At a glance
Dynamic pricing goes by many names, including surge pricing, personalised pricing and price discrimination. It is a pricing strategy where businesses adjust the prices of their products or services in real-time based on demand, competitor pricing, time of day, customer demographics and other factors.
The strategy allows businesses to optimise pricing to maximise profits, increase revenue and respond to market changes, and it is a longstanding practice in travel and hospitality.
Airlines first started to use dynamic pricing in the 1980s when the industry was deregulated in the US. It was later adopted by accommodation providers as a strategic revenue management tool, which allowed them to maximise revenue by adjusting room rates based on real-time factors.
Dynamic pricing has more recently been adopted in ecommerce, entertainment and transportation. Ride-share platforms, for instance, have seized on the concept by increasing prices during busier periods.
The significance of dynamic pricing has notably increased in the era of ecommerce because advancements in AI and technology are enabling more businesses to move beyond traditional supply and demand dynamics to inform pricing decisions. “Dynamic pricing is all around us.
We consume it almost every day in the form of airline tickets, hotels and Uber, but it also exists in our electricity market and more and more in retail markets,” explains pricing strategy expert Ron Wood, founder and director at Pricing Insight.
With access to extensive data, any retail business can adjust prices within seconds to tailor them to the customer behaviours.
With that comes risks and opportunities, as companies must navigate the delicate balance between maximising profits through personalised pricing and addressing concerns related to privacy, fairness and customer trust, Wood argues.
A business strategy
Dynamic pricing is the interplay between supply, demand and the currents of market forces. From online marketplaces to ticketing systems, it is a strategy that replaces the idea of fixed costs with a fluid responsiveness to real-time data and algorithms.
“You know it is working if you have demand and supply throughputs aligned, and you are not holding excess inventory that needs to be written off,” Wood says.
For finance teams looking to protect and manage margins, a dynamic pricing schedule can be very effective, particularly where there are volatile input costs, he says.
“A dynamic pricing model allows you to change the price of any product depending on inventory and demand. It would increase discounts very subtly until such a point to trigger a purchase, which means you are able to calibrate the supply and demand equation more effectively.”
However, it is more complicated than it sounds, he argues, and businesses should avoid outsourcing pricing decision-making without any governance or guardrails.
“I have had clients who bought an off-the-shelf software program that tried to predict demand and then would set prices to optimise profitability, but it kept lowering prices, so competitors would lower their prices, so it would lower its prices, and so on,” Wood explains.
Pricing Strategies for Creating Customer Value
When the price is not right
While dynamic pricing might sound like a very profitable approach, it is not suited to every situation, says Ruth Callaghan, chief innovation officer of strategic communications business Cannings Purple.
“There are two golden rules with dynamic pricing – the first is to be fair, and the second is to communicate well,” she says.
For dynamic pricing to be effective and well-received, businesses must have a solid foundation in their regular pricing, ensuring it accurately represents the value offered. This approach avoids negative perceptions associated with price gouging and contributes to a fair and transparent pricing strategy.
“Customers will react badly if they think you are not being fair. If you are trying to maximise the value of airline seats in short supply, it is fine. It is less fine if there is a pandemic, and you price your toilet paper outrageously high. That is seen as price gouging,” Callaghan says.
It is a real risk, considering that 73 per cent of consumers say that they will switch to a competitor if they have multiple bad customer service experiences with a company, according to data from Zendesk.
“If you do not articulate the value that you are providing your customers, then there is a real potential they will switch or that your reputation is going to get some damage if they feel like they have not been treated fairly,” Callaghan says.
One example is Uber, which has faced opposition with its use of dynamic pricing.
When Hurricane Sandy hit the east coast of the US in 2012, the ride-share platform faced heavy criticism for not turning off its surge pricing feature as people scrambled to get to safety.
Two years later, this time in Australia, the company faced a similar backlash from consumers due to delays in turning off surge pricing during a hostage situation at a cafe in Sydney’s central business district, which saw users charged four times the usual price, for which Uber ultimately apologised.
“We are OK with paying a higher price to get home on New Year’s Eve, but surge pricing when everyone is trying to get out of the centre of Sydney because there is a dangerous situation unfolding is a really bad call,” Callaghan says.
Pricing and the keys to profitability
Who's watching?
While businesses are prohibited from misleading consumers under The Australian Consumer Law, there is little regulation of dynamic pricing. Under discrimination law in Australia, a retailer cannot set higher prices for people due to gender, disability, race, age or other protected characteristics, but it can charge people different prices for the same product or service.
“Dynamic pricing is not illegal, but businesses must be clear about the price consumers will pay,” says a spokesperson from the Australian Competition and Consumer Commission.
“Whether or not a business’s use of dynamic pricing may be misleading will depend on the circumstances involved in each case, including what representations a business may have made to consumers about their pricing."
Dr Jeannie Paterson, consumer law professor and co-director of the Centre for AI and Digital Ethics at the University of Melbourne says it is important for businesses to understand how any approach to dynamic pricing works. “Make sure that it is not actually pricing based on unfair or irrelevant considerations, as opposed to dynamic pricing based on genuine market demand or risk assessments.
“There is little law on this, and there is a lot of concern that dynamic pricing can in fact be discriminatory pricing, which targets people who are not aware of what the market standard is, or it puts higher burdens on some clients without a justified reason for doing that.”
However, so many data points are now used to set a price that it has become difficult to know what the basis for the price is, and this makes it hard to determine if something is fair or not, Paterson argues.
Concerns arise regarding profiling when algorithms, drawing from factors like social media use, location, or demographics, begin influencing higher prices for specific groups.
The justification for these elevated prices may be linked to perceived risk, with one cohort considered more susceptible to opportunistic pricing, while another may be perceived as more willing to pay higher amounts.
“The more factors we use to set the prices, the opaquer and more problematic it becomes. If we used the ‘pub test’, we would not think it is fair for some people to be charged more on the basis of undefined, unexplained assumptions made about them.
“Transparency means also thinking about whether your explanation of why you are doing surge pricing has social licence,” Paterson says.
“There are risks to businesses from customers who do not understand it, or why it is being used, who then perhaps later ask why they were charged more than someone else.”