Dynamic pricing is a pricing strategy that uses flexible prices instead of fixed ones. Prices vary based on changes in the market, such as competitor pricing, demand, supply, time, and customers’ behavior.
In this article, we will talk about the importance of dynamic pricing, its advantages and disadvantages, and the types of dynamic pricing. We will give you a step-by-step guide on implementing a dynamic pricing strategy and take a look at some examples.
Why is dynamic pricing important?
Many business owners prefer flexible prices for their companies — let's talk about why dynamic pricing models work so well.
First, there is a great chance to increase sales with dynamic pricing. You can adjust to the ever-changing market and react to emerging market demands more promptly. For example, there might be times when lower prices can trigger sales and generate more profit. At the same time, raising prices, catching sales opportunities, and maximizing profits is a better strategy when customer demand is at its peak.
Second, it is challenging to set specific prices based on dynamic parameters. The market abounds with complex products, so such situations do not come as a surprise. Companies use dynamic pricing strategies to manage a range of pricing alternatives and adjust the prices according to the relative market value.
Now you know the key reasons why many brands prefer dynamic pricing over fixed pricing. In the next section, we will describe the pros and cons of this pricing strategy.
Advantages and Disadvantages of Dynamic Pricing
The primary idea of dynamic pricing is to make businesses more flexible and raise the margin by reacting to customers’ demands. However, as with every strategy, it has upsides and drawbacks.
Advantages of Dynamic Pricing
Prices can reflect demand. Certain products are in high demand during specific periods and in low demand during others. Dynamic pricing is a way to reflect the changes and increase profits by keeping tabs on the number of people interested in certain products.
For example, Christmas decorations are in high demand in December, so it is a great time to increase their prices and earn more. At the same time, no one needs them in summer, so you can decrease the prices to boost sales. This strategy can also be used in grocery shops, before events, etc.
Price changes can trigger sales and increase profits. You can use dynamic pricing to boost either profits or sales. Lower prices can trigger people to buy more and increase demand. Monitor and analyze your customers' behavior and adjust your prices accordingly to earn more.
Brands can get more insights into customers’ behavior. You can calculate the demand curve for your clients and discover the minimum and maximum price they are ready to pay for a particular product. Keep track of customers’ behavior, think about the necessary changes, and outrank your competitors by providing a better customer experience at a lower price with dynamic pricing.
Your business can become more flexible. Using the dynamic pricing strategy can help you not to concentrate on keeping your prices stable, as you can change them anytime. Focus on other aspects of your business and look for new sources of revenue instead of worrying about prices.
You can manage your product line better. Sell the overstock with a discount and raise the prices for products in high demand. You can control all the changes and maintain a steady flow of your dynamic pricing strategy.
Disadvantages of Dynamic Pricing
Dynamic pricing is not in favor among all consumers. Not every company implements dynamic pricing — clients who do not do enough research to find out about your reduced prices will inevitably pay more, which will make them feel bad. While such consumers can become hostile to your company because of this, the ones who purchased from you and saved money will come back to you again and again.
Clients can beat the system. Many people have figured out how to use any dynamic pricing strategy to their maximum benefit. Consumers know that if the demand for a certain product rises, its price will be increased. So, customers started using private browser sessions to limit the amount of information collected by companies and prevent them from believing that a certain product became more popular.
There are tools that help people compare prices on the same products on different websites, allowing them to buy the cheapest ones without caring about a specific brand. This defeats any dynamic pricing strategy and decreases customer loyalty many brands struggle to achieve.
There is always the risk of dumping prices and price fluctuation. If you lower the price using a dynamic pricing strategy, your competitors may make their prices even lower. It will cause dumping, which is harmful to all business owners.
Using dynamic pricing also can cause pricing fluctuation in the industry. If you increase prices and your competitors lower them simultaneously, it won’t attract customers to your business, leading to lost sales.
Dynamic pricing is not a solution for everyone. Although dynamic pricing usually works well for businesses in the retail, air transportation, and hospitality industry, it is definitely not a one-fits-all strategy. Businesses that prioritize customer satisfaction and brand image over profits will not find dynamic pricing beneficial.
Now you know all the pros and cons of this strategy — continue reading to discover the most popular types of dynamic pricing.
Types of Dynamic Pricing
To effectively use a dynamic pricing strategy, you need to know how to change your prices based on different metrics. Let’s go over the most popular dynamic pricing types, their peculiarities, and the spheres of usage.
With this pricing strategy type, companies can use algorithms or machine learning to set up prices for different segments of customers. Prices vary based on location, demographics, social status, and other information about clients found using open resources. This is the most dubious type of dynamic pricing, as it makes higher-paying customer segments feel disadvantaged and harms brand loyalty and image.
This type of dynamic pricing is often used in online retail, utility pricing, and electricity pricing. It means that prices can change depending on the time of the day or the day of the month. For example, online shops may set higher prices for their products from 9 am to 5 pm, which is a high-demand period.
There is also critical peak pricing. It requires business owners to set their prices on a time-of-use basis except for the critical days when prices rise to reflect some other expenses.
The cost-plus technique is one of the most popular types of dynamic pricing. The price formula is the average fixed cost plus a certain amount of profit. However, this strategy does not reflect many factors, such as consumer value, competitors’ prices, changes in the market, etc.
If you want to succeed in the competitive environment, it is vital to keep track of your competitors' prices. This strategy is often used in online retail. For example, Amazon is one of the leaders in the industry and changes its prices regularly, which encourages its competitors to adjust.
When it comes to high competition in the market, companies tend to cooperate. Setting up similar prices helps avoid dumping and increases profits for all businesses.
In the ideal scenario, the pricing of certain products should be equal to their value for customers. However, it is almost impossible, as the value can differ from customer to customer. Moreover, it depends on the time and retailer. Use value analysis as a guideline in your dynamic pricing strategy.
There is also a subtype of this pricing strategy called conversion rate pricing — it relies on the percentage of website visitors who turn into buyers. When the conversion rate increases, the prices on a website increase, too. This strategy is used among online shops, and its peculiarity is that customers can influence the products’ prices.
According to this dynamic pricing strategy, the price of a product depends on whether it is bundled with other products. The prices for bundled products are lower than the prices of the same products sold separately. Subscription-based platforms, printed media, and online courses often use this dynamic pricing type.
Now you know the most popular types of dynamic pricing strategies. Read the next section to discover how to implement them for your company.
How do you implement a dynamic pricing strategy?
Countless business owners want to change their pricing strategy and implement dynamic pricing into their policies. Below, we provide a step-by-step guide on how to do it successfully.
- Define your commercial goal. Decide on your priorities besides making a profit. This goal will lead you and navigate you in the right direction during your business development, especially when it comes to pricing and marketing.
- Discover more about your target audience. Who do you sell your products to? Quantify the approximate number of clients and find their common needs and pain points. Afterward, segment your audience to offer services, packaging, and pricing based on every group's specific preferences.
- Identify other metrics that influence the price. If you want to leverage a cost-plus dynamic pricing strategy, ensure that you single out proper metrics. While setting up your prices, add a fixed percentage on top of your unit cost.
- Build a pricing strategy. Choose from the dynamic pricing strategies provided in this article or develop a complex one. Then turn it into a plan for your team to follow. Focus on your commercial goal and think about the ways to reach it.
- Choose your pricing methods and rules. Methods and rules are the next steps to developing your dynamic pricing strategy, so think about how you will set up the price for every product. Come up with a system of discounts and consider high-low pricing.
- Test your strategy and make changes if necessary. Launch your product and follow a dynamic pricing strategy. Test different price options and monitor the changes in demand and income.
Let's talk about industries where dynamic pricing fits the most and discuss the peculiarities that influence the implementation of this strategy.
Dynamic Pricing Examples
Dynamic pricing is often used in many industries, such as air transportation, rideshare services, hospitality, and retail. Read more about them in this section.
All travelers know that prices on plane tickets to the same destination change depending on the departure time, season, holidays in the area, and many more. Most airlines use a time-based dynamic pricing strategy — they developed expensive programs that change prices automatically based on specific metrics.
Many taxi and rideshare services, like Uber, use dynamic pricing systems. Fares always rise when it is rainy or snowy outside and during rush hours, meaning that services use dynamic pricing based on time and value. Moreover, food delivery services often use the same strategy in their work.
Just like airline companies, hotels set up their prices depending on the time and season. During the peak season, prices are much higher, and businesses earn most of their income. During the rest of the year, the prices are usually much lower. Hotels also use demand and value to calculate the highest amount of money customers are ready to pay. When the demand increases, business owners raise their prices, too.
Online retailers often use demand-based dynamic pricing and even develop special software to track how many people are interested in certain products. The higher the demand, the higher the prices.
Congrats, now you know everything there is to dynamic pricing. Think about how to use it for your product line and increase your profits.
Last Updated: 09.03.2023
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