What Is Dynamic Pricing? Pros and Cons of the Strategy

One of the most common pricing strategies today is dynamic pricing. So what is dynamic pricing? How is this strategy used in e-commerce? Find out with Mona Media in the article below.

What is dynamic pricing in e-commerce?

The concept of

Dynamic pricing is a strategy in which product prices are adjusted continuously, sometimes within just a few minutes, to respond to supply and demand in real time.

The term drew public attention after the boom of e-commerce. Few people know, however, that it originated in retail from the very first days.

Optimized over time, most markets reach a healthy balance between suppliers and consumers, where supply and demand keep adjusting to satisfy both sides as much as possible.

Examples of dynamic pricing

Many players use it by collecting data from customers' browsing history. If a customer urgently needs something, the price is pushed higher than normal.

Example: Grab is one ride-booking app. Users download the app to request a service. To go somewhere, users enter the destination and their current location. The app responds with a price and an estimated arrival time.

This app uses flexible pricing: a multiplier adjusts the price to the supply of customers and the number of drivers at any given moment. In some cases, such as rush hour or bad weather, the price can double. Users are told about the surge, and can then decide to book right away or wait until the price drops.

Factors used in dynamic pricing

In the digital age, dynamic pricing happens at the speed of data over the Internet through apps. This lets suppliers analyze thousands of supply and demand factors in real time, such as:

• Competitor prices – compiled selling prices from competitors. This information is collected from online stores or within one marketplace
• Costs – fixed and allocated cost data, calculated from internal data on inventory, shipping costs and other sources
• Demand forecasts – calculated using machine learning algorithms combined with the seller's experience
• Actual demand – calculated by businesses to apply “surge” prices during periods of high demand
• Weather and external factors – the effects of natural disasters or disease can affect goods prices and seasonal flights
• Special events – such as festivals or concerts that create sudden spikes in demand for transport and accommodation

The 2 types of dynamic pricing in detail

Today there are two main kinds of dynamic pricing. They are limited supply and matched pricing.

Dynamic pricing strategy with limited supply changes prices based on customer behavior. It is most common in airlines, hotels and other industries where supply is limited or has a usage limit.

By contrast, a price-matching strategy changes prices based on competitor activity. This strategy is very common in retail.

Pros and cons of dynamic pricing

Advantages of dynamic pricing

If you want to go deep into e-commerce, you should seriously study and consider adopting this pricing model, because it brings quite a few benefits to your business.

Boosts sales

Dynamic pricing is often seen as a way for businesses to raise prices. That is true. But the method can also be used to lower prices. Lower prices trigger sales, which helps the business reach its sales revenue over a day, a month or longer.

Maximizes profit

If competitors are offering goods or services at a significantly higher price, dynamic pricing is a strategy to maximize profit. You can adjust item prices based on the shopping habits of potential customers.

Say a customer wants to buy a pencil. A competitor is selling pencils at 20,000 VND each, while you sell at 7,500 VND. A dynamic pricing strategy would let you sell that pencil to the customer for about 12,500 VND. That price makes them feel they are getting a “deal”, while in fact you are earning more than usual.

Creates higher demand

Dynamic pricing is common at events. If the event day arrives and seats remain, they can be sold at a lower price to some consumers. That lets you still maximize profit and capture whatever revenue is possible at that moment.

See also: A guide to growing online revenue effectively, for businesses large and small

Understand customer behavior

Once you understand dynаmic pricing what dynamic pricing is, a business can learn each customer's demand curve. It shows the minimum and maximum price a consumer is willing to pay for a transaction. With this information you learn more about consumer behavior, which helps you sell in higher volumes.

What are the disadvantages of dynamic pricing?

Risk of a price war

Have you ever seen two stores fight a price war? One cuts prices, so the other has to cut lower still. The process continues until one business reaches a point it cannot accept. This is what many retailers fear when they consider dynamic pricing.

Losing customers

Customers are unhappy when they find out someone else paid less for the same item they bought, and they ask for the difference back. Even when it is resolved, customers still form a negative view of the business, which means they are less likely to return.

In addition, with the internet so widespread, customers research the products or services they want before buying. They may even know the price of certain goods when they get in touch to buy.

If a product costs more than they expected, they will buy elsewhere, and the business loses that potential sale.

Increased competition in the industry

Customers usually want to stay loyal to a particular brand if they see value in it. Dynamic pricing, however, changes the value proposition being offered.

It shows that a business is focusing more on its profit than on creating value for customers. Competition in the industry then rises, with a disruptive impact.

Is surge pricing a “good deal” for consumers?

Dynamic pricing can maximize social welfare and business revenue when demand and capacity are well matched. When demand does not change much, this strategy benefits producers. Conversely, consumers can fully benefit from the business's discount periods.

According to research, 65% of purchases on e-commerce platforms are driven by low prices. In essence, dynamic pricing is a “race” to offer consumers the most attractive price, which noticeably raises the competitive edge between companies.

Such rising competition represents a healthy, competitive and free market. In most cases, therefore, this strategy mainly benefits consumers.

In some cases, though, it is different. Price disadvantages for consumers are clear in some situations. For example, Grab raises prices under certain conditions, such as heavy rain or rush hour. Then consumers have to pay a higher price.

At present, companies, especially in e-commerce, are making use of dynamic pricing, because it benefits both businesses and consumers. If you need to understand more about what dynamic pricing is in more detail, we hope this article is useful to you.