How Can You Make Dynamic Pricing Work?

March 20, 2017

Dynamics Pricing

Dynamic pricing, or surge pricing, is a hot topic right now. Many companies have been thinking about it for a long time, but in this day and age, with the digitalisation of transactions and data analytics, it seems to be more realistic than ever. Changing prices in real time based on supply and demand is set to be the next big thing for profit growth.

First, let's have a closer look where it's already working:

Airlines are the pioneers in dynamic pricing and have been using it the longest. If you’ve ever booked a flight and checked prices over a period of time, you know that prices are always changing. It typically gets more expensive when you book close to the actual flight date or when the flight is already quite full. Ticket pricing is a good example of where dynamic pricing works quite well and is often quickly accepted by customers.

Nowadays dynamic pricing is nothing unconventional, even in sports. The New York Mets is introducing dynamic pricing for their 2016 tickets. According to their homepage, they will factor in the week, weather, opponent and many other elements when calculating supply and demand, thus price. Other sports teams, cinemas, museums and event parks have introduced or are surely thinking about introducing dynamic pricing. As always, some will lead the market, others will follow.

Besides ticket pricing, every business where transactions are processed online has an advantage over “offline” businesses. Companies such as Uber are able to steer their pricing in real time since they have real-time data. In the case of Uber, they can thereby not only charge higher prices, but also attract more drivers to hit the streets during peak times. Therefore, through dynamic pricing, they are able to steer both supply and demand.


So let's have a look at why it doesn't always work:

One of the biggest reasons that dynamic pricing fails is customer acceptance. There’s enormous potential that the move will backfire, putting the company’s reputation at risk if the price steering criteria are not commonly accepted. A famous example is Coca-Cola, who tried to adjust prices for a can of Coke at vending machines based on the outside temperature. From a customer perspective, it was no longer perceived as fair to pay more if the weather was hot, even though it’s completely acceptable to pay more at the airport in comparison to a supermarket.

Another risk with dynamic pricing involves a lack of pricing skills. If your pricing is currently based on gut-feeling or the cost-plus method, it’s very likely that you’ll actually destroy margins with surge pricing. Expertise in data handling and sophisticated analytical skills are prerequisites for dynamic pricing. If you’re not able to quickly determine changes in supply and demand, there’s no way you can make it work. This is true for most of the businesses which used to be “offline” and were not historically built in the online environment.

Even when you manage to introduce dynamic pricing and your data looks great, there’s the risk that your customers will start to understand the mechanics behind your system and start “playing the game”. Customers will start waiting for the lowest price, and more importantly, only focus on the price. In contrast, to avoid driving down prices, the discussion you want to be having with your customers is about value, not price.

 

Now let's have a look at how to get it right

  • Start very simple
    Build simple rules around a very small number of variables. Then get more sophisticated (complex rules, more variables) as you gain experience, data, and the ability to track it
  • Focus on a mix of specific targets, not on optimization
    Your targets (attendance, mix, revenue, etc.) drive your pricing strategy and you should focus on achieving them, not on optimization per se
  • Use relative comparisons to your advantage
    You need to decide which approach works better in your context and market: Are your prices the highest you can possibly achieve, with variable discounts? Or do you set lower prices, and then add premiums and surcharges?
  • Don't let consumers set prices
    Prices always begin as a work of fiction. Remember that!
    In other words, no sporting event ever has fixed intrinsic value. Its value is a function of the number (price) you assign to it and the context you provide consumers in order to view that number. If give people the system behind a game, or a path to lower prices, they will seize this opportunity and turn your “fiction” into a “fact” you don’t like.

Whether you’re a brick and mortar retailer with digital price tags, a manufacturing company or an online business — the success of dynamic pricing depends on the right execution.