Dynamic Pricing Strategy: Advantages and Disadvantages

Dynamic pricing has evolved rapidly with the development of pricing technology. Let’s look at how dynamic pricing works, the advantages and disadvantages of this pricing model, and how you can successfully implement it in your business.

What is dynamic pricing?

In its simplest form, dynamic pricing is the practice of charging variable prices for the same product or service based on various market factors. Also known as surge pricing, demand pricing, real-time pricing, or time-based pricing, businesses use dynamic pricing to set flexible prices based on dynamic market conditions, like supply, demand, and competitor pricing.

While dynamic pricing has existed in one form or another throughout human history, the airline industry supercharged it in the 1980s, Following the removal of government pricing regulations. Airlines invested a huge amount in developing technology that could automatically change ticket prices based on factors, like the number of seats remaining on a particular flight or the time till departure (i.e. the closer the departure date, the more expensive tickets will be).

How does dynamic pricing work?

Unlike fixed pricing strategies, dynamic pricing is flexible. It works by collecting market, customer, and competitor data in real-time. This allows companies to accurately reach the right customers at the right time, with the right price. The agile nature of dynamic pricing means that companies can charge the optimum amount each customer is willing to pay and maximise the likelihood of a purchase.

For example, passengers who must fly somewhere at the last minute are usually prepared to pay more for their ticket. Because the supply of seats on the flight may be limited so close to departure, the airline can justify charging these customers more.

Types of dynamic pricing

Let’s look at some of the most common types of dynamic pricing.

Each type represents a different dynamic pricing approach tailored to specific market conditions and customer behaviours.

Segmented pricing or price discrimination

While it’s not the most appealing term, price discrimination refers to the practice of charging varying prices for the same product or service based on different customer segments. In its most extreme form, the business charges each customer the maximum they are willing to pay. Another form of segmented pricing is bulk or bundle pricing, where companies charge different prices based on volume. Lastly, businesses can use segmented pricing to target particular customer cohorts with different price points depending on their level of price sensitivity.

Peak pricing or surge pricing

If you’re in a busy city on a rainy day, you may pay a lot more for a rideshare than when the sun is shining. Peak pricing, or surge pricing, was made notorious by Uber when many passengers were left stranded or out of pocket during severe storms in New York. In response to public pressure, the company has since introduced surge pricing caps to make the service more ethical.

Rideshare is not the only industry to employ this dynamic pricing model. Accommodation sites like Airbnb charge more for bookings during peak periods, like the summer holidays and over Christmas. They justify this based on the principles of supply and demand.

Time-based pricing

Business use time-based dynamic pricing strategies in several different situations. For example, using certain services during peak periods, like booking a removal company over the holiday season, will be more expensive. Likewise, suppose you order something online and you need it immediately. In that case, the company can charge you more for same-day delivery, because you are willing to pay extra for this premium service. Time-based pricing may also refer to the “newness” of certain products. For example, you may find the price of Halloween decorations drops the day after Halloween because demand has decreased.

Penetration pricing

The dynamic nature of penetration pricing means businesses can drop their prices when entering a market to take market share from competitors. Once a significant portion of the market has taken up the product or service at a discounted price, the company increases prices to the expected level. A great example of penetration pricing is streaming services which charge a heavily discounted introductory price for a specified period before increasing to the standard subscription rate.

Dynamic pricing examples

While it’s not a silver bullet, this pricing strategy works well for a number of different types of businesses. Let’s look at some dynamic pricing examples.

Accommodation

Dynamic pricing strategies are the pricing model of choice for the travel and accommodation industry because they tackle some of the critical challenges these businesses face. Selling rooms too cheaply, reaching capacity too soon, or ending up with unsold rooms, are all problems that dynamic pricing can minimise.

Airbnb has developed an intelligent dynamic pricing algorithm that helps property hosts determine the optimum price to ensure maximum occupancy and revenue. This is based on factors like seasonality, weekdays vs. weekends, special events, and around 70 other variables that impact demand. As a result, the exact same property will have a different price, depending on whether you book it mid-week, during the Christmas season, or in the middle of summer.

Transportation

The transport industry is a major adopter of the dynamic pricing model, from airlines to trains and rideshares. Facing many of the same challenges as accommodation, transport businesses can use a dynamic pricing strategy to ensure they sell the most seats at the best possible price, and minimize wastage. The technology used to power these pricing engines has come a long way since the aviation industry developed it in the 1980s. Today’s dynamic pricing engines are powered by artificial intelligence (AI) and machine learning to process vast volumes of data and consider multiple variables simultaneously.

Electricity

Based on the principles of supply and demand, it is usually cheaper to use electricity at night when there is less stress on the grid. During “peak” times, such as the hours after work but before bed, there is usually significant demand on power resources, with people doing laundry, making dinner, and watching TV. It costs power companies more to meet the heavy demand during these periods. To remedy this, they charge a lower cost per unit at night time, encouraging customers to use less power during peak periods.

Entertainment

Your favourite team is playing this weekend, but you should have booked tickets earlier. When you check the ticketing site, you see that ticket prices have increased significantly in the past few days. This is a dynamic pricing strategy in action. Pricing software may be processing several key data points in real-time, including the level of demand, the number of seats already sold, the weather forecast on the game’s day, and the players’ popularity.

What are the advantages of dynamic pricing?

The flexibility of dynamic pricing makes it a popular and profitable choice for many businesses.

Increased revenue

The clearest advantage of using a dynamic pricing strategy is more revenue and better profit margins. Using dynamic pricing software, a hotel can know with reasonable accuracy at what price to sell rooms six months from the date of the stay, considering price elasticity and how much to increase the cost of the same rooms closer to this date. If they strike the right balance, they sell out each room at the maximum price the customer is willing to pay at the time of booking.

Valuable Customer Insights

At the end of the day, your customers are your business. Dynamic pricing software lets you understand your customers in greater detail and answer important questions about them. For example, you may ask, how price sensitive are my customers? When do my customers usually make a purchase? What customer segments exist, and do they have different purchase behavior? What is the maximum my customers will pay at any given time? How does a price increase affect sales? This invaluable customer data informs your pricing strategy and enables you to optimize revenue and profit, forming the basis of a successful dynamic pricing strategy.

Competitive agility

Unlike cost-plus pricing, which is relatively fixed, dynamic pricing is extremely agile. This means businesses can adjust prices in real-time. The flexibility offered by a dynamic pricing strategy allows businesses to act on market opportunities or defend themselves from competitive threats with speed and accuracy.

What are the disadvantages of dynamic pricing?

Many feel dynamic pricing needs more transparency. These are some of the potential pitfalls of this pricing strategy.

Customer dissatisfaction

Finding out that someone has paid less for the exact same product or service can be very frustrating. Dynamic pricing can cause customers to feel they’re being taken advantage of. The Uber example above shows how public pressure can force companies to cap their prices in certain circumstances to make the practice more fair and transparent. Dynamic pricing must be carefully considered so as not to risk customer satisfaction.

Possible price wars

Businesses can use penetration or competitive pricing strategies to swoop in and take significant market share from competitors. But what happens when competitors match or beat these prices? Now they have entered into a price war, which can become a race to the bottom. Dynamic pricing can be useful in gaining a competitive edge, but companies must be cautious to remain profitable, especially when considering variable pricing. Flintfox’s Pricing Engine allows you to manage dynamic pricing while always staying within profitability guardrails.

Making sense of pricing technology

We understand that the different kinds of pricing technology can be confusing. At Flintfox we are here to help you navigate the pricing technology eco-system. We would love to hear about the pricing challenges you are facing as a business and work with you to figure out how we can help.

Contact our team to discover how Flintfox can supercharge your pricing strategy today.