each segment, based on perceived buyer urgency or external factors that affect buyer behavior.
For example, a company may choose to offer first-time customers a more enticing deal in a bid to raise conversion rates, also known as penetration pricing. Another common practice is geo-targeting websites to offer different prices to customers in different regions.
Time-based pricing
With time-based pricing, a company will adjust its prices based on different seasons or times of day/week. This reflects how demand and supply for certain products and services will experience peaks and troughs throughout the year.
For example, airlines use time-based pricing because flights at certain times of the day, week, or year will see higher demand. Popular slots include the peak summer season, flights on Fridays and Sundays, and flights during rush hour. Many airlines will highlight their cheapest ticket prices online, during typically low-demand periods like very early morning or late evening, or during the mid-week.
Demand-driven pricing
Demand-driven pricing is also known as surge pricing and is one of the most well-known dynamic pricing strategies, thanks to its use by ride-sharing services like Uber and Lyft. Demand pricing sees prices adjusted according to the level of demand experienced for that particular product or service. Prices rise sharply when demand is high and availability is more scarce, and decrease when demand falls. Given that demand-based pricing results in some of the biggest price fluctuations (often with little warning) this has sometimes made it a controversial practice.
Examples of Dynamic Pricing
It’s hardly surprising that some of the fastest-growing companies in the world use dynamic pricing to stimulate growth and maximize profits.
Amazon
Amazon uses a highly intricate dynamic pricing strategy that sees prices for products change as frequently as 10 minutes, resulting in an estimated 2.5 million price changes every day. In Q3 of 2023, Amazon’s profits nearly tripled, mostly as a result of price-conscious customers using the platform to find good deals.
Airbnb
The short-term rental platform Airbnb has even incentivized hosts to embrace a dynamic approach to pricing. Their dynamic pricing software, named Smart Pricing, automatically adjusts prices according to factors like location, demand, and time left to book. While it’s up to those listings to decide if they want to use it, Airbnb announced that hosts using it saw as much as a 13% increase in revenue.
It’s worth noting that in these examples, there’s a risk that price optimization will come at the expense of customer satisfaction and loyalty. A consumer might reluctantly pay up for a hefty airline ticket or short-term rental, but that experience might persuade them to choose a different provider next time around.
But dynamic pricing does show there can be serious benefits to consumers and businesses when factors like demand and availability are factored into pricing decisions.
FirstTable
Hospitality services like FirstTable, which gives diners a 50% discount in exchange for booking the traditionally least popular “first table” of the evening, offer consumers an enticing deal while helping restaurants fill up their traditionally slow times. It’s a step back from straight dynamic pricing that avoids accusations of price discrimination, while still achieving a similar level of optimization.
Final Words
Although its use may be controversial, it’s clear that dynamic pricing is here to stay. As consumers and brands collectively adjust to the effect that dynamic pricing has on purchasing decisions and strategic planning, the question remains: Is it a good idea to implement dynamic pricing?
While there is potential for consumer backlash, dynamic pricing can prove advantageous to consumers when implemented well. For example, taking into account factors such as customer loyalty and purchase frequency makes it possible to reward long-time customers with attractive pricing, while still maintaining healthy profit margins. As AI becomes more advanced, we can expect to see much more targeted approaches to dynamic pricing become the norm.
Whether you’re using dynamic pricing or not, having an easy solution for accepting payments is a must. This is where Stax comes in. With Stax, you can use any payment type and integrate essential tools to grow your business. With our payments-as-a-service pricing businesses know what they are paying and when.
Request a QuoteFAQs about Dynamic Pricing
What is dynamic pricing?
Dynamic pricing is a pricing strategy where prices are adjusted in real-time based on various factors such as demand, supply, competitor pricing, and other market conditions. This strategy is commonly used in industries like airlines, hospitality, entertainment, and retail.
Is dynamic pricing illegal?
Dynamic pricing is legal in most industries. However, it must comply with all relevant laws and regulations, including anti-discrimination laws and consumer protection laws. It becomes illegal if it involves price fixing, collusion, discrimination, or deceptive practices.
Is dynamic pricing fair?
The fairness of dynamic pricing is subjective and can vary from case to case. While it’s seen as fair from a market and business standpoint, some consumers may view it as unfair, particularly if there’s a lack of transparency or significant price differences for similar products or services.
Who uses dynamic pricing?
Companies in these industries frequently use dynamic pricing:
- Airlines and Travel: For flight tickets, hotel bookings, etc.
- Retail: Especially online retailers.
- Entertainment: In pricing tickets for events, movies, and theme parks.
- Transportation: Ride-sharing services like Uber and Lyft.
- Sports: For ticket pricing based on demand and importance of the game.
How does dynamic pricing work?
Dynamic pricing works by adjusting prices in real-time or near real-time based on various factors.
Usually, companies that implement it use a system that gathers data related to demand, supply, competitor prices, customer behavior, time of day, seasonality, and other relevant factors. Advanced algorithms analyze this data to understand patterns and predict how changes in these factors affect demand.
From there, prices are set and adjusted accordingly.
