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Dynamic Pricing: 5 Types & How To Implement

dynamic-pricing:-5-types-&-how-to-implement

Every customer has a price they’re willing to pay for a product. That price is unique to the individual based on the urgency of need, their disposable income, their perceived value of the product, and more. One customer might be willing to pay no more than $2 for their morning coffee, while another would pay $8 for that perfect cup of java.

When businesses charge a single, static price for their product, they’re missing out on two opportunities: to serve customers who would only pay less, and to charge more to the customers who are willing to pay more. These missed opportunities have led some businesses to implement dynamic pricing practices.

What is dynamic pricing?

Dynamic pricing, or surge pricing, is the pricing method in which the business changes the price of a product to adjust for changes in customer demand, supply, or price elasticity (how sensitive customers are to changes in price for a product). In a dynamic pricing model, the price for the product, at any given time, is determined by a series of price settings that the business establishes.

For example, kids running a lemonade stand might realize that on sunny days, demand is much higher. So they could set a simple rule for dynamic pricing: cups of lemonade are $1 on rainy days, $2 on cloudy days, and $3 on sunny days.

Dynamic pricing doesn’t always need to be disclosed to the customer—the lemonade stand could opt to simply change the price on their sign each day.

Some of the most well-known examples of dynamic pricing are in the travel/transportation industry. Uber is known for its surge pricing: the cost of a ride can increase drastically if many other people in the same area are looking for a ride. Similarly, airlines dynamically set higher prices at times when more consumers are looking for flights. This is why seasonal flights around holidays are the most expensive.

5 types of dynamic pricing strategies

There are many types of dynamic pricing. The dynamic pricing examples below are among those most commonly used by ecommerce and brick-and-mortar retailers:

1. Time-based pricing

Time-based pricing is when a business changes its prices based on demand at different times of the day or year. Rideshare services charging more on a Friday night and airline tickets costing more around holidays are examples of time-based pricing.

2. Segment pricing

This is when a business explicitly offers different pricing options for select groups of people. When a business offers discounts to veterans, persons with disabilities, health care employees, or another identity group, that is segment pricing. Segment pricing can be administered through self-identification (“If you are a veteran, click here for your discount”) or through restricted access (such as requiring a proof of income).

3. Volume pricing

When businesses offer discounts for customers that are willing to buy a higher number of products, this is a form of dynamic pricing.

4. Auction pricing

There are two types of auction pricing. The first is an actual auction format, in which customers bid on specific products over a specific time period. The second is automated auction pricing, like eBay’s automatic bidding option, in which customers enter what they’re willing to pay and goods are sold to the customers with a matching willingness to pay.

5. Consumer effort pricing

Consumer effort pricing attempts to segment consumers by their willingness to put in effort for a cheaper price. This is most common in brick-and-mortar stores and cut-out coupon books, such as those offered by grocery or electronics retailers. 

Any customer can access the coupon books, but only price-sensitive customers will make the effort to cut out the coupons and redeem them at checkout. Less price-sensitive customers won’t bother, and so they pay a higher price. Lowest-price guarantees are another version of this: Consumers who are willing to identify a lower-priced supplier are rewarded with a lower price than other consumers.

Why—and why not—to use dynamic pricing

For businesses, dynamic pricing has certain advantages over static pricing. By more closely matching the price charged to the price a customer is willing to pay, you can increase your margin on sales to customers willing to pay more and increase your total sales by reaching customers only willing to pay less. If your competitors only use static pricing, dynamic product prices can help win over their price-sensitive customers as well.

Dynamic pricing can have benefits for customers. For example, surge pricing can draw more drivers to a high-demand area, so that more customers are able to be served. Additionally, dynamic pricing can be applied to improve accessibility of products. For example, some electricity suppliers offer cheaper energy for customers who demonstrate they are below an income threshold.

However, businesses must also consider the risks associated with implementing dynamic pricing. When there are no alternative options available, it can be perceived as predatory. For example, if a rideshare app implements surge pricing in an area that doesn’t have access to alternatives like taxis, buses, or alternative rideshare programs, that is considered a predatory pricing practice, as consumers don’t have a choice. 

When consumers have high awareness of a business’s dynamic pricing models, consumers will be less willing to pay the high price range, knowing that other people can pay less. For example, if a brand sells a shoe in their retail store for $150 and sells the same shoe online for $125, they risk losing retail sales as customers realize they can order online for less.

Factors that affect dynamic pricing

A business needs to consider three types of factors to achieve a successful dynamic pricing strategy:

  1. Demand-side factors. Businesses need to understand if demand for their products is stable, or if it changes by time or day. They also need to consider if different customer segments have a different willingness to pay, and what affects that. For example, business travelers are often willing to pay more for flights, but they often need to book them with much shorter notice than other airline travelers.
  2. Supply-side factors. Dynamic pricing can be used to manage supply. If a business has excess inventory, more discounted dynamic pricing can be used to clear it, whereas if you have highly limited supply, dynamic pricing can raise prices to help avoid stockouts.
  3. Business model. Dynamic pricing should be informed by a business’s gross margins. If a business offers dynamic prices that cause it to sell products without making any margin, this is typically not a winning strategy.

How to implement dynamic pricing

  1. Determine pricing factors
  2. Set rules and parameters
  3. Evaluate and update

1. Determine pricing factors

Start by understanding what would cause your customers to pay more or less. This can be due to seasonality, time of day, income, or perceived value. This can be informed by analyzing sales data or through customer research and feedback.

2. Set rules and parameters

Determine the specific events or criteria that would trigger a lower or higher price. For example, you may set rules to increase price when you have less than 10 units left in stock, or to decrease price if you haven’t sold a unit in one week. 

Make sure you have boundaries in place that consider your supply and your business model: Generally, you don’t want a stockout or to be left with excess inventory, or to sell inventory at a loss. Once you’ve determined these parameters, you can work with a web developer to implement dynamic pricing directly on your store using Shopify Functions, a tool that allows you to set custom pricing rules. Dynamic pricing software like Prisync can help automate this process as well.

3. Evaluate and update

Review your dynamic pricing at least once a year. Dynamic pricing should lead to higher margins, happier customers, and more balanced inventory. If it isn’t having that effect, then there is an opportunity to improve, or move back to static pricing.

Dynamic pricing vs. variable pricing vs. price discrimination vs. fixed pricing

In a dynamic pricing model, a product’s price changes on an ongoing basis (sometimes in real-time) based on preset rules, such as changes in customer demand.

In variable pricing, the price changes, but on a set schedule (for example, higher prices on weekends).

Price discrimination is a form of dynamic pricing, but focuses on specific customer demographics, such as age or gender, and is not an accepted practice.

Fixed pricing, or static pricing, is when every customer receives the same price, regardless of supply and market demand.

Dynamic pricing FAQ

Is dynamic pricing legal?

Dynamic pricing is generally legal in most countries, although the context and industry (such as airlines, hotels, and ridesharing services) may impose certain restrictions or requirements. However, it can be seen as predatory in some cases, especially if it leads to price gouging during emergencies, exploits vulnerable consumer groups, or eliminates market competition that may be in violation of antitrust laws. Consult with a legal or pricing expert to assess the risk of your dynamic pricing strategy.

How can I address customer concerns about dynamic pricing?

Start with a dynamic pricing model designed to benefit the customer. Customers should perceive your pricing as offering more value for a higher price and more accessibility for a lower price. 

Is dynamic pricing better?

Dynamic pricing methods can lead to better gross margins, maximized revenue, and happier customers. However, when done poorly, it can reduce customer satisfaction, sales, and margins. So the right pricing model is ultimately the one that best fits your business.

Read More

This originally appeared on Shopify Plus and is available here for wider discovery.
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