Dynamic pricing

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Nowadays, we see more and more companies using dynamic pricing to sell their products or services. Dynamic pricing, also referred to as surge pricing, demand pricing, or time-based pricing is a pricing strategy in which businesses set flexible prices for products or services based on current market demands. Most people can think about airlines companies, but they are not the only ones to collect data about their customers before putting a price on what they sell.

Let's have a closer look at the topic:

When it comes to pricing, companies can use different techniques to determine how much they want to charge:

  1. cost-based pricing
  2. competition based pricing : The principle is to monitor your competitors and adjust. Many companies look at the market leader to stay competitive. This is done by using a matching mechanism where an online bot will search for similar products and lower the price beneath the lowest amount found. In very competitive market, this can be dangerous since it can bring prices down by an important amount. This is why when the market is stable enough and has a long term view, firms will try and cooperate to not undercut each other everytime.
  3. perceived-value based pricing : As seen in our marketing course, the perceived value is found by asking customers what they are ready to pay for a certain product. This price should be justified with marketing efforts to say why we are different and better than our competitors.) The perceived value can increase due to a nice design, the brand, nice features… But perceived value can also be tricky because the true price your give to your product or service can influence its perceived value. For example if you sell something at an extremely low price, people will think it is of bad quality when actually it isn’t. The answer here would be to increase the price in order to drive up your perceived value. This is why using dynamic pricing is important in this case because this perceived value can change due to many different factors and could lead to a huge increase in revenue.

Whatever the technique used, many corporations choose to adopt the dynamic pricing strategy.

Dynamic pricing
Pricing strategy in which businesses set flexible prices for products or services based on current market demands thanks to algorithms and softwares that collect data. Most of the time, software used to adapt the prices to changes in competition, cost or demand are powered by machine learning. The software gains knowledge from data to find the approaches to solving a problem itself, and the more data is being fed to a machine learning system, the more it learns from it and improves its performance.

For further information about machine learning, please refer to From_machine_learning_to_digitalization.

In fact, dynamic pricing implies that data must be carefully studied, since a bad understanding of the market conditions can lead to irrelevant decisions and a loss in total sales. When dynamic pricing is implemented, it is important for the company to know what the price elasticity of demand is for its products.
For instance, if demand is inelastic, the company may have more incentives to raise its prices, as the demand will only slightly react, i.e. decrease, because of this change (e.g. an inelastic demand takes place for necessities such as water and goods that represent a small part of the buyer’s income). In order to analyze this elasticity, historical data of sales are used, and a regression is applied with the price as the independent variable and the demand quantity as the dependent variable. We therefore see that a topic which apparently has nothing to do with IT (marketing) seems more and more linked to data collection and software optimisation to set the right price to the right person at the right moment so that profit can be maximised. Indeed, IT is now integrated in every business departments within a company.

Dynamic pricing in practice

Dynamic pricing is used in many different sectors such as in tourism. When we look at tourism, we easily see seasonalities in demand for certain services or products during certain special events or periods. For example, hotels will adjust their prices depending on the supply and demand needs at different times.

These seasonalities can also impact the business for airlines. We can observe seasonsalities in terms of months like when the demand for tickets increases during certain vacation months or shorter seasonalities on a weekly or daily basis if we look at the day of the week or the time of day. In public transportation, during peak hours where there is a risk of congestion because of an excess in demand, companies surcharge their users in order to drive down the customers still willing to pay that premium.

Retail is also experiencing dynamic pricing especially with the surge of e-commerce. Retailers now need to track competitors, time, conversion rate… to better respond to the demand and increase their revenue.