The success of a business hinges on its pricing strategy. Every profitable company wants to cover production costs, set prices that bring in sales but are also reasonable.
In other words, you need your prices to be competitive. Lower prices bring in more customers but generate less revenue, while higher prices might result in customers going to your competitors.
This is why getting the pricing right is both an art and a science.
Pricing strategies are also influenced by external factors like consumer demand, competitor pricing, and overall market conditions and economic trends. Dynamic pricing is one of the most effective ways of increasing market share because it adjusts prices based on the willingness of customers to make purchases.
Dynamic pricing strategy is not only limited to companies like Amazon, Uber, and Airbnb that used it to grow into multi-billion-dollar businesses. Leveraging this capability can have a transformative effect on businesses across various industries.
What is Dynamic Pricing?
Dynamic pricing is a strategy employed by companies that continuously adjust prices based on external factors, oftentimes in a matter of minutes. That's why it's sometimes called surge pricing or real-time pricing. In essence, the idea is to sell the same product or service at different prices under different circumstances.
Ecommerce retailers like Amazon have really pioneered this pricing strategy — they are able to make price adjustments every 10 minutes!
Dynamic pricing is a popular strategy in several industries including:
- Travel & Ride-Sharing Services
- Public Transportation
Naturally, each industry uses slightly different factors to carry out its dynamic pricing strategy.
Successful Dynamic Pricing Strategy in Different Industries
Companies switch prices with algorithms that factor in supply and demand, competitors' prices, and other external variables. Let's take a closer look at some dynamic pricing examples across industries.
Event organizers use dynamic pricing based models to bring in more sales and create a sense of urgency. Adjusting ticket prices based on interest and time is key.
For instance, an event organizer can write dynamic pricing rules that increase prices every 10 days and every time another 50 tickets have been purchased.
Uber and Lyft set prices based on demand. They use "surge pricing" when demand is hot— holidays, stormy days, and after sporting events— to increase the cost of fares.
Airlines use factors such as the number of seats on a plane, departure date, time of the week, and the number of days before the flight to calculate prices of airline tickets.
During peak periods, public transportation services use congestion pricing to spur a more efficient use of the service. For example, drivers have to pay a higher toll during rush hour and on the weekend to cross the Bay Bridge. This way the city boosts earnings during peak hours, while at the same time regulating demand since drivers who don't want to pay more will avoid those times.
When To Use Dynamic Pricing?
While dynamic pricing is a perfect fit for many industries, nevertheless, it can only be leveraged by companies that meet certain criteria.
The Ability to Measure Market Shifts
A business employing dynamic pricing strategies must understand all the different market forces that create trends in the industry. Otherwise, changing prices to meet demand is impossible.
Customers Respond Well to Dynamic Prices
If an industry’s pricing policies are rigid, and customers are unwilling to pay higher costs regardless of the conditions, then dynamic pricing won't work.
Influence in the Market
A small business that adjusts prices dynamically in a competitive market runs the risk of losing market share. Unless dynamic pricing is a popular strategy in the space, it most probably won’t be beneficial.
How Is A Dynamic Pricing Strategy Implemented?
The most effective way to implement dynamic pricing is by using rules-based algorithms.
They allow businesses to adjust prices to match what customers are ready to pay as they’re looking to purchase an item.
In order to do so, companies need to take into account many different variables to set the right price at the right time.
For instance, some of the variables that online retailers use to determine prices include:
- Supply: Inventory levels, present costs, future costs, etc.
- Demand: Product page views on e-commerce websites, seasonality of items, etc.
- Competitors’ prices.
Clearly, retailers lower prices of products that they have in excess while increasing prices of products that are flying off the shelves.
Controversy Surrounding Price Discrimination
Price discrimination refers to selling the same product at different rates, which is why it is often associated with dynamic pricing.
Typically, dynamic pricing methods are not illegal, but companies need to be careful about what variables they use to set their price points. In other words, it is unlawful if prices change based on buyers' race, ethnicity, gender, or age.
Therefore, brands need to be careful that their algorithms don't use this type of demographic data to calculate prices.
Different Types of Dynamic Pricing
There are several types of dynamic pricing that use various factors to determine the cost of products and services. Let's take a look at all the different methods.
Time-Based Dynamic Pricing
The most common type of price adjustment is based on time.
Organizations use this model to charge more when providing faster service. A simple example is when customers pay more for same-day delivery.
This strategy is commonly used by retailers who sell items that are popular during certain seasons. For example, if a company sells swimwear, then it makes sense to increase prices during the summer and lower them in the winter.
This is a more familiar case of time-based pricing popularized by online lodging and travel agencies like Airbnb and Booking.
These brands dramatically increase prices during peak holiday seasons for popular destinations. Airlines also use this tactic when travelers want to buy the last seat for a high-demand flight.
Over time, a company will discover that an item or service sells much quicker during peak hours.
As the name suggests, this pricing strategy relies on competitors' prices as a basis for adjustments. It uses the going market rate for the product or service.
Therefore, it doesn't prioritize consumer demand when setting prices.
Competition-based pricing is a common strategy in highly saturated markets because even a minimal price difference may be the crucial differentiator for most buyers.
Companies have three options when it comes to using this strategy:
- Pricing items marginally below the competitors
- Using the same prices as competitors
- Pricing items somewhat above competitors
Competitive-based pricing is a proven dynamic pricing method for staying on top in a competitive market.
Changes in Market Demand
Problems in the supply chain inevitably lead to drastic price fluctuations. Think back to the start of the pandemic when hand sanitizers and masks were hard to come by. The prices of these items skyrocketed overnight!
Naturally, the opposite can happen and demand may take a sharp downturn. In these situations, businesses typically lower their prices to meet the slump in demand.
What makes this type of demand pricing effective is that consumers are faced with limited options because there is a lack of competitors offering the same products or services.
Is Dynamic Pricing Fair?
There’s a lot of controversy about whether people like dynamic pricing or hate it. Some companies avoid dynamic pricing because they fear consumers will misinterpret oscillating prices as manipulation.
At the end of the day, consumers decide whether to make a purchase. It’s up to the business to set the price we’re willing to pay.
If consumers are willing to make a purchase, then their need is met.
On the other hand, if the price is too high, then customers won’t buy and revenue will drop. This will in turn push the business to lower the price to a point where consumers are comfortable buying.
Either way, an equilibrium in the market is achieved.
Dynamic pricing is perfect for strategic consumers who anticipate dynamic pricing strategies and love hunting for deals. They love the thrill of getting something at a bargain price as opposed to buying an item that's priced the same everywhere.
Consumers today understand why businesses alter prices — why a sports team has to increase or decrease ticket prices based on the quality of the opposition.
Buyers also understand that businesses based on seasonality will charge last-minute purchases a lot more than reservations made ahead of time.
The most important thing is, to be honest about using dynamic pricing.
Why Do Static Pricing Strategies Often Fail in the Long Run?
Static pricing strategies use a fixed price point for a long period of time. In the retail industry, many businesses use the "daily low price" model where products are priced strategically at low rates.
The static pricing model helps these types of businesses attract a stable customer base.
While this strategy does attract a wide array of customers, it does have serious drawbacks.
The obvious disadvantage is that if your fixed costs increase, then your profitability will take a hit. The only way to counter this is by raising your prices and risking losing some of your customers.
A fixed pricing strategy rests on the mistaken expectation that companies, like retailers, will always meet their target sales volume needed to cover fixed costs.
The vast majority of online retailers, for instance, implement dynamic pricing because they want to have more control over their sales volume.
Companies that use a fixed pricing model run the risk of either losing profit or potential revenue.
Namely, today's buyers are much more dynamic than we give them credit. They look for better prices, compare products and services, and try to get a bargain. Businesses that don't appreciate this fact are losing potential customers to competitors who do.
Benefits of Dynamic Pricing
When done properly, dynamic pricing can be one of the most successful pricing strategies. Let's sum up the many important ways dynamic pricing can help businesses compete and grow.
Helps Out Employees
During an increase in demand, businesses that use dynamic pricing can pay a higher wage to their employees.
Allows Businesses to Launch Attractive Offers
Dynamic pricing allows businesses to create seasonal and promotional offers and still make a profit. Lowering prices when there's a dip in revenue can act as a catalyst to drive sales of certain items. For example, companies can attract those customers who are price-sensitive and aren't always ready to pay the full price.
Discounts are also an effective way of reducing the number of overstocked items by offering lower prices.
And when demand is high for certain items, by increasing prices, dynamic pricing lets businesses generate more revenue while managing the supply chain.
This is practically impossible to achieve using a static pricing model as we've discussed.
Enjoy A Better Understanding of Customers
Dynamic pricing models give companies the ability to study customer behavior. Specifically, discovering at which prices customers are willing to make purchases. This type of insight is difficult to glean from a static pricing model.
Businesses can undercut their competitors by making adjustments in real-time. Being able to quickly adjust your pricing policy in response to what the competition is doing will help cement your position in the market.
Don’t Go Too Far
Obviously, going overboard with price hikes during busy stretches will have negative consequences. Customers will think you’re being too opportunistic and unfair.
Customer Avatars Are Helpful
Look at the profiles of your buyers to optimize your price changes.
Customer avatars are one of the cornerstones of every dynamic pricing model. Fine-tune your pricing to accommodate those avatars. Generally, your avatars have different problems, needs, and goals.
Let the avatars guide how you offer higher or lower prices for different products and services in order to increase the sale volume from clients with different characteristics.
Manage Dynamic Pricing with the Right Software
Finally, consider your business goals as you design your dynamic pricing algorithms.
For example, if your objective is to increase awareness and capture a sizeable share of the market, then using competitive prices on the most popular items is the best way to go.
Regardless of what kind of objective you want to achieve, you need to use the right software to follow best practices.
Test and Analyze
After a certain period of time, analyze the results to see whether the targets are met. This way you can recreate your pricing strategy to reach a better price point.
Set Price Bounds
Set price limits to ensure that prices are not too low or too high. In other words, prices that reflect your products' value while also being flexible enough to stay profitable.
Use a Schedule
Companies that only wish to use a dynamic pricing strategy during a specific season or holiday should use a software solution that schedules price adjustments.
What's The Best Dynamic Pricing Software?
Businesses need a dynamic pricing engine that allows employees to add all the relevant variables and data points, and most importantly, make changes to prices as soon as new circumstances arise. A solution that can, for instance, calculate market demand, inventory levels, and seasonality, and then set prices accordingly.
To make well-timed price adjustments businesses need a certain degree of automation that algorithms can provide. However, designing algorithms requires technical expertise and constant support.
This is why companies use a dynamic pricing tools like Higson.
Higson is a business rules engine built to help companies dynamically price their products and services.
Its user-friendly interface empowers non-technical team members to make instant changes to complex pricing rules.
All this without having to rely on the IT department for help!
This is why leading brands use Higson to enhance collaboration among teams, beat the competition, and respond to market changes in real-time.
Ready to see how Higson's expert team can optimize your dynamic pricing strategy and make you more competitive? Get in touch with us today to see why our premium solution is a game-changer.