The Art of Dynamic Pricing: Strategies and Implementation

October 26, 2023 - 11 minutes read

Optimize pricing without alienating valued customers.

Inventory management software provides the information and analytics necessary to drive innovative and profitable dynamic pricing models.

For thousands of years, the price tag did not exist. Instead, customers and vendors practiced the art of verbal haggling as pricing fluctuated wildly depending on supply, demand, competition, and who was doing the buying. As this traditional model became prohibitively inefficient in the 1800s, fixed pricing suddenly became the norm.

By the 1980s, the airlines had begun to experiment with a new world version of the old world model, reintroduced as dynamic pricing. The concept of dynamic or conditional pricing was so successful that it quickly spread to hotels, taxis, car rentals, and dozens of other sectors prone to demand peaks and valleys.

Computer algorithms and inventory management software have led to the commonplace use of dynamic pricing in E-commerce, retail shopping, and B2B applications, but poor implementation can do more harm than good to your brand reputation and bottom line.

Are you ready to discover the keys to implementing dynamic pricing without alienating customers? Then read on.

What Is Dynamic Pricing?

Dynamic pricing, also known as surge-based pricing, is a strategy used by businesses to adjust prices in real-time based on demand, competition, and other market factors. Anyone who has hailed a rideshare service from a busy airport understands how conditions like driver availability can also feed into the pricing strategy.

Dynamic pricing is expected and tolerated in the travel and service industries, but sometimes resisted by customers in other industries. Before you consider implementing dynamic pricing for your business, it’s important to ask:

How will my customer base react to non-static pricing?
Do I have adequate data sources to judge demand shifts in real-time?
Are similar businesses in my industry already using a dynamic model?
What ethical and regulatory issues must be considered?

Benefits of Dynamic Pricing

What are the benefits of dynamic pricing? More specifically, what are the potential benefits for your business? Dynamic pricing typically provides the following advantages:

Profitability: A fixed price model leaves profit margins relatively flat, even during periods of high demand. Dynamic pricing leverages these spikes to maximize revenue and profits.
Adapting to the competition: Dynamic pricing can be used to differentiate your product from the competition, especially during times of high demand. Careful analysis can reveal whether reduced margins that undercut your competition can be made up in volume.
Inventory management: Dynamic pricing improves inventory management by allowing you to drop prices for overstocked items or increase prices when inventory is low. Inventory management software can make these decisions more seamless.
Promotions: Dynamic pricing lets you time your promotions and specials for maximum impact and profitability.

“It’s not an experiment if you know it’s going to work.” – Jeff Bezos

Dynamic Pricing Strategies and Implementation

The biggest risk associated with dynamic pricing can easily undo the upside—dynamic pricing has the potential to alienate customers, especially established clientele who are used to paying the same price consistently.

If you decide the benefits outweigh the risks, it’s time to methodically develop and implement your strategy with steps that include:

Outlining the purpose and goals of your dynamic pricing model.
Choosing from the available dynamic pricing methods to find the one that’s right for you.
Defining your pricing model in detail.
Testing your model on a subgroup or small segment of your clientele.
Implementing and monitoring your dynamic pricing strategy.
Integrating into your inventory management system.

Let’s review each of these steps in more detail.

1. What’s the goal?

It may seem obvious, but step one is asking yourself why you want to implement dynamic pricing and what you hope to gain from it. For example, are you trying to attract more new customers or offer more flexible pricing options for your existing customers? Maybe you are just looking for a way to deplete excess inventory.

You should also consider whether you are changing your pricing structure simply to follow the competition, since the stability of your current pricing strategy might be working to your advantage. Knowing why will help you choose the best strategies for how.

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2. Choose a pricing method

Dynamic pricing is not a one-size-fits-all solution. Although the term “demand-based pricing” is often used interchangeably, demand is just one of the factors that can contribute to pricing methods. Additional alternatives include:

Time-based pricing: Prices fluctuate based on the time, day, or season. This method works well for industries with predictable fluctuations in supply, demand, or both.
Competitor-based pricing: Methods based on matching or beating competitor pricing require real-time monitoring and analysis to avoid price wars or selling at a loss for the sake of competition.
Segmented pricing: E-commerce platforms often use a segmented pricing approach to make adjustments based on demographics or the past buying history of customers.
Auction-based pricing: Customers bid for items and the seller either accepts or declines their offer. Although this method was a staple of the early eBay and Priceline models, both companies have since shifted to more traditional surge-based pricing.

3. Create a pricing model

The pricing methods you choose to include then become ingredients in the proverbial soup known as the pricing model. Your model can include aspects of any and all available methods. Each factor should be weighted based on its relative value.

Dynamic pricing algorithms leverage historical price, sales, and customer data along with real-time inventory and competitive data gathered from inventory monitoring software and websites. As artificial intelligence (AI) improves, many large companies are utilizing predictive analytics to analyze inputs and strategically adapt price points.

4. Test the waters

Dynamic pricing does not have to be an all or nothing decision. Try launching your strategy with products that lend themselves well to the model, based on a high level of competition or a known acceptance of customers for dynamic pricing of this commodity. You can also implement a limited rollout based on specific segments, locations, or customers.

An A/B test can be a valuable tool for comparing the performance of various pricing strategies by offering two or more options simultaneously and comparing the results. A/B testing can even be continued during full implementation.

5. Implement and monitor

Once you have tested and refined your algorithm with a smaller audience and are satisfied with the results, it’s time to implement dynamic pricing on a broader scale. Monitoring is important in the early stages of implementation to be sure your algorithm is performing as expected and you are getting the results you want.

The importance of customer feedback can’t be overstated. Customer acceptance of dynamic pricing is essential, so you shouldn’t rely on the bottom line alone to tell the story. Solicit feedback from long-term customers to find out how the change is being perceived, and how it is impacting your brand. A short term sales spike could be masking other issues.

“You need the right balance between data and gut feeling.” – Toto Wolff

6. Integrate your inventory management software

To ensure you have the right information available to support dynamic pricing, you need to integrate your pricing model with your existing systems and processes. Automated pricing requires direct pipelines to inventory, sales, customer, and competitor data to support price adjustments.

Inventory management software provides real-time visibility into stock levels to inform scarcity-based pricing and demand forecasting tools to analyze historical sales data and market trends.

Dynamic Pricing: Final Thoughts

With nearly unlimited potential to increase company profits, dynamic pricing is an option every company should consider. As dynamic pricing continues to spread from the seasonal travel industry to online and brick-and-mortar settings that favored fixed pricing for decades, results and customer acceptance have been decidedly mixed.

Dynamic pricing provides enough options to accommodate the objectives of any business. By carefully constructing and implementing your dynamic pricing model, then closely monitoring your results and customer feedback, you can accurately assess the short and long term impact of dynamic pricing on your business.

Inventory management software is the engine that drives advanced strategies like dynamic pricing, but that’s only part of the story. Please schedule a consultation when you’re ready to level up your inventory management and improve your bottom line. Our solution experts are ready to help.