How does dynamic pricing work and why is it useful?
Dynamic pricing involves varying the price of your product or service at different times, for different customers, or in response to changing market conditions. It's a way for your business to maximise potential profitability and stay competitive in a fast-moving market.
In this guide, we'll look at types of dynamic pricing, the pros and cons, and how to implement this sort of pricing strategy in your business.
What is dynamic pricing?
A dynamic pricing model involves continually changing prices in response to external factors. Instead of setting a fixed price based on the cost of providing the product or service, dynamic prices are set according to demand, season, time, competitor pricing and other measures. Many well known retailers and service providers – including Uber, Amazon and AirBnB – use dynamic pricing methods to optimise their profitability.
How can a dynamic pricing strategy be useful in business?
Dynamic pricing – sometimes called adaptive pricing – can be useful because it helps avoid pitfalls like setting prices too low to be profitable or too high for your market. The strategy lets you respond to market changes, cost changes and customer demand, giving you the flexibility to set prices at the right level at the right time. As a result, it can help boost profitability and revenue over time.
Dynamic pricing vs static pricing
Dynamic pricing and static pricing are polar opposites. When you use a traditional static pricing model, you set a fixed price for your products or services and stick to it, only changing prices during a sale or after several years. Pricing decisions are usually based on the cost to your business, competitor pricing and historic sales data. While this strategy is still used by brick-and-mortar retailers and many in the food and hospitality industries, it can mean losing potential revenue thanks to under or overpricing.
Amazon is perhaps the most famous example of dynamic pricing done well. According to McKinsey, the global ecommerce giant re-prices items as often as every few minutes, adjusting based on browsing behaviour, competitor prices, and other factors. This ultra-automated, complex system has helped keep Amazon at the top of the ecommerce heap, but it’s not feasible for most small businesses.
Variable pricing vs dynamic pricing
Variable pricing sits between dynamic and static pricing. With a variable pricing strategy, your prices can vary based on the day or season, but they don't respond to demand or competitor pricing in the same way. For example, movie theatres may charge more for tickets to evening or weekend screenings and less for daytime and weekday time slots. So prices vary depending on day and time, but they don’t shift and change from week to week.
What are the types of dynamic pricing?
There are several types of dynamic pricing, including segmented, time-based, value-based and bulk pricing.
Segmented pricing
A segmented pricing strategy divides prices into segments based on a range of factors, including time of purchase, attributes (like the seating area at a concert), product volume and channel – for example, online buyers may get a lower price.
Time-based pricing
As the name suggests, time-based pricing shifts the cost of your product or service depending on the time of purchase or time of use. The most obvious examples are airline tickets or accommodation rising in price around holidays and 'surge pricing' for services like Lyft and Uber in times of high demand. Time-based pricing can also include things like paying extra for same-day delivery or a last-minute booking.
Competitor-based pricing
Competitor-based pricing is a bit more complicated. With this type of strategy, your business needs to monitor competitor pricing closely, then match or undercut their prices as they change. Think of retailers launching sales at the same time as their competitors or offering price matching or discounts on identical products.
Value-based pricing
Value-based pricing involves setting the price of your product or service according to your customers, not your costs. This can mean setting a higher price than the competition because your brand is perceived as a high-end or luxury brand or selling by offer or auction instead of using set prices. Real estate, for example, is most often sold via value-based pricing – purely about what the buyer is willing to pay, not the inherent value of the property.
Bulk pricing
Bulk pricing is a simple dynamic pricing method used by online retailers and wholesalers. With this method, customers pay less per item when they buy more. For example, a wine seller may charge $20 for a single bottle of wine and $18 per bottle when a customer orders a case. Bulk pricing can also apply to services – for example, a massage therapist may charge a certain price for single massages and a different price for customers who sign up for repeat weekly services. This strategy can incentivise large orders, while helping to smooth cash flow.
Price skimming
With price skimming, your business charges the highest possible price when your product or service hits, then lowers it over time. Early adopters and trend-driven customers buy the product at the initial price, then as competition enters the market, you lower your price to attract the next wave of customers, and so on. The idea is that you maximise the potential profits and pull in as many customers as possible over time.
Penetration pricing
Penetration pricing is almost the opposite of price skimming. With this strategy, you set prices low during your launch in order to attract customers and pull people away from your competition. Once you've built up a strong customer base and proven the worth of your product or service, you can gradually increase the price of your product.
What are the benefits of dynamic pricing?
The benefits of dynamic pricing include increased revenue, better market penetration and more control over your pricing in general.
Increased revenue
Dynamic pricing can increase your revenue by maximising the value of each sale. Instead of charging a fixed price for every customer every time, you can leverage factors like increased demand and customer preferences to charge more for the same product or service.
Grow market share
This pricing strategy can also help you increase your market share. Depending on the specific dynamic pricing method used, you may be able to attract a wider range of customers than with static pricing. For example, by price skimming you may be able to reach a more cost conscious consumer base.
More pricing strategy control
Unlike fixed or static pricing, a dynamic strategy gives you greater control over your pricing. Rather than setting a price that will stay the same for months or years, you can choose to tweak and shift prices according to market conditions, avoiding the issues that can come with over or underpricing.
What are the disadvantages of dynamic pricing?
The downsides of dynamic pricing include a potential loss of customers, setting off pricing battles in your market, and the fact that dynamic pricing can be prone to error.
Potentially lose customers
While dynamic pricing can help you attract new customers, it also has the potential to turn people away from your business. Some customers may lose trust in your business if they find out they were charged more than another customer. Some may not be willing to pay higher prices for the product or service they want, while others may feel that dynamic pricing is unethical or unfair.
Can initiate a pricing war in your market
Dynamic pricing can be a way to outpace your competition, match their price changes and even undercut them. However, if your competitors respond by changing their prices, the strategy has the potential to set off a price war in your section of the market. If everyone is trying to offer the lowest prices, you could end up cutting into your profit margins or finding it difficult to stabilise pricing levels.
Dynamic pricing is prone to errors
Because it’s more complex to manage than a static strategy, dynamic pricing can be error-prone. Depending on the systems and processes you use, you could run into pricing issues – and disgruntled customers – so it’s crucial to implement reliable systems and monitor them closely.
What is an example of dynamic pricing?
One of the best known examples of dynamic pricing is Uber. The ride-sharing company uses an algorithm to vary the price of journeys based on time, distance, traffic levels, customer demand and other factors. While there's been some controversy about Uber's surge pricing – which increases prices sharply during high demand periods, including storms and other emergencies – the company has built a customer base of around 130 million regular users since 2017, so their pricing strategy is clearly working for them.
How to implement a dynamic pricing strategy
Implementing a successful dynamic pricing strategy takes time and expertise. While every implementation is different, there are several key steps to complete, which include:
Identifying your goal
Why do you want to implement a new pricing strategy? Sorting out your reasons for a change and your business goals is the first step. Goals could include boosting profitability, increasing market share, or simply giving customers more price options.
Deciding on a pricing strategy
The second step is choosing a pricing strategy that fits your business. Time-based pricing tends to work well for businesses that sell tickets to events, while penetration pricing or price skimming can be effective for new businesses or product launches. Subscription services or B2B businesses may choose a segmented pricing strategy, offering different levels of service at different price points.
Implementing and monitoring
Implementing isn't just about working with your IT team or external providers to make changes to your ecommerce platform or business management system. This stage also involves communicating with staff and customers to ensure everyone understands your new strategy – particularly if you're shifting from a static approach to a dynamic pricing method. It's also important to monitor your new system carefully, keeping an eye out for errors and other issues.
Reviewing performance and customer feedback
Reviewing performance is an ongoing process. You'll need to track profitability, sales levels and other KPIs as usual, ensuring that your new system is delivering the results you want. Customer feedback is also key – make sure you're monitoring your email system and other channels for complaints or feedback so you can spot any problems, gauge customer sentiment, and tweak your systems if necessary.
Dynamic pricing FAQs
Is dynamic pricing legal in Australia?
Yes, dynamic pricing is legal in Australia. However, there are requirements around misleading or misquoting customers about price or colluding with your competition to keep prices at a certain level.
Is dynamic pricing legal in New Zealand?
Yes, dynamic pricing is legal in New Zealand. But, like Australia, New Zealand has strict rules around anticompetitive behaviour and misleading sales strategies, so it's important to make sure your pricing strategy doesn't break those rules.
Does dynamic pricing increase revenue?
Dynamic pricing can increase revenue, but it’s not a guarantee. The outcome depends on the specific pricing strategy, your business goals, and how your customers react to the change.
Is dynamic pricing ethical?
While there's nothing inherently unethical about dynamic pricing, it can be used in an unfair or unethical way – for example, to take advantage of desperate people during an emergency situation. Perhaps more importantly, dynamic pricing can also be perceived to be unethical or unfair by your customers, which could turn them away from your business.
What industries use dynamic pricing?
A wide range of industries use dynamic pricing. Airlines and hotels, ticketing and events providers, ride-sharing platforms and food delivery services all tend to use some form of dynamic pricing as a matter of course. Other types of dynamic pricing are also used by retailers – particularly online retail – wholesale and distribution businesses, and even professional services firms.
Pricing made perfect with MYOB
Dynamic pricing is one way to use technology to optimise outcomes in your business. Instead of relying on guesswork, gut feel and long-term results, a dynamic strategy lets you change and shift with the market, getting the best possible price and the most customers for your product or service. If your business is struggling to keep up with the competition, it could make a positive change.
MYOB is another way to boost your business with technology. Our accounting software helps you track, manage, and automate your finances, for a business that runs smoothly – without too much complicated paperwork from you. It’s about finding simpler, smarter ways to optimise your business.
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