Dynamic Pricing Strategy – Tips & Examples + Pros & Cons
When your customers visit your bricks-and-mortar or online store to purchase one of your products, most of the time they will want to know the exact prices of your products beforehand. However, if you are providing services like that of doctors, lawyers, accountants, plumbers, or electricians, setting an exact price is not a simple task. Prices vary because of multiple factors, like time, length and complexity of the service provided. That is a form of dynamic pricing and it certain cases it can be used for pricing your products in addition to your services.
Put simply, dynamic pricing is a pricing strategy in which product prices continuously adjust and are reframed, (sometimes in a matter of minutes), usually in response to real-time supply and demand. For example, e-commerce and online stores in general are big users of dynamic pricing as it is simpler to implement online rather than physical stores, you just change your settings, and your digital commerce software does the rest.
Speaking of software, at Pricefx over the last decade we have implemented our price optimization technology to assist hundreds of clients across the globe to build profitability and streamline efficiencies in their businesses. Part of that process has been to work together with those organizations to put a customized pricing strategy in place that fits their overall objectives.
That is the critical first step of the pricing strategy puzzle – you must first determine your business goals. Any pricing strategy or combination of strategies you seek to implement is only as good as what you are looking to achieve with your customized objectives—from selling off your outdated inventory, maximizing profits or increasing revenue or production volume or any of these in combination.
So, let’s dig in and dive deeper into analyzing the finer points and types of dynamic pricing strategies, look at a famous dynamic pricing strategy example, its pros and cons, and tips that can help you in determining if a dynamic pricing strategy is a good one for your organization.
What is Dynamic Pricing Strategy? – The Definition
Dynamic Pricing goes by many names such as real-time pricing. time-based-pricing, surge-pricing, and demand pricing. It is, by definition, a pricing strategy where a company sets flexible and variable prices on its products and services depending on any number of standalone or competing factors such as demand, supply chain, competition, location, time frame, and other market conditions.
However, most importantly, dynamic pricing is contingent on market forces. A dynamic pricing strategy is not designed to work for every business nor in every industry.
Most famously, Amazon is one of the largest retailers to have adopted dynamic pricing and on many of their product lines, they update prices every 10 minutes. (We’ll look at the Amazon Pricing Strategy in detail later in this article).
Other industries that have successfully implemented dynamic pricing include:
- Ticketed events
- Large eCommerce platforms
- General retail
- Public transportation
Be on the lookout for dynamic pricing strategies in different forms.
Types of Dynamic Pricing Strategies
A dynamic pricing strategy can be applied through different methods. Each of the different types may be employed to reach different business outcomes goals. Let’s check out the most common dynamic pricing strategy models adopted by leading companies:
This strategy is characterized by different prices for identical products, with the exact same production and distribution costs. Sometimes, certain segments of the population are willing and able to pay more for the same or very similar product or service. For example, the pricing of airline tickets in business and first-class is higher than a coach class seat because some people prefer luxury and comfort over price, and they are willing to pay more. Sure, you might drink free champagne and eat a better meal in first-class. But at the end of the day, you’re flying the same NYC to LAX route as those people sitting at the back of the aircraft and you’ll arrive at the same time.
Segmented pricing can also be used to target customers in different geographical areas. The pricing of your products differs based on your customer’s current location. Using segmented pricing you can potentially attract niche customers who place more value on a service or product than others. For example, home security companies may have more success focusing on high-crime areas.
This pricing strategy is popular in industries where the demand for the product or service changes surge throughout the day, or where businesses are looking to offer incentives to trigger customer purchases for different reasons.
- Transportation businesses often benefit significantly from different tariffs (e.g., night tariffs for taxis, or Lyft or Uber ‘surge pricing’ late in the evening)
- With every new fashion collection released, fashion houses lower the older collection’s prices to clear the redundant stock.
- Delivery companies may charge extra for express or same-day delivery.
A close relative to time-based pricing, peak pricing is predicated on peak hours, or peak seasons equating to high demand. Peak pricing is directly related to market demand based on seasonality or rush hours.
Effectively, the prices are set high as limited choices exist for consumers and there is a lack of competitors providing similar products or services. The cost of hotel rooms during peak seasons versus the cost of a hotel room during off-seasons is a good example of peak pricing put into practice.
Price discrimination involves setting the same product at different prices on different channels. There are varying degrees of this;
- First-degree price discrimination – charge the maximum amount for each product based on the channel in which they are being sold.
- Second-degree discrimination takes quantity into account. Bulk purchases are offered at a lower price per unit.
- Third-degree discrimination is based on the individual consumer. Ladies’ nights or special seniors or student’s prices are good examples.
It is recommended to only use price discrimination if it’s bringing a direct benefit to your shoppers and your business can see a benefit too. Most importantly, you need to be able to justify your prices to your customers when using price discrimination.
Price Shifts Due to Random Market Fluctuations
Markets are vulnerable to sudden shifts like pandemics, conflicts and other unforeseen events that suddenly cause product shortages or rapid boosts to demand.
Anyone who has been tracking market conditions since the global pandemic hit in March 2020 and the events since can attest to both the unpredictability and uncertain state of marketplace moves and their fluctuations.
Penetration Pricing Strategy – Penetration pricing is a pricing strategy that is used by new companies to gain a significant market share quickly by setting an introductory low price to entice customers to buy their products. Established companies also use the strategy when launching new products to build market share.
Amazon Pricing Strategy – A Famous Dynamic Pricing Strategy Example
Amazon is the world’s largest e-commerce business with its 2020 sales in the United States alone amounting to almost $386 billion. And Amazon didn’t arrive at the imposing sales figure by good luck or accident – it is dynamic pricing strategy in action.
Amazon’s pricing strategy revolves around offering the most competitive prices to shoppers. Which means that the prices are not constant and can change even multiple times a day. That’s why dynamic pricing is often also referred to as ‘repricing.’ The low prices on offer at Amazon ensure brand loyalty and retention and make it profitable for sellers using the Amazon platform to sell their products and build a customer base.
Amazon’s dynamic price change factors can be divided between variables which refer to market and customer behaviors;
- Demand volume – Amazon’s price changes are based on expected market demand for products. Additionally, Amazon factors in whether the demand is seasonal or predictable, and why the user will make their purchase: need, peer pressure, fashion etc.
- Stock volume – As always if demand is outstripping supply, the higher the product. On Amazon, if stock units are already low, and continued demand is anticipated, prices will likely increase.
- Product visits: Repetition and Frequency – Using cookies to track users, the Amazon sales platform knows how many times a shopper may have viewed the same product, the time of day they viewed it and if they browse related products at the same time. Based on that data a price is generated for the potential buyer and additional products may be offered to increase the average value of each transaction.
- Day and time of purchase – The purchase of certain products increases on certain days of the week or even particular times of the day, just like airline seats or hotel rooms. (For example – Airbnb users – have you noticed you regularly receive the latest offers on Sunday mornings?) Usually, these are the times when the user has more relaxation time to browse, compare, and decide. Amazon usually implements defined price changes at these times.
The secrets behind the algorithms that drive Amazon’s dynamic pricing strategy are closely guarded. Suffice to say that it is pricing software that makes its repricing possible and provides the data-driven insights for this task, as with many other competitive price analyses.
Your company might not be as big as Amazon, but the same rules apply if you are looking to use dynamic pricing and reprice your products to win business. Without data and pricing software to empower it, the kind of proactive repricing that is used in true dynamic pricing is not feasible.
The Pros & Cons of Dynamic Pricing Strategy
Depending on your industry, dynamic pricing can potentially assist you in growing your business. However, being fully aware of the pros and cons of the strategy before you jump in. There is no universal answer to know how implementing dynamic pricing will impact your business. Ultimately, your decision to implement (or not) a dynamic pricing strategy will depend upon your confidence that the possible benefits outweigh the disadvantages.
The Pros of a Dynamic Pricing Strategy
The dynamic pricing strategy has several advantages – here are the main ones:
- Dynamic pricing allows your business to set real-time prices based on the trends that impact your company most –Using dynamic pricing, you can simultaneously maximize revenue while remaining competitive.
- Dynamic pricing can potentially save your company money over the long term – Since software determines your automatic timing and extent of repricing, you will not need to allocate additional budget for your market research and manual price inputs.
- Dynamic pricing can have a significant impact on the growth of your business – A dynamic pricing strategy can help you achieve a 2 to 5% sales growth and a 5 to 10% bump in profit margins, according to McKinsey.
- Dynamic pricing can assist your retail business in understanding the ever-changing trends and track customer behavior, all while enhancing your inventory management, allowing you to clear off outdated inventory quickly and in real-time.
- Dynamic pricing can be managed effectively with the right pricing software – Monitoring hundreds of thousands of products and keeping a tab on the real-time supply and demand shifts is a challenging and complex task, far beyond the scope of manual pricing in Excel. However, you can manage it with carefully chosen pricing software. Taking the guesswork out of dynamic pricing, automating the entire process can assist in setting optimal product prices to achieve your desired business outcomes.
The Cons of Dynamic Pricing Strategy
A dynamic pricing strategy may not be the right fit for every business. There are also drawbacks like;
- Customers Sentiment – Customers usually do not appreciate things that make them uncertain. Fixed pricing of products or services and knowing what you will pay for your favorite products can lead to a feeling of comfort. As a result, dynamic pricing can make customers feel like the company is playing them. Before implementing dynamic pricing, make sure that it fits the brand image of your company.
- Price War Risks – Dynamic pricing can sometimes escalate ‘price-matching’ wars. And competing companies can cannibalize each other and drive each other out of business.
- Not Suitable for Every Industry – Dynamic pricing is good, but it is difficult to implement a dynamic pricing strategy in every industry. It is a pricing strategy staple in the tourism, hospitality, and service industries. However, it is less suitable where there are a limited number of customers e.g. OEM manufacturers to Auto, Aero & rail as an example. Additionally, original equipment manufacturer (OEM) pricing is often “dictated” by the equipment manufacturer, so there is no dynamic pricing possible.
- Lost sales – Many customers research product prices on the internet well in advance of making a purchase. If they go into a store or shop online and discover a product is priced higher than what they researched or expected, they may leave to shop elsewhere and complete their purchase.
How Can Your Businesses Implement a Dynamic Pricing Strategy?
Now you know what a dynamic pricing strategy is, and how it might be beneficial to your business, take the time to make sure to dive a little deeper and follow these steps before implementing anything extra into your business’s practices.
- Set Clear Business Goals – Make sure you know exactly what your business is hoping to achieve before you put any strategies into practice.
- Research Your Competitors – Check if your direct competitors are using dynamic pricing.
- Talk To Your People – Notify your staff of any price strategy changes. Liaise with your salespeople for customer feedback on your prices. They know your customers better than anyone.
- Select the Right Dynamic Pricing Strategy for You – Look at different methods of dynamic price adjustments and carefully select which products would be best suited for pricing changes. Don’t make changes en masse across your entire product line – start small and extend the strategy over time if it is working.
- Consider AI-informed Dynamic Pricing Software – Dynamic pricing cannot be done manually across hundreds of thousands of products in Excel spreadsheets. On the other hand, next generation pricing software can manage the dynamic pricing of your products.
Modern software solutions can optimize your products at different channels and locations, including tracking a myriad of factors including shopping history, competitor pricing, past sales volumes, and supplier pricing. The software can then adjust your prices, optimizing them according to what your business objectives are.
AI-informed pricing software like that from Pricefx can assist your business to put in place a definitive pricing strategy or range of different pricing strategies based on precisely the outcomes your company is trying to achieve.
To learn more about how to implement a customized pricing strategy for your business, check out the handy article below: