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Dynamic pricing, also referred to as surge pricing, demand pricing, or time-based pricing is a pricing strategy in which businesses set flexible prices for products or service based on current market demands. Businesses are able to change prices based on algorithms that take into account competitor pricing, supply and demand, and other external factors in the market. Dynamic pricing is a common practice in several industries such as hospitality, travel, entertainment, retail, electricity, and public transport. Each industry takes a slightly different approach to repricing based on its needs and the demand for the product. Dynamic pricing can be unpopular with consumers and favours the wealthy, who are less likely to be priced out of a market when there is high demand, such as for electricity during a heat wave or for food during a famine.
- 1 History of dynamic pricing
- 2 Dynamic pricing today
- 3 Dynamic pricing methods
- 4 Controversy
- 5 References
- 6 See also
- 7 External links
History of dynamic pricing
Dynamic pricing has been the norm for most of human history. Traditionally, two parties would negotiate a price for a product based on a variety of factors, including who was involved, stock levels, time of day, and more. The Quakers were the exception to this rule, because they charged the same price for every product in the name of fairness. This “fixed pricing” model was a way to fight back against a society that they Quakers saw as unfair.
Outside of the Quaker fixed-price model, the rest of the western world used dynamic pricing up until the industrial revolution. As consumerism grew during this period, so did the size of retail assortments and the number of retail stores. Retailers, who had previously relied on experienced shopkeepers to negotiate prices, realized this was an inefficient model in the new consumer market. The invention of the price tag in the 1870s presented a solution: one price for every person. Unlike the Quakers, who used fixed pricing as a way to maintain fairness, retailers used fixed pricing to reduce the need for highly skilled shopkeepers and smooth out the shopping experience within a store.
Dynamic pricing in air transportation
Dynamic pricing has re-emerged since the 1980s though, albeit somewhat differently than the previous version of it. Today’s dynamic pricing still presents a clear price to consumers and leaves no room for negotiation between consumers and the seller. They dynamic aspect refers to the fact that prices will change throughout the day based on a number of different variables.
The practice as we know it developed during the 1980s by the United States airline industry. Before the 1980s, the airline industry’s seat prices were heavily regulated by the United States government, but change in legislation during the 1980s gave airlines control over their prices. Companies invested millions of dollars to develop computer programs that would adjust prices automatically based on known variables like departure time, destination, season, and more.
Dynamic pricing in the rest of the travel and tourism industry
After seeing the success of dynamic pricing in selling airline seats, many other verticals within the travel and tourism industry adopted the practice. Dynamic pricing is now the norm for hotels, car rentals, and more.
Dynamic pricing today
Dynamic pricing has become commonplace in many industries for a variety of reasons.
Time-based pricing is the standard method of pricing in the tourism industry. Higher prices are charged during the peak season, or during special-event periods. In the off-season, hotels may charge only the operating costs of the establishment, whereas investments and any profit are gained during the high season (this is the basic principle of long-run marginal cost pricing: see also long run and short run).
Hotels and other players in the hospitality industry use dynamic pricing to adjust the cost of rooms and packages based on the supply and demand needs at a particular moment. The goal of dynamic pricing in this industry is to find the highest price that consumers are willing to pay. Another name for dynamic pricing in the industry is demand pricing. This form of price discrimination is used to try to maximize revenue based on the willingness to pay of different market segments. It features price increases when demand is high and decreases to stimulate demand when it is low. Having a variety of prices based on the demand at each point in the day makes it possible for hotels to generate more revenue by bringing in customers at the different price points they are willing to pay.
Airlines change prices often depending on the day of the week, time of day, and number of days before the flight. For airlines, dynamic pricing factors in different components such as: how many seats a flight has, departure time, and average cancellations on similar flights.
Congestion pricing is often used in public transportation and roadways, where a higher price at peak periods is used to encourage more efficient use of the service or time-shifting to cheaper or free off-peak travel. For example, the San Francisco Bay Bridge charges a higher toll during rush hour and on the weekend, when drivers are more likely to be travelling. This is an effective way to boost revenue when demand is high, while also managing demand since drivers unwilling to pay the premium will avoid those times. The London congestion charge discourages automobile travel to Central London during peak periods. The Washington Metro and Long Island Rail Road charge higher fares at peak times.
Dynamic pricing is also practiced by on-demand transportation network companies such as Uber and Lyft. Uber's system for "dynamically adjusting prices for service" measures supply (Uber drivers) and demand (passengers hailing rides by use of smartphones), and prices fares accordingly.
Some professional sports teams use dynamic pricing structures to boost revenue. Dynamic pricing is particularly important in baseball because MLB teams play around twice as many games as some other sports and in much larger venues.
Sports that are outdoors have to factor weather into pricing strategy, in addition to date of the game, date of purchase, and opponent. Tickets for a game during inclement weather will sell better at a lower price; conversely, when a team is on a winning streak, fans will be willing to pay more.
Dynamic pricing was first introduced to sports by a start-up software company from Austin, Texas, Qcue and Major League Baseball club San Francisco Giants. The San Francisco Giants implemented a pilot of 2,000 seats in the View Reserved and Bleachers and moved on to dynamically pricing the entire venue for the 2010 season. Qcue currently works with two-thirds of Major League Baseball franchises, not all of which have implemented a full dynamic pricing structure, and for the 2012 postseason, the San Francisco Giants, Oakland Athletics, and St. Louis Cardinals became the first teams to dynamically price postseason tickets. While behind baseball in terms of adoption, the National Basketball Association, National Hockey League, and NCAA have also seen teams implement dynamic pricing. Outside of the U.S., it has since been adopted on a trial basis by some clubs in the Football League. Scottish Premier League club Heart of Midlothian introduced dynamic pricing for the sale of their season tickets in 2012, but supporters complained that they were being charged significantly more than the advertised price.
Dynamic pricing is quickly becoming a best practice within the retail industry as e-commerce grows in importance and the size of assortments expands. To keep track of their product prices, retailers are increasingly turning to dynamic pricing solutions. Some retailers will build their own dynamic pricing software, but many more will outsource to a software program.
Retailers, and online retailers in particular, adjust the price of their products according to competitors, time, traffic, conversion rates, and sales goals. The aim of dynamic pricing is to increase revenue and profit. There are three basic ways to do this.
- First, retailers can use price intelligence to reprice based on the prices of their competitors.
- Second, retailers can drop prices when demand is low.
- Third, retailers can increase prices while demand is high.
Amazon.com engaged in price discrimination for some customers in the year 2000, showing different prices at the same time for the same item to different customers, potentially violating the Robinson–Patman Act. The company stopped and apologised after it was discovered.
Dynamic pricing methods
There are a number of ways to execute a pricing strategy with dynamic pricing software, and certain softwares even let you combine different pricing methods into a larger pricing strategy.
Pricing based on value or elasticity
Ideally, companies should ask the price for a product which is equal to the value a consumer attaches to a product. This is called value-based pricing. As this value can differ from person to person, it is difficult to uncover the perfect value and have a differentiated price for every person. However, consumer's willingness-to-pay can be used as a proxy for the perceived value. With the price elasticity of products, companies can calculate how many consumers are willing to pay for the product at each price point. Products with high elasticities are highly sensitive to changes in price, while products with low elasticities are less sensitive to price changes (ceteris paribus). Subsequently, products with low elasticity are typically valued more by consumers if everything else is equal. The dynamic aspect of this pricing method is that elasticities change with respect to product, category, time, location and retailers. With the price elasticity of products the margin of the product, retailers can use this method with their pricing strategy to aim for volume, revenue or profit maximization strategies. 
Pricing based on competitors
Businesses that want to price competitively will monitor their competitors’ prices and adjust accordingly. Amazon is a market leader in retail that changes prices often, which encourages other retailers to alter their prices to stay competitive. Competitor-based dynamic pricing can increase sales, especially if they take advantage when other retailers run out of stock. As of 2018, several third-party tools have allowed merchants to take advantage of a time based dynamic pricing including Pricemole, SweetPricing, BeyondPricing, etc.
Time-based retail pricing
Many industries change prices depending on the time of day, especially online retailers, whose customers usually shop the most in during weekly office hours between 9AM-5PM. Raising prices during the morning and afternoon and lowering prices during the evening is a common practice with dynamic pricing.
Time-based utility pricing
- Time-of-use pricing (TOU pricing), whereby electricity prices are set for a specific time period on an advance or forward basis, typically not changing more often than twice a year. Prices paid for energy consumed during these periods are preestablished and known to consumers in advance, allowing them to vary their usage in response to such prices and manage their energy costs by shifting usage to a lower cost period or reducing their consumption overall (demand response)
- Critical peak pricing whereby time-of-use prices are in effect except for certain peak days, when prices may reflect the costs of generating and/or purchasing electricity at the wholesale level
- Real-time pricing whereby electricity prices may change as often as hourly (exceptionally more often). Price signal is provided to the user on an advanced or forward basis, reflecting the utility's cost of generating and/or purchasing electricity at the wholesale level; and
- Peak load reduction credits for consumers with large loads who enter into pre-established peak load reduction agreements that reduce a utility's planned capacity obligations.
A utility with regulated prices may develop a time-based pricing schedule on analysis of its cost on a long-run basis, including both operation and investment costs. A utility operating in a market environment, where electricity (or other service) is auctioned on a competitive market, time-based pricing will typically reflect the price variations on the market. Such variations include both regular oscillations due to the demand pattern of users, supply issues (such as availability of intermittent natural resources: water flow, wind), and occasional exceptional price peaks.
Price peaks reflect strained conditions on the market (possibly augmented by market manipulation, as during the California electricity crisis) and convey possible lack of investment.
Conversion rate pricing
Conversion rates measure how many browsers on a website turn into buyers. When conversion rates of viewers to buyers is low, dropping the price to increase conversions is standard with a dynamic pricing strategy.
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Uber applied for a U.S. patent last year for 'dynamically adjusting prices for service' using mobile devices. The system measures supply (Uber drivers) and demand (passengers hailing rides with smartphones), and prices fares accordingly.
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- Futures contract
- Hedonic regression
- Pay what you want
- Price discrimination
- Price gouging
- Variable pricing
- Demand shaping