Dynamic Pricing Explained

Introduction

Price, an important part of marketing strategy, is the only element that generates revenue for the business. All other elements, such as product, promotion, and distribution, have costs. Price is also one of the most important factors determining the purchase decision of customers. It is also the most flexible element of the marketing mix. Price-competition is the main type of competition in the market. Pricing means setting the right price of a product, which is neither too high nor too low. Right pricing can help a business increase its revenue, profits and market share. There are many pricing techniques used by business firms to achieve various objectives. Some of the pricing techniques are cost-based pricing, penetration pricing, price skimming, leader pricing, promotional pricing, competitive pricing, value pricing and price discrimination. In this article, we will explain dynamic pricing, which has become popular among many online businesses.

What is Dynamic Pricing?

A pricing strategy used to manage the prices of goods or services by considering changing demand for these goods and services in the market is called dynamic pricing. Dynamic pricing is also known by three different names, such as surge pricing, time-based pricing, and demand pricing. 

In dynamic pricing, the price of a product is constantly changed and adjusted based on the demand for that product. For instance, in case of an increase in demand, the price increases. The word ‘dynamic’ in dynamic pricing means constantly changing. So, dynamic pricing means the process of changing the price of a product based on its changing demand and that too very quickly.

Conditions of Dynamic Pricing

The following are some conditions or prerequisites of dynamic pricing:

• Business has some degree of market power or the ability to change the price. This is possible in imperfect competition where business is a price maker.
• There are different types of customers in the market with different price elasticities of demand. 
• Business has a continuous access to the data about the changing demand for its products.
• Business can prevent the re-selling of the product between customer groups.

Understanding Dynamic Pricing

Have you ever checked the price of an airline ticket and noticed that the price of the same ticket in the same airline is different the very next day? If yes, then you have experienced dynamic pricing. Contrary to static pricing, that uses a single price point, dynamic pricing uses multiple price points, to increase business revenue. Let’s illustrate this with the help of the following diagram:

In the above diagram, there are two graphs: one is for static pricing, and the other is for dynamic pricing. Both graphs have the price on the horizontal axis (x-axis) and the quantity demanded on the vertical axis (y-axis). The static pricing graph shows a normal downward sloping demand curve and a normal value of revenue earned when the standard price is static at single price point P1. But the other graph shows the use of multiple price points (P1, P2 and P3) due to which the firm earns extra revenue. P1 is the premium price, and P3 is the discounted price. The demand curve remains the same in both situations; however, the revenue earned by using dynamic pricing is greater than that earned through static pricing.

Examples of Dynamic Pricing

Airline Industry

An example of dynamic pricing is the airline industry, in which pricing strategy changes according to the seat types (economy class or business class), total time of the flight, and number of available seats remaining on the flight. This pricing strategy is effectively used by many airlines, such as Ryanair and Flydubai.

Hotel Industry

Dynamic pricing is also seen in the hotel industry, as they also change prices depending on certain factors like holiday cycles and seasonal variations. For example, hotels charge a higher price when more tourists visit certain place due to peak season. 

Online Retailers

Amazon, one of the biggest ecommerce retailers in the world, has successfully used dynamic pricing to increase its revenue. Amazon changes the price of its products after every 10 minutes based on the demand data. It means that the price is changes 144 times on a given date. 

Utility Providers

Utility provider companies also used dynamic pricing. The prices of electricity and gas vary with the seasons, as the prices of gas tend to increase in the winters because more heaters are used, and the prices of electricity in the summer increase because more air conditioners and fans are used.

Ride-hailing Services

The companies offering ride-sharing services, such as Uber, are also using dynamic pricing. The ride prices will change depending on demand, supply, time of day, distance and geographical area.

Google Ads

Google is also using dynamic pricing for its ads. The ad price will vary depending on the demand and the nature of the target keyword. If the keyword is getting more competitive, the ad price will increase. 

Factors Affecting Dynamic Pricing

The following are some factors that affect the dynamic pricing:

Consumer Behaviour

Consumer behavior majorly affects dynamic pricing because customer behavior varies in different situations and their preferences change based on their buying behaviour. Businesses use the data about the buying behaviour of customers to change the price accordingly. 

Fair Prices

Customers prefer fair prices and hate being cheated by offering different prices. The fairness of prices is explained by the customer’s evaluation, no matter what the difference is between the seller’s price and the other party’s offering. While using dynamic pricing, businesses should make sure that the price differences are reasonable and justified.

Market Structure

The dynamic pricing of products in a monopoly only depends on customer demand. It does not affect competitor pricing. But in other cases, the oligopoly market is also dependent on competitor pricing, not consumer demand. The market structure affects the dynamic pricing.

Models of Dynamic Pricing

The following are some models of dynamic pricing:

Price Skimming

In the price skimming model, businesses initially charge a high or a premium price for their new products in order to gain maximum profits from their initial customers. Later on, the price is gradually decreased in order to target other layers of customers with a low purchasing power.

Bundling

This is a dynamic pricing model used by businesses in which they offer a group or a bundle of products at a specific price instead of offering the products separately. This pricing is useful to increase the sales of related products.

Penetration Pricing

In the penetration pricing model, businesses, initially keep the prices of their goods or services very low in order to attract as many customers as they can. When the business achieves a reasonable market share, the price is gradually increased.

Price Discrimination

Price discrimination is the practice of charging different prices to different customers for the same product with the same cost of production. In price discrimination, businesses discriminate prices between their customer groups based on certain factors, like demographics, income, age, location, and time of purchase.

Advantages of Dynamic Pricing

The following are some advantages of dynamic pricing:

Increased Revenue

Businesses can adjust prices according to market demand. This practice will help them increase their revenue and hence their profits.

Effective Inventory Management

Businesses also use dynamic pricing to meet the demand of the market, which helps them reduce the excessive use of inventory and manage their stock levels effectively.

Competitive Advantage

Businesses remain competitive in the market with the help of dynamic pricing. Dynamic pricing helps them change or adjust prices according to the demand at that time.

Disadvantages of Dynamic Pricing

The following are some disadvantages of dynamic pricing:

Customers may Feel Cheated

Customers always prefer to buy from businesses that fairly charge for their services. Customers hate when businesses charge unfairly; due to this, they feel cheated and change their preference towards another firm.

Price Wars

Price wars also affect dynamic pricing because there is immense competition between business firms over prices. If a competitor decreases the price of its product, you have to decrease your product price in order to match the market price; otherwise, you will lose a large market share. The price war between firms will lead to a decrease in prices to attract more customers.

Lost Sales

Customers prefer to check reviews from previous buyers before making further purchases. Businesses will lose a large market share if their dynamic pricing strategy goes wrong. Customers only prefer lower rates for purchases and shift their preferences towards cheaper ones.

Strategies to Implement Dynamic Pricing

The following are some strategies used by businesses to implement dynamic pricing as the part of their marketing strategy:

Demand-Based Pricing

Demand-based pricing is a strategy used by businesses to adjust the prices of their goods or services according to the demand for those goods or services in the market.

Time-Based Pricing

Time-based pricing is a strategy used by businesses to adjust prices according to the time of day, week, month, season, or even year. 

Segment-Based Pricing

Segment-based pricing is a strategy used by businesses to adjust prices according to the different segments of the market, such as age, income, and geographical regions.

Event-Based Pricing

Event-based pricing is a strategy used by businesses to adjust prices according to specific events. For example, sports events, vacations, and others, like Christmas, Easter, Halloween, etc. 

Cost-Plus Method

The cost-plus method is a pricing strategy used by retailers. In this strategy, they add some markup to the actual cost of the demanded product. This will make sure that the product cost is covered and the business is making some profits.

Competitor-Based Method

In this strategy, retailers or businesses adjust their pricing according to the pricing of their competitors, whether they increase or decrease the price as per the level of competition in the market.

How to Implement Dynamic Pricing?

The following are some ways to implement dynamic pricing:

Understanding the Target Market

Businesses should know their exact target market to correctly determine and adjust prices according to the demand in that market. By knowing the exact target market, business can decide what to offer and what their customers are excited to purchase.

Knowing the Manufacturing Cost

Businesses must have the information about the manufacturing costs of their products so that you can set prices according to their profit margins.

Testing and Adjustment

When businesses decide to use dynamic pricing strategy, they need to test it, first. If they find that it is not working according to their plan, they can adjust it and again pass through the testing process so that they can get the desired outcome.

Dynamic Pricing Software

Dynamic pricing software is software used by businesses that automatically adjusts prices in real-time with changes in market trends. These changes occur due to various factors that affect the prices of goods or services in the market. These programmes use real-time data and automatically change the price by using algorithms and with the help of modern AI (artificial intelligence) techniques. The following are some major benefits of dynamic pricing software:

Automatic Price Adjustment

With the help of dynamic pricing software, price changes occur automatically according to the current market conditions, without any human intervention.

Quick Response

Businesses are able to quickly respond to competitors’ price fluctuations. 

Maximum Profits

Dynamic pricing software maximises profits by automatically adjusting the prices based on the preset parameters.

Conclusion

In conclusion, dynamic pricing is a pricing method used by many firms to increase their revenue and profits. The price is constantly changed in response to the changing demand for products. Many businesses, such as e-commerce stores, taxi-riding apps, accommodation apps have used dynamic pricing successfully to their advantage. Businesses should also keep in mind the cons of dynamic pricing while using it. Moreover, dynamic pricing is not suitable for every business. For example, it is not suitable for a restaurant offering meals or a hairdresser offering hair-cutting services.