Out of the Box Learnings for Chemical Companies: How Airlines Maximize Profits Through Dynamic Pricing

November 13, 2019

Booking flight on laptop

Chemical companies are often focused on operational excellence; to cope with the industry’s increasing challenges, they have to up their game regarding commercial excellence. Thinking outside the box is now in order: What can chemical companies learn from other industries? Our four-part series is all about experts from other sectors sharing their knowledge and how it can be applied to the chemical industry. In the second part, we look into dynamic pricing techniques deployed by airlines around the world.

When planning a trip and researching airplane tickets, you’re bound to notice that ticket prices vary widely. And not only depending on vendor and departure time, but rather on time of purchase. When you buy last-minute, it is much more expensive than a month in advance. Additionally, when the plane is almost booked-out, the price is higher than when demand is low. 

Tying prices to non-product factors like market situation or customer demand is called dynamic pricing. Certainly not a new technique; dynamic pricing was pioneered by airlines in the 1970s and is now widely used by hotels, airlines, car rental providers, and tour operators. Taking cues from the travel industry, we’re seeing more and more players in other industries’ moving towards dynamic pricing too, for example the retail sector.

Why is that? Because dynamic pricing is a powerful tool to protect and improve margins despite rapidly changing market conditions. Whether it is increasing raw material costs or new tariffs, dynamic pricing enables companies to pass these costs on to their customers. Furthermore, when there is a clear capacity constraint, dynamic pricing provides the opportunity to monetize excess demand. And that is exactly why the chemical sector should think about deploying the technique as well: Increasing commoditization brings lower margins and a renewed focus on operational excellence. Dynamic pricing might be the tool to improve margins where cost cutting ends.

3 questions to digitalization expert Wolfgang Johann Mitschke about dynamic pricing


Wolfgang, why do airlines use dynamic pricing?

Wolfgang Johann Mitschke: The potential of dynamic pricing is huge. Using it, companies of all industries have newfound ways to maximize monetization, reduce waste, and balance supply and demand. At the same time, dynamic prices allow businesses to respond more flexible to market trends.

What are the decisive factors whether dynamic prices are right for a company?

Wolfgang Johann Mitschke: During our projects in the travel industry, we have seen both: projects where dynamic pricing has worked as well as some, where it has gone very wrong. If, for example, your inventory is perishable or there’s a clear capacity constraint, dynamic pricing is perfect to steer demand and avoid waste. Also, dynamic pricing works well if your products are in demand seasonally or when your price is fluid.

Which companies shouldn’t use dynamic pricing?

Wolfgang Johann Mitschke: You shouldn’t use dynamic pricing if it doesn’t align with your overall strategy. Also, this method does not work when there’s no seasonal demand or urgency to purchase your product. Another problem is comparability – if customers can easily find out that your prices are higher than those of your competitors, they not only won’t buy it; they will also think you’re profiteering, which will hurt your company’s image. And even when dynamic pricing is the right decision: Make sure to not rely overly on algorithms and neglect the human element – this could lead to costly mistakes.

 

What chemical companies can learn from this

Right now, most chemical companies in volatile environments use traditional pricing models and thus often miss potential margin improvement. For example, chemical companies tend to use yearly or even multi-year contracts or price agreements. Attempts to adjust and implement higher prices when costs increase often lack traction due to these long price validities. Worst case, costs are on their way back down before cost recovery is completed. By using a realistic pricing horizon in contracting terms, with clear guidelines on allowed adjustments, unnecessary margin erosion can be avoided. By setting a clear pricing horizon, hedging instruments can be used to minimize exposure.

Dynamic pricing helps to achieve price increases

Furthermore, chemical companies are often slow to implement price increases and quick to implement price decreases. Sales teams fear volume loss when prices increase, while maintaining lower prices with increasing costs erodes net margin more drastically. An agile pricing process, spearheaded by senior leadership in the company, is necessary to obtain an effective pricing organization.

For specialty products, prices should be typically adjusted on an annual or semi-annual basis, with moderate price changes to reflect inflation. For commodity-type products, volatile markets and fluctuating costs require shorter pricing cycles, for example quarterly or monthly, where price changes may occasionally even be double digits. Furthermore, the sales team needs to be equipped to communicate price adjustments to the market; both up and down. Dynamic pricing provides a breadth of margin improvement opportunities for chemical companies, as long as you make sure to prepare your sales team and customers.


Read more from our series: Chemical companies learning from others

Part 1: How the Travel Industry Digitalizes Customer Journeys

Part 3: How the Software Industry Optimizes Product Packaging

Part 4: How B2C Industries Utilize Digital Marketplaces