Addressing the Most Common Misconceptions and Concerns About Dynamic Pricing

Retailers and online sellers are frequently found concerned or worried when it comes to implementing dynamic pricing into their overall pricing strategy. Sometimes, that’s completely justified. Perhaps the industry, market, business logic, or available resources don’t allow for it. That’s completely fine.

However, there are cases where we believe some businesses and decision-makers exhibit a higher level of concern than it is actually warranted. 

In this article, we will go over what those cases and misconceptions are, share with you what we think is behind all of it, and how all those objections aimed towards dynamic pricing can be debunked. 

Dynamic pricing can lead to a decrease in customer loyalty

According to Emarsys’ Customer Loyalty Index, incentivized loyalty levels have dropped from 45% (in 2021) to 39% (in 2022). They define incentivized loyalty as loyalty developed through discounts, incentives, and rewards. These all can be looked at as price-related incentives.

On the other hand, overall levels of loyalty are increasing, and in 2022 76% of consumers worldwide claim to be loyal to one or more brands.

This is why it’s important to recognize the fact that yes, pricing is a sensitive and important topic, but loyalty goes beyond just that.

To truly foster loyalty you need to develop your brand and promote its values through your pricing, but perhaps even more importantly through your messaging and other practices your customers are aware of.  

Furthermore, there are even industries where customers show a significantly more pronounced reaction to price changes, where the demand drops almost immediately. This means that in industries where the competition is high and where each product has numerous substitutes, it is extremely difficult to talk about customer loyalty.

Industries where price sensitivity is the most prominent and thus loyalty on the lowest level are:

• FMCG (Fast moving consumer goods),
• Travel,
• Consumer electronics,
• Apparel and (fast) fashion,
• Mass-market cosmetics.

Everything mentioned above gets an additional layer of complexity when we include online stores and related websites in the equation.

With numerous price comparison websites present and with customers being more aware than ever of price differences, it’s crucial to stay on top of your game and know how you are positioned relative to your competitors. 

Dynamic pricing and price monitoring can only help you with that. Having information and the ability to respond quickly to market changes is what dynamic pricing is all about. It does not mean alienating your customers.

Dynamic pricing is the same as surge pricing

Dynamic pricing is a wider category than surge pricing. Surge pricing is a sub-type of dynamic pricing which is why they cannot be equaled. 

Surge pricing in practice means increasing your prices as the demand increases. This practice is especially apparent in delivery and other on-demand services, ride-sharing services, and event ticketing. 

Dynamic pricing, on the other hand, can mean both price drops and price increases. This is the main difference. Whereas surge pricing means (often abrupt) price increases, dynamic pricing also includes price drops. 

Besides this main difference, there’s another important distinction between these two pricing strategies. It’s related to factors that are behind them and which trigger these strategies.

Surge pricing primarily aims to capture and profit from higher levels of demand.

Dynamic pricing, on the other hand, can be based on various other factors besides current demand. As you will see later on in the article, unlike surge pricing, dynamic pricing can be based on your competitors’ prices, your desired pricing position, market forecasts, and many other factors.

Dynamic pricing can lead to pricing wars and race to the bottom

The theoretical background of this statement is based on the worst outcome in what is known as a “prisoner’s dilemma”.

Prisoner’s dilemma is a concept within game theory that, in essence, describes how a seemingly the most optimal strategy from one rational actor’s perspective turns out to be the least optimal one overall when employed by both actors involved. In short, it goes as follows:

1. Two persons are arrested and brought to completely separate interrogation rooms.

2. The authorities lack sufficient evidence and require a confession from one of the actors.

3. Each actor has two options, presented by the authorities: remain silent or confess and testify against the other.

4. If one of them confesses, and the other doesn’t, the one who didn’t confess will receive the maximum punishment.

5. If both confess, they will both receive a medium punishment.

6. If both remain silent, they will receive the mildest punishment.

The best outcome is achieved if they actually decide against following their immediate self-interest and remain silent. 

We can take this example and its principles and apply it to our eCommerce context. If two sellers act solely based on their immediate self-interest by eroding prices and undercutting each other, it will lead to a race to the bottom and become a vicious spiral that results in a negative sum game.

To see why this doesn’t have to be the case, it’s crucial to understand two things.

1.  Price erosion isn’t the optimal long-term approach for sustainable growth.

A quick boost in sales by sharply dropping prices can seem tempting (although, sometimes painful). And truth be told, in the short term it may bring the desired results.

However, if you are a retailer who aims to achieve long-term sustainable growth, then it is paramount that you understand why this approach is hurting the chances of you reaching your goal.

First of all, your profit margins may become so compressed that you are unable to even cover your operating expenses, let alone fund your growth. 

Second, your brand’s perception of value is likely to drop in the eyes of your customers. Prices are highly correlated with how your customers perceive your brand and its value.

2. Utilizing proper price management tools & algorithms can prevent the worst-case scenario.

The other thing you have to understand is that it’s highly recommended you use an established and market-tested solution if you are venturing into dynamic pricing.

You, at the very least, need to be able to set the prices you are not willing to go under (or in some cases, above). 

On top of that, it should be able to give you suggestions on how to optimize your prices that aren’t solely price drops.

To sum things up — dynamic pricing enables online sellers to be more versatile and agile. That’s the main point of this pricing strategy, not instigating price wars between retailers. As a matter of fact, properly implemented dynamic pricing rules can prevent escalation.

Dynamic pricing is difficult to implement

It depends. Certainly, it doesn’t have to be the case. 

Two factors are crucial here. Your dynamic pricing rules and the tool you are using to implement them.

The six essential dynamic pricing parameters are:

• Your product price;
• Your competitor’s product price;
• Desired profit margin;
• Desired pricing position;
• Minimum and maximum price values;
• Stock availability of a product.

Other factors that you may include are:

• Seasonality – different products and services meet different demand levels depending on the time of the day (eg. coffee), weather (eg. taxi rides), season (eg. hotels), etc.
• Supply and demand – utilizing your internal data for various markets and products can enhance your dynamic pricing strategy by making it more nuanced and precise.
• Customer segmentation – not all customer groups exhibit the same levels of price sensitivity, loyalty, or behavior in general. This fact can be taken into account when setting your dynamic pricing rules.
• Product lifecycle – differing dynamic pricing approaches are possible depending on which stage your product is in (introduction, growth, maturity, decline).

All of this can seem like a lot, but for starters, you could only focus on the six essential dynamic pricing parameters and build upon that. 

When it comes to the tool you use to implement your dynamic pricing strategy it should at least offer the ability to edit basic parameters (with a friendly and intuitive interface, to reduce the time you spend lurking around each possible menu).

On top of that, it should ideally have an option for custom development, meaning your requests that are not within the basic parameters, can be realized. This is, by the way, what Price2Spy can do (and actually does for numerous clients already).

In essence, for starters, you should focus on the basic parameters with a toolkit that won’t bottleneck you and you will be good to go.

Ethical considerations related to dynamic pricing

In one of its aspects, dynamic pricing can mean charging different prices to different customers based on their location, time of the day, purchasing behavior, and other relevant criteria. This fact alone can lead to numerous questions.

Is dynamic pricing fair? Is it and should it be as transparent as possible? Does it breach your customers’ trust?

It only makes sense to answer these questions jointly, because the concepts mentioned in them are closely related to each other. 

Before we continue, let’s clear up one thing – it is a touchy subject. We have an example of Wendy’s receiving a backlash from their audience when they mentioned potential price changes of their items throughout the day. They then had to issue a statement in which they denied they were going to introduce dynamic pricing.

This, however, is an example of prompt and transparent communication with your customers, which in turn helps build trust and long-term relationships. 

To get back to the topic of ethics when implementing dynamic pricing, there are several key considerations.

First of all, dynamic pricing on its own has no intrinsic value – it’s neither good nor bad. It all depends on the rules that are utilized, what the market circumstances are, and what each retailer’s goals are.

Second, we are aware that it is difficult to be completely transparent about your pricing strategies with your customers. This, however, doesn’t mean that it’s a forbidden topic to discuss about. You need to find the nuanced measure where you satisfy your customers’ communication needs while not revealing what you consider confidential.

Lastly, you should continuously monitor your rules and revise them when required. If you notice a bias or discrimination against certain customer segments, you should address it promptly.

Is dynamic pricing the “big bad evil” in the world of eCommerce?

To answer the question and conclude this article — no, far from it. 

Characteristics of any specific dynamic pricing strategy depend on the intent of the one who is setting its rules. 

Let’s take a step back and see dynamic pricing for what it really is—an algorithm, or a set of rules, that are automatically implemented with the main benefits of (1) acting quicker than anyone would be able to do manually, (2) saving significant amounts of time, (3) protecting your pricing position, and (4) making more precise pricing decisions.

It can potentially come with side effects that may negatively affect certain customer segments, but as we have already emphasized, you should keep an eye on both your rules and the prices of your products.

This will enable you to promptly address any issues that may arise.