Dynamic Pricing

Dynamic Pricing

The lecture introduces dynamic pricing as a business decision-support approach and a precursor to the next topic, online auctions. It explains how prices can respond to changes in supply and demand, customer segments, inventory, and market conditions.

Core Concepts

• Market equilibrium: Prices coordinate the decisions of buyers and sellers. Higher prices tend to reduce consumer purchases and encourage production, while lower prices tend to encourage consumption and discourage production.
• Fixed pricing: Businesses often prefer fixed prices because they are simpler to manage, make cost recovery and break-even planning easier, reduce price uncertainty, and can support customer loyalty. Common approaches include:
  • Markup pricing: Adjusting unit cost by a markup.
  • Target-return pricing: Setting prices based on costs and a desired return on invested capital.
  • Perceived-value pricing: Charging based on customers’ perceptions of a product’s value and quality.
  • Going-rate pricing: Setting prices with reference to competitors.
• Conventional pricing is not always truly fixed. Volume discounts, promotions, and negotiated prices already introduce variation.

How E-Commerce Enables Dynamic Pricing

The internet lowers the costs of searching for prices and changing or communicating them. Buyers can quickly compare sellers and substitutes, while sellers can monitor behavior and adjust prices using software. This makes it easier to respond to changes in demand without the time and expense of producing and distributing new printed price lists.

At the same time, greater price visibility and competition can increase price uncertainty and demand volatility.

Dynamic pricing is the adjustment of prices in response to changing supply and demand. The lecture also refers to it as flexible or customized pricing.

Pricing Approaches

Price Dispersion

Different prices are offered for the same item:

• Across sellers at the same time: For example, airline tickets listed at different prices on different websites.
• Across time by one seller: A seller changes a price as demand or other conditions change.

Price Differentiation

Prices vary according to the customer, purchase, or product configuration:

• First-degree differentiation: Different buyers pay different amounts for the same product, potentially allowing the seller to capture more of the available consumer surplus. Auctions are one mechanism that can support this approach.
• Second-degree differentiation: The price per unit changes with quantity or usage, while the pricing rule is available to all customers. Volume discounts are one example.
• Third-degree differentiation: Different customer groups receive different prices, such as student or senior discounts.

Customized Products

A seller can change product attributes or features to create different versions at different prices. Dell computers are cited as an example.

Conditions for Dynamic Pricing to Work

The lecture identifies several requirements:

1. Customers differ in their willingness to pay.
2. The market can be segmented into identifiable groups or situations.
3. Resale from a lower-priced segment to a higher-priced one can be restricted.
4. The revenue gained from customization or segmentation exceeds the cost of implementing it and communicating price changes.
5. Customers perceive the pricing as fair.
6. Pricing is supported by appropriate analytical models, such as:
   • Inventory-based models, including yield management.
   • Data-driven models using customer preferences and purchasing patterns.
   • Auction models that let prices respond to supply and demand.
   • Simulation models.

Examples and Lessons

• Airline yield management: Ticket prices change as demand and remaining seat inventory change. Unsold seats may be discounted near departure to generate marginal revenue.
• Priceline and online auctions: Examples of online negotiation and auction-based pricing.
• eBay: An example of online auctions in which prices are shaped by market conditions.
• Amazon DVD pricing: The lecture describes an early experiment that adjusted DVD prices based on demand. Frequent fluctuations caused confusion and customer complaints, so the approach was discontinued. Lesson: A pricing model can be technically feasible but fail if customers find the changes confusing or unfair.
• Buy.com: The company reportedly tried to undercut competitors, sometimes selling at prices that resulted in negative profit. Lesson: Competing solely on the lowest price can undermine profitability.

Metrics and Targets

No specific financial metrics, numerical targets, or implementation timelines are provided. The main business test is whether the additional revenue from price differentiation exceeds the associated costs.

Source

The lecturer is not named in the subtitles. Source: E-business channel.