What is dynamic pricing?
Dynamic pricing is a new trend among e-commerce businesses that takes advantage of the laws of supply and demand to generate as much business and turnover as possible. It is based on traditional economic theory, although it combines economic analysis with behavioural observations in order to maximise profits.
Traditionally, retail outlets set a price for each item that they feel is competitive, based on how much supply (and competition) there is for the item and the anticipated demand. The price is (ideally) set at a point that is attractive enough for stock to sell out while making the store a handsome profit. Dynamic pricing changes all that.
This new technique takes advantage of the instantaneous access to information allowed by the internet to set costs based on demand, so that when lots of people are trying to buy a certain item it will become more expensive, while when not many are buying its value will fall. This is similar to the practice of end of season sales practised by many retail stores; however prices can change far more rapidly on e-commerce websites – and you can keep track of what your competition is offering.
How does it work?
Dynamic pricing uses the same principles as the Uber surge charge, although without the justification that the increased fee means supply will increase. Some brands are even changing prices on their products based on the time of day, to take advantage of peak times to make more money while attracting customers when the number of shoppers is low. It also bases prices on what your competitors are charging, so that you can maintain an edge.
The practice of changing prices to take advantage of time based demand is not a new one. Happy hour in bars, for example, is designed to use lowered prices to attract customers at times when the venue would usually be empty, so that even though the profit margin is reduced on each drink more money is still made over the course of the happy hour.
What are the risks?
The example of happy hours in bars and pubs also shows what can go wrong with dynamic pricing. While they at first worked to attract customers to the bars which had happy hours, once the practice became widespread it became a necessity rather than a bonus.
Any pub that does not have good happy hour deals loses out, and venues now compete to offer the lowest prices (and earn the least profit) to avoid losing all of their clientele to competitors.
In terms of e-commerce, dynamic pricing can be a slippery slope. While the first website in an industry will gain a competitive advantage by offering lowered prices at off-peak times, if they get a significant revenue boost from the practice then other websites will very quickly follow suit and start a price war.
It is also very important to remember that the goal is to maximise profit, not just pure sales. If customers realise that by waiting a few hours they will get the same product cheaper, they will stop buying from your website in peak times. By the same token if you regularly sell out of stock anyway then dynamic pricing will only lead to you making less money, as you would sell the product for peak price anyway.
How can you do it right?
The goal is to modify your prices enough to give you the competitive advantage in slow periods without sacrificing profits. Changing the cost of an item several times a day will not be productive in the long run, for reasons mentioned above, but that doesn’t mean that the overall concept is flawed.
Airlines, for example, frequently offer cheaper fares when you book during the week compared to the weekend. This is to take advantage of impulse purchases, as people are more likely to plan holidays when they don’t have to go to work, while the cheaper weekday prices allow the company to capture the market. Petrol is also typically most expensive at the start of the weekend, when people may be fuelling up for a long trip.
The best way to use dynamic pricing is to develop an algorithm that slowly lowers your prices over time when demand decreases (limited by the point at which you stop making a profit) and then slowly raises them as demand increases. This will mean that your prices will always be as high as possible while remaining competitive.
Dynamic pricing is a new and exciting technique for e-commerce brands, but you shouldn’t get carried away with it. You should be taking advantage of the increased information that the internet gives you – but also remember that other people, including your customers, have access to unprecedented levels of information too.