An intelligence firm once revealed that Amazon changes its products’ prices more than 2.5 million times in a day.
Dynamic pricing is when a business changes prices based on the product’s (or service’s) demand or supply.
This guide covers the importance of dynamic pricing, its different types, and examples of businesses implementing it.
Read on to implement a successful dynamic pricing strategy.
The Basics of Dynamic Pricing
Dynamic pricing involves adjusting prices to match the product’s demand. For example, airline tickets are more expensive over the holidays and weekends because of their high demand. So airlines rake it during these times while providing the best experience to their customers.
It’s an automated process that relies on market data (e.g., how many people want the tickets), company data (e.g., how many seats are available), and machine learning (e.g., what time most people book a ticket) to set an appropriate price.
Companies can adjust prices based on:
- Level of demand (e.g., hotels charge high prices when the demand for rooms is high, especially during the holiday season.)
- Competitors’ prices (e.g., fuel industry where different companies compete to have the best prices in the market.)
- Certain events (e.g., increasing the price of roses on Valentine’s Day or doing “Back to School sales”)
An eCommerce company, for example, can set up dynamic pricing software on their store to adjust prices to be the lowest at any moment. But of course, up to a minimum that makes sense for their profit margins. The software will monitor the competitor’s prices and adjust accordingly.
Here are dynamic pricing examples
Below are brands that use dynamic pricing strategies to build multi-billion businesses:
Amazon
As I mentioned, a past analysis found that Amazon’s average product price changes every 10 minutes. The app uses dynamic pricing to match product prices to the cheapest competitors. So it tracks the competitor’s activities to predict how to make the most sales with the best profit margins. It also analyzes the inventory, customer shopping patterns, and profit margins before adjusting prices.
Google Ads
Google Ads uses a bidding system where advertisers determine the price of a keyword. The most demanded keywords are the most expensive.
The application’s dynamic pricing strategy depends on;
- The price that competitors are bidding for a keyword
- Industry/niche
- Target audience
- Location
Uber’s Surge Pricing
Uber rides are usually in high demand during rush hours. Once the app detects this, it increases prices for a few hours. So they make more money from customers willing to pay more. And at the same time, they make it worthwhile for riders to be available during rush hour. So customers will always find a ride no matter the time, day, or season.
Types of Dynamic Pricing
Based on the data used to change prices, the most common dynamic pricing methods are:
- Time-based pricing: where prices change during certain periods – for example, Black Friday deals and end-month discounts;
- Peak pricing: where companies increase prices during periods of peak demand. For example, Air BnB prices are higher during holidays;
- Competitor-based pricing: where a company sets its prices lower than the competitors – e.g., Amazon’s strategy;
- Cost-plus pricing: where a company sets flexible prices based on the cost of the goods plus a markup;
- Value-based pricing: where prices change based on the customers’ perceived value – for example, a big part of Apple’s success is based on the value their customers believe they are getting. Hence, they are willing to pay more;
- Conversion-rate pricing: where prices change based on website conversions – e.g., offer discounts when conversions are low.
- Segmentation pricing: setting different prices for the same product depending on the customer group, location, etc.
- Penetration pricing: setting a discounted price initially to attract new customers
What is the difference between fixed and dynamic Pricing?
With dynamic pricing, you can increase or reduce the prices to meet the rise or decline in demand. On the contrary, fixed or static prices are consistent no matter the demand changes.
Why is dynamic pricing important for your business?
Dynamic pricing utilizes opportunities to make more profits. It also helps your business respond to consumer demands and changes in inventory. For instance, you can increase prices when the demand is high or the product is limited.
Dynamic pricing increases sales and maximizes profit
Dynamic pricing programs automatically increase the price when the demand is high. And for that limited time (when demand is off the roof), they make more profits. For example, you can set up a program to increase your product’s price by x% whenever the demand is at y%. The program will track the market and adjust accordingly.
Implementing dynamic pricing also ensures that you set competitive prices. For instance, an eCommerce store can use pricing software like Netrivals to track competitors’ prices and lower their prices automatically. Tracking the competitors’ prices ensures that they don’t underprice or overprice their offerings.
Finally, dynamic pricing data helps you understand your customers. How much are they willing to pay for your product’s value? This information is vital not only for your sales strategy but also for the marketing, branding, and product development teams.
Dynamic pricing helps in managing your inventory
You can set lower prices for slow-moving products to get them rolling. At the same time, you can raise your prices for popular products to increase the demand for slow-moving items.
Conversely, you can discount popular items to increase their demand.
But there’s a caveat:
Dynamic pricing works when prospects are willing to pay that amount. The average person does not want inconsistent prices; or, worse, ridiculously high prices.
Recently, Bruce Springsteen’s fans were outraged by Ticketmaster’s dynamic pricing that increases ticket prices when demand is high. Springsteen’s tour tickets went as high as $5,500.
In fact, dynamic ticket prices have been a decades-old battle between concert-goers and Ticketmaster.
In the end, you always need to think about your target audience and how your decisions might reflect on the overall reputation of your company.
How To Implement Dynamic Pricing
Considering the resources needed to implement dynamic pricing, you must first build a business case for the new pricing strategy. Will flexible prices drive business success significantly?
Answer these questions to determine if dynamic pricing will suit your business:
- Are your customers willing to accept inconsistent prices?
- Do your competitors use dynamic pricing successfully? If so, then it works, and the customers are okay with it.
- Can your company pinpoint how and when demand changes? You need this data to create your strategy and define pricing rules.
- How much market share do you hold? A small business can easily lose customers to competitors when they raise prices.
Next, follow these steps to create your strategy:
1. Start with a business objective
Your objective will determine your dynamic pricing strategy and tools.
I recommend building an objective around your customers. How do you want your customers to perceive your brand? And what do they expect?
For example, Amazon wants to be perceived as a website that offers the cheapest products and fastest delivery options.
You also need to consider your overall business strategy. What business outcome do you want to achieve with dynamic pricing? It could be boosting sales for some products or increasing your overall profits.
2. Choose your dynamic pricing strategy
Develop a pricing strategy to achieve your objectives. It should align with your customers’ expectations and market demand.
For instance, Amazon’s pricing strategy is to undercut competitors. So their dynamic pricing engine monitors competitors and adjusts accordingly.
Your strategy dictates the pricing method you use; i.e., whether time-based, competitor-based, peak pricing, etc.
3. Define your pricing rules
Companies use pricing rules to program their dynamic pricing engine.
For example:
- If demand for product A decreases by 15%, reduce the price by 8%.
- If competitor X charges Y amount, increase the charges by 12%.
The pricing rules can apply to specific products, product categories, or the entire product line. But they should always consider the market demand (when does it increase/decrease) and competitors’ prices (you don’t want to undercharge or overcharge).
4. Choose a dynamic pricing software
Implementing dynamic pricing primarily involves using an automated system. You can either hire a team to build it or buy it. Small businesses don’t usually have the resources to build a high-cost solution that will need maintenance. And big companies that build their systems could take months to complete.
Buying dynamic pricing tools is the easiest option because you only need to set up your rules and monitor. The pricing software, e.g., Price2Spy, will conduct real-time pricing analysis to adjust your prices while aligning with the market changes.
But how do you choose the best tool?
Besides fitting into your strategy, let the vendor show you how their system helped another company like yours. And they should be able to run a backtest (at a fairly low cost) to see what prices it’ll set and simulate your business’ performance. The results will help you analyze your pricing model’s profitability and risk. If it produces positive results, then the strategy will likely bring profits.
You can also buy dynamic pricing software through a management consultant. Consultants also help with change management (i.e., helping employees learn and adapt to the new system).
5. Implement and monitor your dynamic pricing strategy
Launch your pricing software and test that the rules are working well. And after rolling out, monitor it to ensure it aligns with market dynamics and achieves your objectives. Improve as needed.
Final thoughts: Is dynamic pricing fair?
Some customers criticize dynamic pricing because it mostly favors the wealthy. While it’s true to some extent, it also depends on your target customers and your product’s perceived value.
Even though dynamic pricing’s goal is to boost revenue whenever you have opportunities, it also helps the customers have the best experience. For example, Uber uses dynamic pricing to ensure that we have riders available every time.
If your customers see the value of your product to the point that they’re willing to pay more, then dynamic pricing is fair.
Also, it doesn’t always include making the products more expensive, sometimes it’s the exact opposite.
At the end of the day, the only way to find out whether dynamic pricing works for your business is to experiment, monitor, and learn from your mistakes.
Good luck!
