What is Variable Pricing?

Variable pricing is a system for altering the price of a product or service based on the current levels of supply and demand. It is commonly employed in environments where supply and demand information is easily available. It is more likely to be used by businesses that have a transactional orientation, which want to maximize the income from a single transaction. Other businesses that want to build relations with their customers are more likely to use fixed-rate pricing, which is less likely to annoy their customers.

Examples of Variable Pricing

As an example of variable pricing, the price of an item that is being sold through an auction will change depending upon the amount of demand for it, as evidenced by bid prices. The same principle works in a stock market, where the sale of new shares by a company will increase the supply, thereby dropping the stock price; conversely, intense demand to own a company's shares will increase the price of the shares on the market. Yet another example is airline seats, where an airline can adjust its pricing based on the number of seats that have already been sold. A final example is electricity production, where prices increase during periods of peak usage and decline thereafter.

Variable pricing also follows the business cycle. For example, the price of lawn mowers is high as the summer season approaches, since this is when demand spikes. Once the summer season is over, prices decline because there is little demand and sellers want to clear out their excess inventories.

Advantages of Variable Pricing

The use of variable pricing has several advantages for a business, including the following:

Maximizes revenue. Businesses can charge higher prices during periods of high demand (e.g., peak seasons, events) and lower prices during low demand to attract more customers. This ensures optimal revenue generation.
Improves market segmentation. Variable pricing allows businesses to cater to different customer segments. For example, price-sensitive customers can take advantage of off-peak pricing, while those willing to pay more for convenience can be charged premium rates.
Enhances inventory management. For businesses with perishable or limited inventory (e.g., airlines, hotels), variable pricing ensures that inventory is sold at the best possible price over time, reducing waste and maximizing utilization.
Encourages customer behavior. Pricing can be adjusted to influence customer behavior. For example, offering discounts during off-peak hours can help distribute demand more evenly and reduce strain during peak times.
Flexibility in adapting to market changes. Variable pricing enables businesses to quickly respond to economic conditions, such as inflation or supply chain disruptions, without committing to a fixed pricing structure.
Encourages early or last-minute purchases. Offering lower prices for early bookings or last-minute deals can stimulate sales that might not have occurred otherwise, helping to fill gaps in demand.

While variable pricing has numerous advantages, it also requires careful management and transparency to avoid alienating customers or facing backlash over perceived unfairness.

Disadvantages of Variable Pricing

Some companies refuse to use variable pricing, because they find that it annoys customers. For example, someone who paid a high price for a seat on an airplane will be annoyed if he finds that the person sitting next to him spent a fraction of that amount. Variable pricing also does not work in situations where pricing is physically fixed, such as when prices are manually affixed to goods.