A growing number of companies are using “dynamic” pricing

Schumpeter: Flexible figures.  as printed in The Economist Jan 30, 2016

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A growing number of companies are using “dynamic” pricing

IF A cynic is someone who knows the price of everything and the value of nothing, as Lord Darlington observes in Oscar Wilde’s “Lady Windermere’s Fan”, then it is getting progressively harder to be a cynic. A growing number of companies keep their prices in a constant state of flux—moving them up or down in response to an ever-shifting multitude of variables.

Businesses have always offered different prices to different groups of customers. They offer “matinée specials” for afternoon cinema-goers or “happy hours” for early-evening drinkers. They offer steep discounts to students or pensioners. Some put the same product into more than one type of packaging, each marketed to a different income group.

Dynamic pricing takes all this to a new level—changing prices by the minute and sometimes tailoring them to whatever is known about the income, location and spending history of individual buyers. The practice goes back to the early 1980s when American Airlines began to vary the price of tickets to fight competition from discounters such as People’s Express. It spread to other airlines, and thence to hotels, railways and car-rental firms. But it only became the rage with the arrival of e-commerce.

The price of goods and services sold online can be varied constantly and effortlessly, in accordance with the numbers and characteristics of those making purchases, and factors such as the weather. Competitors can be monitored constantly, and their prices matched. Amazon updates its price list every ten minutes on average, based on data it is constantly collecting, according to Econsultancy, a research and consulting firm.

The practice is spreading to physical retailers, which are installing electronic price displays and borrowing pricing models from e-retailers. Kohl’s, with nearly 1,200 stores in America, now holds sales that last for hours rather than days, pinpointing the brief periods when discounts are most needed. Cintra, a Spanish infrastructure firm, has opened several toll roads in Texas that change prices every five minutes, to try to keep traffic moving at more than 50mph (80kph). Sports teams, concert organisers and even zookeepers have embraced dynamic pricing to exploit demand for hot tickets and stimulate appetite for unwanted ones.

The dynamic-pricing revolution provides plenty of benefits for businesses. Besides helping them smooth demand (which can spare them the cost of maintaining extra capacity for peak times), it makes it easier for them to squeeze more out of richer customers. Travel websites have experimented with steering users of Apple computers—assumed to be better-off than Windows PC users—towards more expensive options. Airlines have been caught charging loyal travellers more for a ticket than infrequent travellers, on the assumption that they are more likely to be on a work trip, so their employer will probably be paying. The technology is far from perfect: ever since buying a coffee machine online your columnist (who is not good at newfangled tasks such as clearing browser cookies) has been inundated with offers for coffee machines, as if the purchase was proof not of a need that had been satisfied but of an insatiable desire.

Even if the technology becomes more sophisticated, there are two risks for businesses with dynamic pricing. The first is psychological resistance: companies’ reputations can suffer if they offend customers’ sense of fairness. Uber encountered a backlash when it increased its prices eightfold during storms in New York in 2013. Such “surge” pricing makes perfect economic sense: drivers are more likely to go out in hostile conditions if they get paid more; and many customers would prefer a high-priced ride to no ride at all. But these arguments cut little ice when prices run counter to people’s sense of equity. So, in this week’s snowstorms in New York, Uber capped its surge prices for its regular taxis at just 3.5 times the normal fare.

Psychological resistance can be fierce when companies use data collected from their customers to charge them more. That is why, in 2000, Amazon quickly dropped a scheme to charge some customers more for DVDs based on their personal profiles, and why it has trodden carefully since. Customers are learning to play the game. Some are searching for flights from an internet café instead of their living-rooms, to get lower fares. Others are piling goods into their online baskets and then failing to click “buy”, hoping this will prompt the seller to offer a better deal.

Price-fixation

The second risk with dynamic pricing is that it ends in a race to the bottom. Companies that sell online have long been caught up in a war for the top slot on price-comparison sites: even being cheaper by a penny can make all the difference. Physical retailers are being caught in the same logic: those adopting dynamic pricing are mostly doing so to avoid being turned into mere showrooms by customers who inspect the goods but then buy online. The Nebraska Furniture Mart constantly watches what competitors such as Amazon and Best Buy are charging, and updates its in-store electronic displays each morning to meet its guarantee of offering the lowest price. This is obviously good for customers. But getting fixated on prices can distract businesses from seeking ways to make their products and services so attractive that customers will be less fussy about their cost, as the most successful purveyors of luxury items, from Ferraris to Hermès scarves, do.

The oldest form of dynamic pricing was practised in ancient bazaars, where merchants would size up their customers before the haggling began. Those retailers might not have been able to compute as many different variables as today’s algorithms. But they still have something to teach today’s dynamic pricers about the importance of establishing trust and playing on desire. Cynical as it sounds, to understand a customer’s underlying willingness to part with their money you need to pay a good deal of attention to values.

At the Core: Lessons in Pricing from Apple.

apple

Apple has taught many entrepreneurs the importance of design, how to create buzz when introducing new products to the marketplace, how to pioneer new technology and the importance of superior quality.

But Apple also has wily pricing experts who have used pricing strategies to create extra profits.

The most recent example is the Apple response to Samsung’s huge presence in the India market. Apple’s products are too pricey for the average Indian, where many people still survive on $2 per day. Smart phones make sense in countries where electricity supplies and telecoms infrastructure is weak and prone to frequent blackouts. Phones add value to people’s lives by bringing them close to the markets. This has already happened in some poor fishing communities that dot the coastline. When heading back with the catch of the day, they can check the spot prices at various ports within reach and choose the best paying one. Clearly smart phones are an economic accelerator. So, how to get more smart phones into Indian hands?

Apple has used a price skimming strategy for the consumer market. Early adopters pay greatly for the newest and brightest toys. But Apple also knows that competitors can enter the market easily and quickly after Apple has pioneered the technology. So constant innovation is a hallmark of Apple products.

But that means the earliest smart phones are soon obsolete. Apple could NOT “dump” the old phones on the American or early adopter market, for fear of cannibalising its own consumer segment. So Apple took the older phones to India, effectively buying market share with a great if outdated product that has already generated all the profits Apple expected.

But not all of us have the luxury of dumping our old products on a foreign market. How can Apple’s leadership in this pricing gambit be put to use in a Canadian small business?

If your pricing model demands a profit margin on each and every inventory item you sell, you will not be able to sell the end of season or dust covered items for a dollar. You will lose money.

But Apple has a simple idea. Not all inventory moves equally. If you sell seasonal or fashion products, some product will be left over after the majority has sold. If your pricing model allowed for this hangover – check your records in prior years -, then you could sell the leftovers for $1 and make a profit.  See my prior articles on how the big box stores price this way or take a look at my book , Pricing Strategies for Small Business. If you sell strategically, you can gain new clientele. By contacting your customer list and advising of a tremendous sale, you move inventory that would otherwise gather dust and gain loyal customers at the same time.

Contact Andrew Gregson for your next convention, conference or workshop.

 

Thinking twice about price

WHEN bosses promise to make their companies more profitable they usually say they will do so by increasing sales or cutting costs. But a third road to profits is rarely mentioned: putting prices up. Managers often fail to ask how they might do better at plucking the goose to obtain the most feathers with the least hissing. The spiel from the management consultants who advise companies on pricing—whether specialists like Simon-Kucher or giant generalists like PWC—is that it is now more vital than ever to be smart at it. In today’s austere age many businesses cannot depend on rising sales volumes to lift their profits. As for cutting costs, most have already pared them to the bone. Prices are all that is left. And a business can do a lot with clever pricing, to boost its share of the limited spending-power that is out there.

Makers of high-tech products such as smartphones can opt to add whizzy new features and push up prices. In the case of luxury goods, their exclusivity is a large part of their appeal, and this in turn is a function of their price, so firms usually have scope for limiting supply and charging more: Ferrari, a sports-car maker, and Mulberry, a purveyor of posh bags, have both recently signalled that they plan to do just that. But raising prices by making products better or more exclusive is a strategic decision, open to only a few types of business. For all sorts of mundane goods and services there is much that can be done tactically, the consultants say, to charge more for the same thing.

Second, companies need to remember that, as the late Peter Drucker, a management guru, once put it, customers do not buy products, they buy the benefits that these products and their suppliers offer to them. So, businesses that fail to identify what benefits they are offering each type of customer are likely to be undercharging some of them. Equipment-makers who sell to other businesses can be especially prone to a “cost-plus” mentality, in which they charge the same margin to everyone instead of identifying those that are less price-sensitive and finding ways to earn more from them. Oil companies, for example, can suffer huge costs in lost drilling time if a pump goes down, so pump-makers could charge them a premium for guaranteed same-day dispatch of spares.

Airlines have learned to “unbundle” their product, charging separately for baggage and meals and increasing their overall takings. But industrial suppliers may still charge the same to customers who never call their technical helpline as to those who ring it daily. Makers of everything from aircraft engines to lorry tyres have gone further in selling benefits rather than products, by offering “power by the hour” contracts in which customers only pay when they use their goods. The suppliers earn more overall, while their customers preserve scarce capital.

A third route to charging more is to manage customers’ expectations better. In the early 2000s executives at General Motors were told to wear badges with “29” on their lapels, as part of a disastrous plan to get back to a 29% market share in America. This merely reinforced car-buyers’ assumption that GM would offer them whatever discounts it took to shift its metal off the forecourts, putting the firm on the road to bankruptcy. (Last year its market share fell to 17.5%, its lowest since the 1920s.) Once customers know that a firm’s price list is a work of fiction and that it will resort to discounts as soon as sales dip, it will be a long haul to get them used to paying full price, let alone accepting increases. Simon-Kucher’s consultants praise DHL, a logistics firm, which spent years drilling into its customers that whatever the economic conditions there will be a rate rise each year.

You’ve been framed

Fourth, there are lots of simple presentational tricks that almost everyone is wise to but which still, miraculously, work. Restaurants add some overpriced wines lower down the menu to make the ones at the top seem reasonable. Makers of ice cream offer “33% extra free” rather than “25% off” the cost of the regular size, even though these are arithmetically the same thing. Buyers at big industrial firms are just as susceptible to such “framing” when reviewing a list of widget prices.

The pricing experts make it sound so easy. But there are of course limits to how far firms can go in tailoring their prices to the customer without appearing sneaky. Last year Orbitz, an online travel agency, was criticised for offering a costlier selection of hotels to people browsing its site on an Apple Mac because it assumed they were richer than PC users. Although a firm’s customers may not notice the odd price rise slipped in here and there, they will eventually notice if their overall bill starts to swell: Tesco, Britain’s biggest grocer, is now having to offer expensive discounts to win back a damaged reputation for value.

And sticking to a pricing strategy takes guts. The irony, confides a senior management consultant, is that firms like his have such a taboo against letting go of a client that they are the worst at taking their own advice to be fearless in asking for more, and walking away if they do not get it.

Economist.com/blogs/schumpeter

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