Dynamic pricing has been trending in the eCommerce industry since 2015 but will shine and burst in 2021. Why?
Well, before, it was a strategy that was only accessible to privileged retailers such as Amazon. Now there are many affordable services and tools almost for any scope. Therefore, you'll see an adoption race between B2C businesses this year and the first adopters will most likely beat the competition.
Since adoption comes after understanding, we'll explain all the concepts around dynamic pricing. To make this concept meaningful and understandable, we'll talk about the subtopics below:
- Definition of dynamic pricing
- Different types of dynamic pricing
- Benefits of dynamic pricing
- Examples of dynamic pricing.
- How can you implement it into your pricing strategy?
What is dynamic pricing?
In essence, dynamic pricing is the concept of selling the same product at different prices based on the changing dynamics of the current market demand. This is why it is also called real-time pricing, surge pricing, or time-based pricing.
The decision-making process behind the dynamic pricing model is quite impressive. Under the hood, machine-learning robots are working for you to develop new algorithmic models based on the market demands and your competitors' actions. This data-driven process allows companies to adjust the prices of their goods continuously within seconds.
Dynamic pricing strategy is popular among many business models. But the first companies that spring to mind are the airline industry, eCommerce businesses, public transportation, retail, and entertainment. Since each of these industries has different mechanics, they use different types of dynamic pricing models. Let's explore what those pricing strategies are.
Five types of dynamic pricing
The perceived value of a product can be flexible for different segments. This is why segmented pricing offers different prices (two or more) for the same or identical products. One could also see it as psychological pricing. Segmented pricing is also called "price discrimination". This term doesn't feel fair at first glance, but it goes without saying that high-value segments often demand the top service and quality. So the price is an equalizer. Here, we justified it for you!
This pricing strategy involves a broad spectrum of use cases. It's popular in industries where the demand for the product or service changes throughout the day. Or where businesses want to offer incentives to trigger purchases for different reasons.
Here are a few quick examples:
- Transportation businesses often benefit significantly from different tariffs. E.G night tariffs for taxis.
- With every new collection, eCommerce businesses lower the older collection's price to get rid of the redundant stock.
- Many delivery companies charge extra for same-day delivery.
Changing market conditions
Market conditions can change due to numerous reasons. Recently, in the pandemic era, we witnessed how simple products such as toilet paper, sanitizers, and mouth masks were sold for 500% profit. Remember, a convenience store sold a single toilet paper at $10 with a sign reading: "This is not a joke." The reverse can also happen, for some reason, demand can decrease which will force companies to lower their prices.
This pricing strategy benefits from high demand at certain times of the year. If you ever rented a place via Airbnb, you already know what it means. The price of apartments goes up in certain months (especially during holidays). The same goes if you want to buy the last airplane ticket to Bali in the holiday season.
The penetration pricing model is often used when a new business enters the market, or an existing business wants to dominate the market. Companies do that by offering lower prices compared to the competitors. Of course, the prices won't remain low for a long time. After businesses reach a certain amount of customer base and demand, they gradually increase prices.
A great example of this was the Uber eats vs. Deliveroo food delivery battle in the Belgian market. During the pandemic, Uber eats offered a 50% discount for the first five orders (six-month straight) to acquire the customers of Deliveroo. Personally, I ordered 6-7 times. So, it's working, folks.
Dynamic pricing advantages and disadvantages
Many businesses are leveraging the power of dynamic pricing strategies. As you see in the examples above, you can increase your market share, benefit from seasons and develop psychological pricing strategies to increase your revenue.
You'll see soon, there are many more upsides of using a dynamic pricing model. But as you know, things that have an upside often have a downside. The good news is: many businesses experienced these downsides for you. All you need to do is to be cautious about downsides and only focus on the benefits. Let's start with pleasant flavors.
Advantages of dynamic pricing
Bird-eye view of the market
Know your customers. This is the foundational building block of a great dynamic pricing strategy. Well, knowing your customers is not a one day work, you need to follow them and answer these questions continuously:
- Who are they?
- What are their prices?
- What are their pricing strategies?
- How often do they pivot their strategies?
By doing this, you are shaping your dynamic pricing strategy and finding out the trends and patterns in your industry. By the way, you don't have to do all this by yourself, there are dynamic pricing tools that could do all of this stuff for you.
Get to know your customers better.
As you implement your dynamic pricing model, you'll start to measure and track your customers' behavior. This will give you an overview of many things such as:
- Frequency and timing of the purchases.
- The minimum and the maximum price that your customers are willing to pay.
- A detailed overview of the demand curve.
This process will fuel your dynamic pricing machine and will guide you to a better pricing strategy with each insight.
By fueling your dynamic pricing machine with each insight, you'll have a better understanding of your customers' shopping patterns, preferences, and limits. Eventually, this will guide you through creating a better and more accurate pricing strategy. Aside from that, you'll have an almost unfair advantage against your competitors. You'll always know about their pricing and set a specific set of rules to adjust your price based on your strategy. This alone, can give you market domination in the long run.
Now let's look at the downsides.
Disadvantages of dynamic pricing
Before we get into the disadvantages, we would like to remind you of Amazon's story. Amazon dominated the market by using dynamic pricing strategies that go beyond human capabilities. The company invested in machine learning, AI and big data analytics to estimate future demands and trends. Since Amazon's pricing engine makes millions of price changes in a day, of course, some customers noticed and complained about this price discrimination strategy.
BUT. But it doesn't change the fact that Amazon is the biggest eCommerce company in the world. And dynamic pricing plays a huge role in this story. Also, remember, you don't have to play on the edges as Amazon did.
People hate when they realize that someone else paid half price for the identical item they bought. Simply, they feel like they've been ripped off. So there is a risk of losing your loyal customers and their circle of influence. But hey, you can set some preventive limits to the maximum amount of fluctuation to keep things accountable. And as we mentioned in Amazon's case, you'll most likely end up gaining more customers.
Storytime: Uber surge pricing.
In 2013, New York was in the middle of a powerful storm, and Uber users saw prices go up to 8x times. Of course, this strategy backfired, and lots of people (including celebrities) stormed Uber's price policy. After this event, Uber placed caps on the highs of their surge pricing strategy.
Leads a price war in the market
Even loyal customers don't stand a chance against aggressively low price offers. Remember I mentioned Uber eats 50% discount above, even though we eat homemade food 99% of the time, we ordered because it was simply too powerful. So powerful that it could change the behavior of a person.
Naturally, if a business can compensate for low-prices and provide powerful offers, one way or another, it'll increase its market share. But what if the competitors up the ante? Then, it's a war, and many companies die on the battlefield every year. So, think twice when you're setting the rules of the game.
Some popular examples of dynamic pricing
eCommerce: Many businesses adjust their prices automatically based on competitors, market price, seasons, and internal marketing efforts (new collection, outlet seasons, etc..).
Events: dynamic pricing helps the event industry to generate more revenue by using the levers of urgency and scarcity. Cheaper early bird or more expensive last chance tickets are great examples.
Bnb and hotel Industry: as we mentioned before, here prices are correlated with seasons and certain times of the year such as holidays, special days, or events.
Ride-hailing services: Snowy, rainy, rush-hour, or during the storm, riding services use dynamic pricing (surge pricing) to benefit from the environmental conditions.
Airline pricing: regulars can organize their flights 5 months in advance. But business people often need to reserve flights at the last minute. Therefore ticket prices change in a matter of minutes with time-based pricing strategies.
Google ads: the price of ads (keywords) is determined by the market's current supply and demand rate. Say you want to target the keyword "gift ideas" in the Christmas season, you can pay a lot more than a typical day.
How to implement dynamic pricing in your organization?
There are many marketing softwares in the market. These tools monitor thousands of various products and environments to give you the most viable options in real-time. However, we think these tools are the second essential element of a great strategy.
What is more important is the strategy itself. This strategy should be created by insiders who know the dynamics of the given industry. If you need a hand concerning eCommerce businesses, Amaury can help you to set your dynamic pricing strategy. You can schedule a free call with our expert to discuss the details.
We'll shortly discuss the steps we follow below:
#1 Defining a commercial objective
We start with some foundational questions: why does your company exist? What customers can expect from your business? What do you want to bring to the market?
Do you want to be the fastest or most-friendly, or the cheapest? Your objective will be your compass for your business and help you build a strategy to hit your goals.
#2 Building a pricing strategy
In this step, we'll determine your pricing strategy based on your commercial objective. If your objective is to increase your visibility and dominate the market, you might want to set competitive prices on the most popular products. Then, once they purchase, you can redirect your customers to less popular products.
This stage is tailored for your needs, so it's hard to give general advice on this one.
#3 Choosing pricing methods
We already mentioned some of the methods earlier in this article. But there are dozens of methods to choose from. The most common are:
- Competitor based-pricing: you adjust your prices based on the competition.
- Value-based pricing: taking into consideration the customer perception of the product.
- Cost-plus pricing: production costs of the product + the margin you want.
You can pick one or three models at the same time. It depends on your objectives.
#4 Setting some pricing rules
Dynamic pricing tools need your input to make efficient decisions. Usually, there are two steps: you choose the products and formulate the pricing rule.
Example for selecting the products based on data: For spring collection sweaters with a stock < 5, apply pricing X.
Formulation example: X=follow lowest price of competitor A and B.
#5 Implement, test, and monitor
Now you have everything from 1-4. All you have to do is to test and validate your strategy. See whether the rules are working properly. Since it's going to be an automated system, all things should work like a clock (of course, you can configure it anytime you want, but that's not the point).
After a while, monitor and evaluate your results to see if you're hitting your objectives. So you can recreate and iterate your strategy to reach a better place.
These are the steps and map of progression in a nutshell!
Wrapping everything up
I hope you get the fundamentals of dynamic pricing. In theory, it looks easy, and in practice, it's quite easy when you're working with eCommerce experts! If you're considering adopting a dynamic pricing strategy and tools, feel free to schedule a free call with our expert. We can help you validate whether it's something for your business!
See you around.