DYNAMIC PRICING: HERE COMES BIG BANG
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Contextual pricing, revenue management, yield management, market segmentation: Dynamic Pricing (DP) has many monikers these days. We stand today confronting the third major milestone in the evolution of dynamic pricing: its wholesale integration into day-to-day business-to-consumer transactions. This makes it an appropriate time to examine its origins, its current usage and its future potential.
Three Stages of Evolution
The first stage in the contemporary development of DP can be attributed to the deregulation of the American domestic aviation industry in the late 1970's. Most of the incumbent airlines developed a three-pronged strategy in the face of micro-economic restructuring: the development of (i) loyalty/frequent flyer programmes, (ii) hub-and-spoke networks and (iii) yield or revenue management systems. The latter have evolved into highly complex algorithm-based systems, in some cases incorporating neural networks. They have enabled airlines to achieve some semblance of demand and supply equilibrium as price and availability is used to match the well-known characteristics of particular market segments.
The second quantum leap for DP was driven by the Internet boom of the late 1990's. The Internet proved to be the enabling technology for buyers and sellers in a business-to-business (B2B) environment to dump excess capacity or distressed inventory into markets, everything from electricity to telecommunications capacity. These products then clear through real time, market clearing, dynamic pricing.
To date, dynamic pricing has worked best for commodities and intangible perishables (such as airlines seats or hotel rooms). The third phase of this evolution will see it move into the retailing mainstream: the real and virtual world of everyday business-to-consumer (B2C) transactions.
When to Use Dynamic Pricing?
Airlines were dynamic pricing's "first movers", and significant amounts of revenue are attributed to it: $100m in incremental revenue according to Delta Airlines. Chances are, if your industry is complimentary to one using revenue management, you should be using it too. Hotels have discovered this: guests want a cheap room rates as much as they want a cheap airfare. Likewise, car rental firms, cruise lines, railways and many other travel-related service providers have adopted yield management techniques.
The Market Bar in London's financial district is an unexpected, if somewhat extreme example of dynamic pricing complementarity. Its clientele of city traders leave their equity trading screens to relax in front of “drink trading” screens, which show the going rates for a range of beers and spirits. As demand rises, prices fall: after all, who would want drinking to get more expensive as the night goes on?
Low-cost leadership, the ability to produce more units at a lower cost than competitors, also provides the opportunity to implement dynamic pricing. All of the major US PC manufactures have admitted exploring dynamic pricing to reduce inventories and optimise profits. Dell believes they are almost there with their "5 day built-to-order" model, which is complimented by their "negative cash conversion cycle" (keep five days inventory, manage receivables to 30 days and payables to 59 days). To consumers, there may appear to be a vicious price war going on between Dell & Gateway at present: it is in fact a cost war, which Dell is better positioned to win.
DP also helps smooth demand and supply imbalances while optimising revenues. easyEverything, a chain of 24x7 Internet cafes with over 8,000 PCs in 22 stores, dynamically prices the cost of accessing the Internet. While demand is strongest in most stores from 16:00 – 20:00hrs, pricing that varies according to how full the store is enables it to maximise revenue from its most inelastic customers, while the more (price and time) elastic customers can be shifted to off-peak times of the day and night.
Product life cycle and other marketing strategies are also supported by dynamic pricing. It facilitates cheap, penetration pricing for new product launches, revenue optimisation during the mature phase of the product life cycle and, if necessary, the deployment of expensive prices for a market or product exit strategy.
What's Next?
There are many products and services that are ripe for dynamic pricing: some are being priced dynamically now. Concerts, cinemas, theatrical and sporting events typically have some pricing architecture (e.g. cheap matinee's, Saturday night premiums etc). Like golf courses, hairdressing and the hire of squash and tennis courts, these industries all have further scope for the application of dynamic pricing and revenue optimising practices.
Technology companies also stand to benefit from the implementation of dynamic pricing, especially when they understand the value of their offerings to customers. Internet Service Providers (ISPs) are already exploring the possibility of the option of extra bandwidth, at a price premium, as customers download the latest MP3 file, and less (cheaper) bandwidth for simple tasks like emailing.
Likewise, providers of information, data and software, need to understand (a) the value of real time vs. historical data, and the premium the former can command, as well as (b) the nature of marginal costs in such industries. This understanding offers numerous revenue optimisation opportunities through market segmentation and versioning.
Electronic Shelf Labelling Systems will perhaps take dynamic pricing further than any other innovation to precede it. Eight years ago, Electronic Shelf Labels (ESLs) cost in the vicinity of $22 each. Today, a typical supermarket carrying 20,000 lines could be e-tagged for around $100,000, or $5 an e-tag. ESL's also come with more bells and whistles than they did nearly a decade ago: the price can be updated through out the day and can be made to flash when a price has been dropped. They can also be used to tell the retailer when to re-order inventory.
Some commentators believe that dynamic pricing can be used to price tangible perishables, such as burgers and fries as they near the end of their shelf life. This remains to be seen, as dynamic pricing is not for every industry: just ask Amazon. Stick to applying dynamic pricing where complementarity, low cost leadership, demand and supply imbalances and the pursuit of certain marketing strategies permit its implementation.
References:
Is Price Right for e-shelf Labels?, www.pricingsociety.com
Why Dell's war Isn't Dumb, www.pricingsociety.com
Two perspectives on the Digital Future, www.ebizchronicle.com/wharton/19_digitalfuture.htm
Beer Market: A London Bar Tries Pricing Drinks Based on Demand, www.wright.edu/~tdung/beer.htm |
