June 3, 2014
How to Implement a Dynamic Pricing Strategy (Without the PR Backlash)

Recently I was interviewed about dynamic pricing by Tixboo, a dynamic ticket pricing company out of the UK. Interestingly enough, that same week I encountered an intoxicated gentleman on a Boston bus openly complaining about the New England Patriots’s new dynamic pricing ticketing policy.

Whenever pricing strategy becomes worthy of a drunken rant; you know it’s a big deal -- and a great opportunity to explore a concept that can boost revenue.

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Yet, over the past few years companies utilizing dynamic pricing have come under fire from consumers. While the push for fatter margins through pricing is admirable, these implementations fell short of a few tests to ensure customers and the business were ready for such a dynamic and variable step.

To ensure you don’t make the same mistake(s), let’s take a dive into what exactly constitutes dynamic pricing,  review some pros and cons, and then present some ways to make your pricing dynamic - without the backlash.

Dynamic Pricing 101

At it’s core, dynamic pricing is the concept of selling the same product at different prices to different groups of people. Technically, this is the same definition as “price discrimination”, an illegal practice with roots in the Robinson-Patman Act of 1936.

Yet, that Act has more holes than a wheel of swiss cheese, which makes any legal basis of a price discrimination lawsuit incredibly grey, especially when dealing with non-commodity goods online. In fact, US Courts and the Federal Trade Commission have repeatedly shot down dynamic price discrimination cases unless the discrimination took place on the bases of a suspect category (gender, race, sexual orientation, etc. and is incredibly difficult to prove) or was anti-competitive, which is highly unlikely to occur in an online market.

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As a result, business have taken it upon themselves to institute dynamic pricing in two forms:

1. Dynamic pricing based on groups: In this scenario, companies are using algorithms or just statistical splicing to offer different prices to different groups. This can be as simple as a split A/B test or more sophisticated by predicting a higher willingness to pay based on machine type, location, demographic information, etc. and showing a different price to a particular group. Most lawsuits and consumer backlash involves this form of dynamic pricing (although, few of these lawsuits have been won by consumers).

2. Dynamic pricing based on time: My drunken subway friend was complaining about this form of dynamic pricing - having a price go up or down based on time. In it’s most basic form you’ll see this purely in a car lot - at the end of the month prices are lower as salespeople push for quotas. In a highly sophisticated method, individuals will use something like Tixboo to make these decisions on the fly to maximize revenue for events and meet different levels of demand.

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Theoretically, consumers should be completely ok with dynamic pricing

In it’s purest form, we all should theoretically be perfectly ok with dynamic pricing, because we, the consumers, ultimately have a decision of whether we’re going to purchase the product or not. The onus is on the producer to make sure the price presented meets our willingness to pay to ensure a purchase -- aligning to our own personal equilibrium price in real time.

If you’re not willing to pay for the product, you’ll leave and maybe come back when there’s a sale or a cheaper version. If you’re willing to pay for the product, then your utility is met and you’re none the wiser about your friend getting a cheaper price. It’s perfect pricing and harmony in the free market. 

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In reality, of course they're not ok with dynamic pricing

Unfortunately, like most economic theories, reality is a bit more complicated. When blatant dynamic pricing is revealed to a consumer, it appears more like price discrimination than the fluffy world I illustrated above, because we feel like we were just lied to and that we didn’t get as good of a deal as someone else. Years of travel commercials have taught us that we can only hope that the person sitting next to us on the plane paid more than us. Ironically, some how we’re ok with this scenario, but assume everything is nefarious if it occurs with a book on Amazon.

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This isn’t a huge deal if your customer never finds out or you’re in a “dynamic industry” - travel, tickets, etc. Yet, for most SaaS products (and I would argue most retail products, as well), we’re awful at tracking and measuring the different equilibrium prices for our customer groups. Most dynamic pricing engines out there don’t get enough data to truly differentiate. Even then, tracking technology hasn’t gotten to the point where we can ensure that an individual who received a price on Tuesday gets the same price on Friday or even shows the same price to their business or family member in a different time zone.

The result means that if you have a product where the sales cycle is more than 24 hours or involves multiple people, the risk that your secret gets out increases exponentially with each day and individual involved in the buying process.

So how can we make dynamic pricing work? I want those profits.

This doesn’t mean you can’t institute some aspects of dynamic pricing successfully. After all, not all of your customers are the same, therefore you should be able to extract more revenue from some than others. You just need to implement them in the proper manner:

1. Price Differentiation - Two prices are better than one

One of the bedrock concepts in pricing strategy is to quantify your customer personas and then align your packaging and pricing to those personas. Typically, you’ll find your personas aren’t all created equal, and if you do, then you probably aren’t thinking about your personas properly. You can then offer lower and higher end versions of your product to bring in dynamic revenue from customers of different sizes. For more on product and feature differentiation check out this post.

2. Ensure you’re using a proper value metric

Hand in hand with price differentiation is pricing along a value metric, which is what you’re physically charging for in terms of a product (per user, per GB, etc.). This is difficult for a retail product, because you’re charging for a physical item, but in the software world, you can split your pricing up based on number of users, amount of storage, number of views, etc. or a combination of multiple metrics. The impact here is every customer is paying you a different among - accounting for dynamism and less cash being left on the table.  For more on value metrics, take a look at this break down of value metrics and how to properly use them.

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3. Utilize Time in an auction type model

Similar to what many sports teams and concerts are doing, you can make sure your price goes up or down based on time. Airlines and travel booking sites do this all the time. There’s no reason someone launching a software beta or releasing a new widget can’t use dynamism in their pricing.

4. Couponing and Discounts

We’re not a huge fan of discounts, because of their negative impact on future sales and your brand, but they can be used effectively in discretely providing a dynamic price to a subset of prospects or customers. Keep in mind that with social products you’ll want to ensure the coupon doesn’t spread, but this is typically less likely compared to a public site having different prices and is more socially acceptable. For more on discounts and the right way to push for them, check out our discount pricing post.  

Be upfront and transparent

Most proponents of dynamic pricing say you should just be transparent that you’re employing dynamic pricing on your site. This is great, but it still doesn’t solve for the cognitive dissonance of, “am I truly getting the right deal?”

You’ll notice that all of the above suggestions solve for both being transparent and eliminating the feeling of missing out. That being said, although you probably won’t get into legal trouble with dynamic pricing, you need to be careful about your brand, image, and any PR backlash that can leave a long lasting impact. We’ve found price transparency is key and will definitely continue to advocate for more, rather than less.

 

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