Dynamic Pricing: A Complete Guide

You must have experienced a time when you sat to book an airline ticket to your favourite destination, checked the prices and thought of booking it later. You log on the next day, check the prices and see that the prices have changed. Now, they are asking you to pay a different price, which is more than what you saw earlier! This change of prices is frequent in the airline and e-commerce industries and is called dynamic pricing. In this blog, we will talk about dynamic pricing and how businesses use it to their financial advantage.

Table of Content

• What is Dynamic Pricing?
• Origins of Dynamic Pricing
• Types of Dynamic Pricing Strategies
• How Companies Use Dynamic Pricing in Their Pricing Strategies?

What is Dynamic Pricing?

Dynamic Pricing is a pricing strategy that adjusts the price of a product or service in real-time to reflect current market demand. This means that the price of a product can vary depending on different factors, such as time of day, time of year, geographic location, and supply and demand.

This type of pricing applies to businesses that sell their products over the Internet and physical stores using digital labels to display their prices. In both cases, digital technology has made it possible to continuously adjust prices thanks to data-based marketing and automated analysis, making tasks easier.

Image - Dynamic pricing model compared to the static pricing model

Here is some background on dynamic pricing - 

Origins of Dynamic Pricing 

Dynamic pricing has since the time unknown. For example, shopkeepers in open-air markets have traditionally bargained with customers to negotiate prices based on factors such as the scarcity of the product and the customer's perceived willingness to pay. However, the modern concept of dynamic pricing emerged in the 70's, primarily driven by the airline industry.

Airlines and the Rise of Dynamic Pricing

In the early 1970s, the airline industry in the United States was heavily regulated by the government. However, in 1978, the Airline Deregulation Act was passed, allowing airlines to set their prices and prohibiting states from regulating the price, route or service of an air carrier to keep national commercial air travel competitive.

This deregulation led to a surge of innovation in pricing strategies. Dynamic pricing became a popular trend, and airlines began using computers to track demand in real-time and adjust prices accordingly.

For example, prices for flights on popular routes during peak travel times would be higher than prices for flights on less popular routes during off-peak times. 

This dynamic pricing strategy allowed airlines to maximise revenue by charging higher prices to customers willing to pay more for convenience and flexibility.

Types of Dynamic Pricing Strategies

There are mainly three types of dynamic pricing strategies, as discussed below -

Time-Based Pricing Strategy

The time-based pricing strategy is a dynamic pricing model that allows companies to adapt prices to the supply and demand of goods or services. This pricing model has gained popularity recently, allowing companies to maximise their profits while guaranteeing competitive prices.

The time-based pricing strategy can be used in different sectors, from hospitality and tourism to retail and e-commerce. It is beneficial for sellers whose industry is characterised by significant variability in the demand for goods. Time-based price adaptation allows them to react quickly to changes in the market and optimise profits without reducing customer satisfaction.

Peak-Pricing Strategy

Peak pricing is a strategy companies use to adapt prices according to customer demand. This strategy is an excellent way for companies to increase revenue while guaranteeing customers the best value for money. It helps sellers stay competitive in a constantly changing market by adapting prices to customer requirements. 

Peak pricing, in combination with dynamic pricing, allows companies to react quickly to changes in the market and take advantage of opportunities that might otherwise be missed.

Penetration Strategy

The penetration strategy is a pricing strategy generally employed by new companies and those entering the market. Their goal is to gain recognition and gain a share of the market. It involves setting the initial price of the product or service at a lower level than the competition’s to attract more customers and increase sales.

How Companies Use Dynamic Pricing in Their Pricing Strategies?

Below are some examples of companies that use dynamic pricing strategies. 

1. Amazon 

Amazon has been at the forefront of dynamic pricing. In an interesting revelation by Business Insider, Amazon makes price changes to its products every 10 minutes, and with these price changes, its profits have increased by 25%.  

How does Amazon implement dynamic pricing on its products? 

Amazon does this by adopting the following strategies - 

1. Data Collection: Amazon continuously collects a vast amount of data on customer behaviour, competitor pricing, historical sales data, and real-time market conditions. This data is crucial for making informed pricing decisions.
2. Machine Learning and Artificial Intelligence: Amazon has heavily invested in machine learning and artificial intelligence. These technologies analyse the collected data to identify patterns, trends, and correlations. Algorithms are used to process this data and make pricing recommendations.
3. Real-Time Adjustments: Amazon's pricing algorithms work in real-time to adjust product prices based on various factors, such as demand, inventory levels, competitor pricing, time of day (yes, it matters at what time you search), customer's browsing and shopping history, etc.
4. Competitive Pricing: Amazon closely monitors its competitors' prices and adjusts them accordingly. It aims to be competitive while also maximising its profits.
5. Cart Abandonment Strategy: Amazon collects data to personalise individual customers' pricing. You may have seen that the price of a particular product that you searched on Day 1 is Rs. 500, but if you left it in your cart for a few days, you may see that some percentage slashes the price of that product, say it's Rs. 450 now. This happens because either the demand for that product was relatively low, or Amazon may have adjusted the price to see how it affects your decision-making. They may offer a discount if they believe reducing the price will encourage you to complete the purchase.

Amazon's pricing strategy can vary by product category, region, and other factors. The company's ability to adapt and refine its pricing in real-time makes it an e-commerce leader.

2.  Airbnb 

Airbnb started as an alternative to hotels. It is a marketplace that connects people who have houses or apartments for rent with people who are looking for a place to stay. Airbnb also uses dynamic pricing but differs from Amazon; here, the host decides. Airbnb calls this feature Smart Pricing. It defines this feature as - “When you turn on Smart Pricing, your nightly prices automatically adjust based on demand”.

Metrics used by the Smart Pricing tool: 

1. Local demand in the area: If many properties are booked, Airbnb will raise prices because it is a popular location. During times of low demand, Airbnb will lower prices. 
2. Services: The longer the list of amenities and services the property offers, the better. 
3. Visits: The smart pricing tool considers the number of clicks and views potential clients make on your property listing. More visits and interest in your property can lead to higher pricing recommendations.
4. Reviews: Five-star ratings and favourable reviews tend to result in higher suggested prices.
5. Room type: The demands would be higher if the room has a balcony, a good view or a private bathroom. If you don't have these things, don't worry. Adding an extra bed, a smart TV, or air conditioning also helps. 
6. Availability: Hosts prefer customers looking to reserve the property for a longer time. 
7. Similar properties: If people look for similar properties you manage, the price will rise because of more demand. 

Conclusion

Dynamic pricing is a complex and evolving pricing strategy that can maximise revenue, improve efficiency, and enhance the customer experience. However, it is essential to use dynamic pricing judiciously, as it can also be seen as unfair or discriminatory. Businesses that use dynamic pricing should ensure transparency about their pricing practices and not take advantage of customers.