Dynamic pricing isn’t popular — but don’t ignore the benefits

There’s a growing discontent with the use of surge pricing — so much so that pricing experts Marco Bertini (Esade) and Oded Koenigsberg (London Business School) say they are faced with increasing requests from students and journalists to defend it. 

In an article published in Harvard Business Review, the marketing professors acknowledge the frustration of customers faced with these fluctuating prices for more and more everyday products. But dynamic pricing is not new. Businesses have long tried to earn extra money when demand outstrips supply, from snow shovels in a blizzard to waterproofs at a rain-soaked festival.  

However, Bertini and Koenigsberg argue that companies are not doing enough to properly understand and apply dynamic pricing strategies. The authors argue that companies that want to avoid shooting themselves in the foot should help their customers understand and get the most out of this methodology.  That way, both parties will be satisfied.

Examples of dynamic pricing

Through the following examples, we will be able to deeply understand what dynamic pricing is. Uber stands out as an example of dynamic pricing strategy, as it is perhaps the best known company that employs dynamic pricing. In their case, if prices were fixed, drivers would have no incentive to give up vacations with their families or spend their Saturday night driving people around partying. This would result in lack of service at peak hours, long wait times, and people stuck with no transportation options.

Another representative example of dynamic pricing is in the airline industry, where fares are constantly changing based on demand, how far in advance the booking is made, the time of year or even the user's browsing behavior. This strategy allows maximizing revenues by adjusting prices to the willingness to pay of each customer at a given time.

Dynamic pricing: how does it work?

Static pricing is the alternative to surge pricing, but when there’s one single price point for every customer, it doesn’t account for the different circumstances of each sale. 

When pricing patterns are unpredictable it can impact the customers' sense of control over buying decisions and lead to distrust

Uber is perhaps the most renown company to employ surge pricing. But if all prices were fixed, drivers would have no incentive to leave their families over the holidays or spend Saturday night driving around drunk partygoers. The result would be a lack of service during peak times, long waits, and stranded people. 

Dynamic prices become a problem when they start to have an impact on people’s lives. When pricing patterns are unpredictable it can impact their sense of control over buying decisions and lead to distrust and suspicion. Not only can this damage corporate reputations, but it can also trigger an overly cautious approach to spending.  

The importance of a clear narrative in dynamic pricing

Dynamic pricing ultimately succeeds when it benefits the company and its customers — and the customer should be aware of this ongoing benefit. 

This is an area many companies ignore at their peril. Setting the price is just the starting point — they also need to set the narrative to ensure the customer doesn’t perceive pricing as unfair. But fairness is subjective, so how do companies quantify it? 

Companies need to set the narrative to ensure the customer doesn’t perceive pricing as unfair

According to Bertini and Koenigsberg, they should ask themselves four key questions: is price the only option? Will customers see the price changes? What’s the motivation for the purchase? And finally, does the customer have a valid alternative? 

Understanding why

Before altering consumer price points, companies should examine whether there’s a solution with the supplier. Are there any valid options to cut costs further up the chain and keep consumer prices stable?  

If price increases are unavoidable, customers need help to understand why. Price comparison sites and word of mouth make it easy for customers to spot the difference in deals. As soon as they realize that they are being treated unfairly, they will start comparing prices, which can lead to problems with product pricing if not managed properly.

The company may simply have different price points for online and physical sales to reflect costs, but if the customer perceives this as unfair, the damage is done.  

However, if dynamic pricing is guaranteed to remain under the radar, start setting those algorithms. 

Want or Need? The impact of dynamic pricing on purchasing decisions

Every purchase has a motivation, whether it’s a want or a need. It’s easier for a customer to walk away from something they want if it’s priced out of their budget. But if a needed item, such as groceries, is impacted by fluctuating prices we have to ask ourselves a final question: does the customer have an alternative?  

Finding a cab on a Saturday night in a city center is difficult, justifying the price rise to keep more drivers on the roads and customers getting home. But if the product or service has competition that offers better deals, the customer will find them. 

After running through these four questions, companies should have a better sense of whether and how to implement dynamic pricing. And, if they do, Bertini and Koenigsberg have some advice. 

The relevance of transparency in dynamic pricing

Transparency is essential to assure customers that dynamic pricing is the best option. If the motivation of the company is to create and share value, explaining the rationale and customer benefit behind it should be an easy win.  

Companies that openly share their strategies and show customers how to get the best prices will gain trust

Customers are less likely to complain if they feel they have options and retain autonomy over their purchasing decisions. Rather than operating in a secretive manner, companies that openly share their secrets and show customers how to get the best prices will gain trust.  

For example, an airline that’s transparent about the best time to book a trip to get the lowest prices and reminds customers to book when prices are low is more likely to retain loyalty than one that advertises low fares but adds on unavoidable costs at checkout. 

Offer value, not bargains

Rather than focusing on price, companies should stress the value of their product or service and how adopting dynamic pricing benefits the customer. This can work in two ways: by helping people with lower incomes to access products or services, or by improving service across the board by smoothing out demand. 

How the value is framed matters. “Dynamic pricing” and “surge pricing” have negative connotations, but if the company clearly defines the different periods of pricing and the benefits of buying at that time, customers feel more empowered to make the choice that works for them. 

Ultimately, if a company wants to employ a dynamic pricing strategy, it must take ownership of the decision. If it shares only part of the story, customers and the media will fill in the gaps. By clearly explaining the reasons for the decision and the value it brings to both parties, dynamic pricing retains the potential to expand customers' access to products and services and to generate more profits for companies.