Dynamic pricing is increasingly prevalent in today’s market, although it is met with skepticism by some customers who perceive it as opportunistic or even unethical, reminiscent of “price gouging”.
However, upon closer examination, dynamic pricing is not a new concept: fluctuating prices have always existed, driven by market forces such as supply and demand (think about the price of gold and diamonds). In the last decade, the travel industry, for instance, has employed dynamic pricing strategies for airline seats, hotel rooms, and car rentals to optimize profitability and prevent resource wastage.
Dynamic pricing will become even more ubiquitous, necessitating strategic implementation with customer satisfaction in mind. When executed effectively, it can offer advantages:
- Potential to further fine tune your customer segmentation and lead to higher profits, by differentiating price points, tweaking them on the fly, etc. For example, some airlines can expand or shrink their premium cabin space (by tweaking seat configuration), based on customer demand and willingness to pay.
- Ability to better balance supply & demand, driving increased use of existing capacity and reducing waste. For example, the prime parking lot next to the stadium will have peak pricing until the big game starts, then lower the price to the usual rate once demand subsides.
- More gradual price changes over time (e.g., compared to jarring, periodic one-off price increases), which reduces the knee-jerk customer reaction of shopping around for better deals. Pricing becomes a much more “fluid” experience and it is easier to run price experiments and test price elasticity. Amazon is an expert at changing prices in a dynamic way.
So how can you reap the benefits of dynamic pricing, without triggering negative customer perceptions?
Here are five pricing tips:
- Be transparent: communicate upfront that your price will be dynamic and what metric will drive the price change. For example, some highways have variable toll lanes: the expectation is that if you pay the toll, you will experience a faster commute than non-toll lanes and the toll price will increase based on demand (i.e., how many cars are trying to enter the toll lane). Uber included a dedicated page on their website to explain their pricing model.
- Set clear boundaries: where possible, clearly outline price boundaries the customer could experience. For example, in a toll lane, what is the theoretical maximum a driver could pay? Avoid surprises (i.e., sticker shock).
- Make it equitable: the best versions of dynamic pricing swing in either direction. You could be paying a premium in some cases but in others you could experience a lower price. This can become a win-win for both parties. A few grocery stores in Europe are experimenting with electronic shelf labels, which allow them to dynamically change product prices. In a recent study, a significant reduction in food waste (as much as 39%) could be achieved by gradually lowering product prices, selling products faster before they spoiled. Historically, grocery stores would move older produce in a separate marked down section, but this takes time and planning (plus precious display space).
- Do not make it personal, especially for the essentials: when customers feel “trapped” into paying the higher price point, dynamic pricing becomes very antagonistic to the consumer experience. Some restaurants have experimented with dynamic pricing to better manage the inflow of customers around major mealtimes, especially for lunch. However, since many workers typically share a similar mealtime, dynamic pricing is viewed as a “money grab”, leading to a poor customer experience, see this customer study by Capterra. Similarly, when fashion retailers have experimented with dynamic pricing, they found that customers expected the price of the basic options (e.g., the basic white t-shirts) to remain stable, whereas they accepted broader price variation for high-end, fashionable garments.
- Be mindful about your offering and alternatives for customers: Think about Uber and Lyft when they implemented “surge” premiums (i.e., a higher price, when demand for their services reaches certain peaks) …customers understand how price changes due to increased demand. However, now imagine you are trying to get a ride from a station and there are no other alternatives (e.g., train, buses, taxis). Make sure your customers are willing to pay the higher end of your dynamic price as a choice, not because they are being forced to, which would cost you brand perception and long-term customer loyalty.
Hopefully these five points will help you evaluate the potential for dynamic pricing in your business which, if thoughtfully implemented, can be a solid lever to improve your margins.
If you need additional help thinking through the applicability to your business, please reach out.
