Dynamic Pricing: What Is It, Why Use It, and How to Implement It

What is dynamic pricing? Simply put, dynamic pricing is a flexible pricing strategy that considers market demands and other factors to quickly implement price changes.

Perhaps this definition seems like a too-simple way to start a discussion of the relevance of dynamic pricing for your online retail business. Take a closer look. Keep that definition in mind. Like dynamic pricing itself, the definition is more complicated than it may at first appear.

The Effect of Dynamic Pricing on Profitability

A dynamic pricing strategy isn’t new. The basic idea of adjusting pricing to market demands is as old as pricing itself. In fact, pricing used to be based on haggling. A fixed price seemed more “fair” and it was certainly less time-consuming for retailers. Customers caught on to the idea and now expect fixed prices, especially in the retail market. But that’s changing.

Using a dynamic pricing algorithm enables retailers to capture the most revenues from their products.

Retail Prophet put it this way: “It enables a retailer to optimize their pricing based on real-time inputs, as opposed to setting a price over the long term and either pricing too low and giving up margin needlessly or charging too much and losing sales.”

It also ensures that the customers who value a product the most have the opportunity to purchase it.

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Why Do Other Pricing Strategies Fail?

If you refuse to be dynamic, you’re left with two basic pricing strategies. You can set a static price based on your variable costs and your desired profit margin.

This pricing strategy assumes you will achieve the sales volume necessary for your desired profit margin to cover your fixed costs and is common with manufacturers. Most retailers, however, prefer fluctuating prices, because it allows them to influence sales volume over time.

Fluctuating prices are basically what dynamic pricing used to be. You compile market data, process the data, and then set different prices. This process can take weeks. In the meantime, your customers are all charged the same price over that period of time. Prices are still dynamic, but they’re slow and rather unresponsive in a rapidly changing market.

Either way, you’re talking about fixed prices. Remember JCPenny’s “Everyday Low Pricing”? It has demonstrated how well that works (hint: not well).

According to Scott Randel of iProspect, “With fixed pricing, businesses can be either missing out on profit or potential sales depending on consumers in the market.”

In other words, these pricing strategies fail, because your customers are more dynamic than you are. They shop around. They look for better prices, better products, and better choices. If you’re not responding, then you’re losing them to competitors who will.

When Does Dynamic Pricing Not Work?

There are two big challenges when it comes to effectively implementing dynamic pricing.

Dynamic pricing does not equal price discrimination: selling the same product to two different buyers at different prices. According to the Harvard Business Review, an honest and trustworthy approach to dynamic pricing can avoid price discrimination. After all, the objective of dynamic pricing isn’t to damage your customer relationships. Your purpose is to respond to your customers more individually.

The second problem is actually more difficult to solve on your own. Think back to our original definition of dynamic pricing. The premise of this definition is that you know the level of demand and the type of customer and other relevant market conditions and then respond.

According to Retail Prophet, “Inputs such as demand and popularity for the product and competitor prices prompt real-time fluctuations in the listed price of an item.”

In other words, you need data in order to make your prices effectively dynamic. You need to select the data sets you use in a way that does not alienate your customers. You need to process this data in a way that makes it useful to you. And you need to use the information you glean from the data to change your prices in real-time.

What you need is a platform that can help you determine the variables, compile and process the data, and change your prices accordingly. What you need is a solution.

You need data in order to make your prices effectively dynamic.

How an Effective Dynamic Pricing Strategy Works

That solution is dynamic pricing backed by machine learning. For example, Wiser’s dynamic pricing algorithm uses competitive price intelligence to recommend new prices and reprice automatically.

Some data points considered are stock levels, consumer demand, and seasonality. The more SKUs repriced this way, the better the algorithm becomes at pricing your products. Data is continually collected to refine prices to best serve your business and your customers.

An effective dynamic pricing strategy uses competitive pricing intelligence and automates the process. The platform knows the important variables, has all the market data needed, and reprices your SKUs. If you want to implement dynamic pricing on your own, make sure you’ve got the good pricing data to guide your decisions. Don’t reprice dynamically based on assumptions.

Editor’s Note: This post was originally published in November 2013 and has since been updated and refreshed for readability and accuracy.

Arie Shpanya

Arie is the former COO, Executive Chairman, and Co-Founder of Wiser, a dynamic pricing and merchandising engine for online retailers and brands. He has extensive experience in business development with a focus on eCommerce (eBay and Amazon), and is a guest blogger on Econsultancy, VentureBeat, and more.

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