What is Dynamic Pricing?

Dynamic pricing is a partially technology-based pricing system under which prices are altered to different customers, depending upon their willingness to pay. Several examples of dynamic pricing are:

Airlines. The airline industry alters the price of its seats based on the type of seat, the number of seats remaining, and the amount of time before the flight departs. Thus, many different prices may be charged for seats on a single flight.
Hotels. The hotel industry alters its prices depending on the size and configuration of its rooms, as well as the time of year. Thus, ski resorts increase their room rates over the Christmas holiday, while Vermont inns increase their prices during the Fall foliage season, and Caribbean resorts reduce their prices during the hurricane season.
Electricity. Utilities may charge higher prices during peak usage periods.

Some industries, such as airlines, use heavily computerized systems to alter prices constantly, while other industries institute pricing changes at longer intervals. Thus, dynamic pricing can be adopted along a broad continuum, ranging from constant to infrequent pricing changes.

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When Dynamic Pricing Works Best

Dynamic pricing works best when it is used in concert by all of the major players in an industry. Thus, if a single hotel were to keep its prices low during the peak tourist season, it could likely steal business away from competitors. Also, dynamic pricing works well when demand fluctuates considerably in comparison to a relatively fixed amount of supply. In this situation, sellers reduce prices as demand falls and increase it as demand increases.

Advantages of Dynamic Pricing

A key advantage of using the dynamic pricing method is profit maximization. If a seller constantly updates its prices with dynamic pricing, it will likely maximize its potential profits. Also, dynamic pricing involves a considerable amount of inventory monitoring, with price reductions in response to higher inventory levels. This approach tends to eliminate excess inventory quickly.

Disadvantages of Dynamic Pricing

Despite the preceding list of advantages, there are also several disadvantages associated with use of the dynamic pricing method. First, if prices change constantly, customers can become confused by the situation and be attracted to those sellers who do not use dynamic pricing. Thus, it can result in a loss of market share. Second, sudden changes in price can alter the demand for goods, which makes it difficult to plan for inventory replenishment. Third, it may require an expanded marketing presence in the marketplace to communicate pricing changes to customers. Fourth, if used in a retail environment, it requires considerable activity to update prices on products as soon as the system alters prices. And finally, if an entire industry adopts dynamic pricing, then a company must invest in competitor price monitoring systems, to see if its prices are similar to those offered by competitors.

Evaluation of Dynamic Pricing

This approach can be an annoying one for customers, but its proven ability to maximize profits means that it will likely continue to be used in many markets. Its use must be balanced against the likely loss of customer satisfaction with the business, especially if dynamic pricing results in much higher prices being charged to customers.