Posted in Finance Articles, Total Reads: 4085
, Published on 28 November 2012
Dynamic pricing is a flexible pricing mechanism wherein goods and services are offered at a price that changes depending on various factors as decided by the seller including the level of demand, the seasonal nature of demand, type of customer etc. This strategy of pricing involves determining the value of the product or service in a fluid manner based on the prevailing market conditions and the value that customers attribute to products and services. In the current scenario dynamic pricing strategy is gaining ground in comparison to the traditional fixed pricing method.
In this pricing policy, often called ‘third degree price discrimination’, customers are usually divided into two or more separate groups based on demand curves and separate prices are charged from each group. This pricing strategy has resulted in increase in the profits of the firms by enabling them to extract more “consumer surplus”- the difference between the amount consumers actually have to pay and the amount they are willing to pay. There are many factors that have contributed to wide adoption of this pricing strategy. The increased availability of demand data due to technological advancements, ease of changing prices with new technologies etc. are some of the contributing factors. Dynamic pricing is largely dependent on the balance between demand and supply and with increased use of internet as a sales channel, changes in demands as a response to price changes can be quickly noted.
Dynamic pricing strategy is practiced in a wide variety of forms. Some of them include Time-of-Use (TOU) which involves charging a higher price during peak hours of usage and a discounted price during off-peak hours, Critical Peak Pricing (CPP) where customers are charged higher during peak period on certain number of event days say 15 days and at discounted rate during remaining hours, Peak Time Rebate (PTR)involves the existing pricing scheme with rebates being provided for every unit of reduced demand during peak hours (mainly followed in power sector) etc.
The practice of dynamic pricing though has received great deal of attention in the recent years; the basic idea has been around since earliest period of commerce. The essence of dynamic pricing is point-of-sale price adjustments taking place for customers meeting certain pre-determined criteria as established by the seller. ‘Haggling’ is the oldest and the most common form of dynamic pricing strategy. Unlike haggling which involved price adjustment based on person-to-person discussion between seller and buyer, dynamic pricing uses advanced tools and sophisticated computer technology to adjust price.
The benefits of dynamic pricing methods is being experienced by industries such as airlines, hospitality and electric utilities and also there is an increased adoption of this type of pricing policy in retail and other industries in the recent years.
Dynamic pricing in airline industry
Dynamic pricing strategy is used in pricing tickets in airline industry where the date of purchase of ticket and the customer type mainly affects the price. Airlines frequently vary ticket prices with the aim of filling all seats and getting maximum possible price for a ticket. It is usual that passengers sitting in a particular flight have all paid different prices for the same ticket. The demand of business travelers is relatively inelastic and hence they are more tolerant to high prices and so flights that are expected to be more populated with business travelers have higher ticket prices. On the contrary the leisure or family travelers are more price conscious and so such flights which are expected to have more number of leisure travelers have lower ticket prices. Also the prices being charged are low if tickets are booked well in advance and it increases as the date of flying approaches.
Dynamic pricing in hotel industry
The economic downturn has adversely affected the hotel industry and so they have resorted to dynamic pricing strategy to attract customers. This strategy was introduced initially by chains like Marriott, Hilton etc. and was then gradually adopted by others. The price is mainly affected by the seasonal nature of demand and the customer type. For corporate clients who are unwilling to compromise on services, the prices charged are higher as opposed to family customers who hunt for affordable prices. Similarly peak season prices are higher than off-season prices. There is also a concept of pricing based on booking dates, a well in advance booking are charged less that on the spot bookings.
Dynamic pricing in power sector
The prices charged for electricity is different for different times of the day and year. There are pre-determined slabs wherein price is decided based on the units of usage and also different prices are being charged for commercial and domestic customers. In case of peak hours there are also rebates provided for every reduced unit of usage up to a certain lower limit which is done to reduce consumption and wastage. Thus in power sector dynamic pricing is used not only to extract consumer surplus but also to conserve electricity.
Dynamic pricing by Amazon
Amazon had also adopted the dynamic pricing strategy in the past which was different from usual peak-pricing strategy. Their prices were determined based on their analysis of consumers’ past purchase history, place of residence and certain other factors using software. This resulted in highly negative publicity and the brand image was adversely affected. Amazon thus withdrew the dynamic pricing practice.
FUTURE PROSPECTS OF DYNAMIC PRICING STRATEGY
When I try to see the future of dynamic pricing there are two major issues related to the same. On one hand it is the ease of practicing this strategy with the advent of new technologies and e-commerce while on the other hand it is the question of legality of practicing dynamic pricing.
The emerging e-commerce has opened the doors for shifting the pricing strategy to dynamic pricing. E-commerce has a potential to affect pricing strategies of retailers by enabling them to change prices with time, quickly and at low costs. Proper study of customers’ browsing and selection (of goods and services) process can help a great deal in planning the dynamic pricing policy. Also with easily available customer data and their purchase practices, the sellers can develop and implement sophisticated pricing strategies that would help them to increase their profit margins. These opportunities are not restricted to online stores only but can be replicated to physical stores as well. With ESL (Electronic shelf labeling system) the retailers can very well use the offerings of e-commerce in physical stores. Also ESL enables to monitor purchases of individual customers over time which can also be used to analyze consumer behavior. Currently with loyalty programs stores usually track customer purchases and using this information they do personalized promotions, this information can be used for designing the pricing strategy as well.
With increased advancement in web world there have been issues and tensions which have raised many questions on jurisdiction, intellectual properties, privacy, freedom of speech etc. Although in current times issues of price discrimination in e-commerce and practice of dynamic pricing have gained little attention, the burgeoning potential of this strategy can have severe implications on the clash between law and technology. As the customers will become aware of this strategy and its use by sellers to exploit customer surplus they would raise questions against this practice and there will possibly be a demand to formulate legal rules against use of dynamic pricing to address the unfairness of discriminated prices. Then there would be a need for some form of monitoring and regulation that would put a check on the excessive use of dynamic pricing to exploit customers.
I see agricultural sector as a potential field for application of dynamic pricing. This would not only help the farmers to grow but would also help the country to be self-sufficient in food.
Pricing strategy which would be based on time of purchase, with earlier purchases being charged lower prices and subsequent increase in prices with time, can be practiced. This would help in development of cold storage facilities by capable industrialists who would be tempted to buy the produce from the farmers soon after the harvest with the aim of earning profits by selling it later. Also to prevent farmers from being exploited government intervention would be necessary that would plan a policy for deciding the ‘floor prices’ and ‘ceiling prices’.
Pricing strategy could also be based on the amount of purchase with certain lower limit that would help quick sale of the produce. This will help farmers to sell off their produce as early as possible and overcome the problems of loss due to damaged produce because of lack of storage facilitates.
This kind of dynamic pricing practice would be helpful to farmers as well as retailers or businessmen who can earn greater profit margins by purchasing harvest earlier.
This article has been authored by Shujata Singh from IIM Shillong.
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