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Dynamic pricing for today's businesses

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Dynamic Pricing is when prices change based on supply and demand.

Dynamic Pricing is when prices change based on supply and demand.

In contrast to static pricing, where a retailer will for example print a price tag and never change that price, dynamic pricing adjusts based on many factors in order to capture the most value–and deliver the most value–to customers. 

Two types of dynamic pricing 

Not all dynamic pricing is created equal. The two types of dynamic pricing are:

  1. Revenue management, driven by changes in demand. Typical in hotel, airline, rental car, ticketing, and similar industries. 
  2. Supply-driven. Typical in ecommerce and retail, driven by price-matching or competitor out-of-stocks.

The most profitable type, based on revenue management algorithms, adapts prices to changes in demand or availability of supply. You have experienced this if you've ever taken an Uber at a surge price, or flown on a commercial airline. Even some rental car companies and hotels use this type of dynamic pricing. 

The other type,  supply-driven, can have significant impact as well. Companies either raise or lower prices based on what competitors are doing, or they mark down inventory to clear room for new inventory soon to arrive and recover cash tied up in the inventory that hasn't yet sold. Amazon changes prices more than 15 times per day on some products, based on what specific competitors are selling the same products for, and whether they are in stock. 

A key difference is that in most industries, supply-driven pricing has a ceiling: the manufacturer's suggested retail price or MSRP. Even if Amazon knows it has the last exciting new doll for Christmas, if the box says "MSRP $49.99" few retailers (including Amazon) would charge more than the MSRP. However, that isn't to say someone else wouldn't buy it at $49.99, then turn around and list it on Amazon's marketplace for its "market price" (which might be 2-3x the MSRP). 

Crucially, dynamic pricing for revenue management has the goal of predicting the market price and matching prices to demand, to create equilibrium. When demand is high, companies profit–perhaps, offsetting loss-making periods of low demand. For supply-driven dynamic pricing, the goal is usually articulated as maintaining a brand promise, or ensuring traffic from Google or other sources remains consistent and is not siphoned off by a competitor selling for a lower price. Here the upside is limited–and the downside is unlimited, as if some other store sells the doll for $10 less, they may take all of the traffic searching Google for that doll. 

How to know if dynamic pricing is right for your business

Dynamic pricing based on demand is extremely powerful. When American Airlines implemented it in the 1980s, it bankrupted People's Express, costing the startup $160 million in losses in one year. In the 1990s, National Rental Car swung from a $1 million monthly loss to profitability, after increasing revenue $56 million just one year after implementing dynamic pricing.

To understand if revenue management type dynamic pricing is right for your business, answer these questions: 

  1. Is your capacity relatively fixed?
  2. Is your demand predictable at all? 
  3. Is your inventory perishable? (For example, a seat on an airline or in a bus) 
  4. Are your fixed or sunk costs relatively significant compared to your variable costs?
  5. Does demand vary by time? (For example, is there more demand on weekends?) 

If you answered "yes" to at least four of these questions, dynamic pricing may work for you. If you answered "no" to two or more, it may still work for you if based on supply, depending on which two. Contact us if you would like to discuss with an expert. 

What if I'm a retailer or manufacturer selling direct to consumer? 

To understand if dynamic pricing makes sense in an ecommerce or retail environment, there are two steps. First, run an experiment on your current systems, adjusting price to see if you can impact your sales and profitability. This can apply to your prices, your prices vis-a-vis your competition, or a markdown or promotion compared to an earlier one. You may have already done this (for example, raising prices after a supplier changed its own pricing).

Data in hand, your second step is to analyze the impact. If there was no impact, or even after a month, results were not statistically significant, dynamic pricing might not be right for you. But if you observe significant changes to revenue, conversion rate, customer acquisition cost, lifetime value, or profitability, dynamic pricing may be a fit. 

Dynamic pricing systems 

In the revenue management use case, there are several options. Some companies build dynamic pricing in house; for example, Starwood spent $50 million building its own system. Because this can be prohibitively expensive, time consuming, and risky, other large enterprises have acquired companies (for example, Staples acquired Runa, and Home Depot acquired Black Locust) or they contract with outside vendors. 

Any quality revenue management system has at least four major components.

  1. Data collection and cleanup: collect, in as close to real-time as possible, indicators of demand such as purchases, page views, etc.
  2. Demand model generation: generate estimates of demand based on observed data.
  3. Burst detection: determine if demand in the current moment is exceeding predictions enough to warrant a change in price. 
  4. Pricing service: The API or system which updates prices the consumer sees based on the demand model and any burst in demand. Typically these are highly customizable. 

Each component is critical; however not all use cases require burst detection. To our knowledge only Perfect Price offers burst detection, or the ability to detect if a spike in demand in near real time, separating real spikes from simply noise. Burst detection simplifies long term demand estimates by capturing and adjusting for difficult-to-forecast features such as weather in multiple markets.

Additional components are usually available, sometimes packaged up as "modules", sometimes customized for specific use cases. For example, a company may want to use the same models that set prices to also forecast revenues. This can be possible depending on the vendor and architecture chosen. 

Vendors for dynamic pricing

For demand based, model driven pricing, vendors vary by industry.

Multiple Industries

  • Perfect Price
  • Zilliant

Airline

  • PROS
  • Sabre

Retail Banking

Retail 

  • Revionics 
  • Boomerang Commerce

For supply-driven dynamic pricing, there are a multitude of vendors. Perfect Price does have an offering, Boomerang Commerce offers a solution for the Internet Retailer 100 (very large, multi-billion dollar turnover retailers); for smaller businesses there is Wiser. A key feature most companies shop for–perhaps, the key feature–is the ability to accurately collect competitive data on prices. Larger companies may want fully automated price changes while smaller companies or companies with smaller assortments will want humans to review and change the prices manually. 

Summary

Dynamic pricing enables companies to capture more value–and deliver more value. Frequently upon implementing dynamic pricing, overall prices may only rise 1-2% but revenue and profitability increase as much as 10%. This is because dynamic pricing both is a form of price discrimination, charging some people more (early adopters, business travelers, etc.) and also improving the utilization of underutilized assets (the hotel room that would have sat empty at $100 but is rented at $50, or the shipping department at 10% capacity where if prices were lowered on key items, it might be at 30%).

When you consider dynamic pricing (or simply price optimization), engage with all stakeholders in your company and outside. Frequently many customers ask for and embrace dynamic pricing; today's generation expects "right pricing" whereas prior generations may have grown accustomed to simplicity and stasis. After all, only two generations ago department stores were a tremendous innovation–with standardized pricing across the country.  

Contact us if you'd like to learn if dynamic pricing is right for your business. 

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