A win-win proposition
The practice of dynamic pricing is considered to be a promising instrument to increase revenue and margins. Meanwhile, the undesirable side effect that dynamic pricing may be perceived by customers as being unfair is always imminent. There are, however, benefits in dynamic pricing for both customers individually and society as a whole imaginable that go beyond the possible unpleasant experience of being exposed to different prices all the time. In this blog we will make three of such potential benefits explicit.
Stefan van Duin - 14 July 2017
Flexibility and Availability of Supply
Arguably, the classical and most well-known benefit of dynamic pricing regards the notion that by adjusting prices dynamically, firms are better capable of meeting fluctuating demand. This pertains to the observation that businesses can decrease prices when demand is lagging behind and vice versa. So, how do customers benefit from this in practice? In the airline industry, for example, it is well known that ticket prices increase as the departure date approaches. In doing so, airlines ensure that seats are still available just days before the flight departs. Therefore, for customers that have to book and travel on a short term notice, it is because of the increasing prices that they can still be on a particular flight. Stated differently: by adjusting prices accordingly, a customer is given the opportunity to purchase a relatively expensive ticket, whereas quite likely no ticket would have been available otherwise. Similarly, Uber uses dynamic pricing to increase its capacity during busy hours, since higher rates brings more drivers to the streets. Here too, a customer can be offered a relatively expensive taxi ride, whereas possibly no taxi would have been available otherwise. Needless to say, the fairness of such practices will (and should) remain a topic of public debate.
The Food and Agriculture Organization of the United Nations estimates in their report Food wastage footprint (2013) that approximately one-third of all food produced globally is wasted. This substantial figure warrants a responsibility upon all stakeholders in the industry to work towards a more efficient and sustainable market. One way of doing so, may be through the real-time optimization of prices in, for example, grocery stores. In this way, the effects of unforeseen variability in demand can be mitigated by adjusting prices accordingly. An interesting dimension to this problem is that for grocery retailers it may be more profitable to remove products that are close to being outdated from their inventory than clearing the products by heavily discounting them (thereby minimizing food spoilage). This will certainly be the case for products for which price elasticity is low, such as bread. By relying on statistical and mathematical models, (grocery) retailers are given the opportunity to quantify all such effects and make decisions accordingly.
Gamification, Interaction and Personalization in Pricing
Once the paradigm shifts from fixed prices to an environment of dynamic prices, one could also argue that customers should be involved in the formation of prices. Already, retailers are experimenting with ways to let customers exercise influence on prices. For example, Amazon introduced in 2014 the “Make an Offer” program on its website, which allows you to haggle online in certain product categories and, similarly, Priceline has enabled a “Name Your Price” button for some of the products on its websites. Such mechanisms are able to enhance the customer experience by allowing for interaction and giving customers self-control over the pricing process. Even more alluring is the idea of introducing a game element to the pricing process (gamification). One such an example is Spotluck, which is a mobile app that allows you to discover local restaurants and save money, for example, by taking a spin on their wheel of restaurants, for which you can win a discount.
All in all, dynamic pricing beholds more than just the unpleasant experience of ever-fluctuating prices. As we have discussed, it can help make markets function more efficiently and can enhance the interaction with customers. Evidently, the question on how fair certain practices are will remain a matter of public debate for time to come that should be followed with great interest by the industry.
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Dynamic pricing in retail – Developments from science and practice.
ABOUT THE AUTHORS
Ruben van de Geer is PhD candidate at the department of mathematics and at the Amsterdam Center for Business Analytics, which is a cooperation of academia and industry in which Deloitte and de Vrije Universiteit participate. He studied ‘Econometrics and Financial Mathematics’ and ‘Operations Research and Business Econometrics’. His PhD project is joint research with Deloitte and focuses on dynamic pricing in the retail industry.
Stefan van Duin is Director Analytics & Information Management at Deloitte Consulting. He has 20 years of experience in business intelligence and data analytics and loves working on complex, strategic projects, especially when these projects play in an international context.
Sandjai Bhulai is full professor of Business Analytics at Vrije Universiteit Amsterdam. He studied ‘Mathematics’ and ‘Business Mathematics and Informatics’, and obtained a PhD on Markov decision processes for the control of complex, high-dimensional systems. He is co-founder of the Amsterdam Center for Business Analytics, co-founder of the postgraduate programme Business Analytics / Data Science, and also co-founder of Prompt Business Analytics.