It is New Year’s Eve, and you decided to go to a party. Together with your friends, you order an Uber via the Uber app and once you’ve opened it you get a notification: “Demand is off the charts! Fares have temporarily increased to get more Ubers on the road. Your ride will be 2.1 times more expensive than normal.” Ever wondered what this phenomenon is called? This is an example of a surge pricing strategy.
In this article, the definition of surge pricing will be explained followed by different occasions where surge pricing happens. Furthermore, both the use-cases, advantages, and disadvantages of surge-pricing will be discussed. At the end of the article, some practical advice will be given on how to implement surge pricing tactics within your pricing tooling.
Definition Surge Pricing
Surge pricing is a dynamic pricing method where prices are temporarily increased as a reaction to increased demand and mostly limited supply. Therefore, this form of dynamic pricing responds to market factors and helps to flexibly increase your prices. Surge pricing takes place in all kinds of industries, such as hospitality, tourism, entertainment, and of course in retail.
Surge pricing can often be linked to time-based pricing. This dynamic pricing tactic changes prices depending on the time of day and expected or real-time measured high demand peaks. Research showed that customers shop online mostly during weekly office hours and therefore online retailers raise prices during the morning and the afternoon, between 9 AM and 5 PM. When the evening starts, prices can then be lowered again to a normal level to react dynamically to market demand and only surge prices on times related to high demand. Another example of surge pricing connected directly to time-based pricing is during special events. When for example the Grand Slam is organized, demand for certain tennis products increases. During these moments, surge pricing tactics are often applied.
Secondly, surge-pricing can also be connected to weather-based pricing. This approach incorporates the weather forecast in pricing decisions and once the weather conditions are favorable for a product category surge-pricing is applied. Imagine you are selling BBQs and the weather forecast for next week looks promising for the first time this summer. As a pricing strategist, you might want to increase prices as soon as possible, because of the higher expected demand for BBQs.
The third most frequently used surge-pricing tactic is location-based pricing. When this dynamic pricing method is used, selling prices are adjusted upon the geographical location of the buyer. Surge-pricing can often be noticed in crowded cities or locations with high-income populations. In these cities, an elevated willingness to pay can be noticed. Places, where the cost of goods sold is higher due to above-average shipping costs, are another example of cities where prices often surge.
Explanation source: above the supply and demand curves of a market are shown. When increased demand can be noticed, the demand curve will shift to the right. With a stable supply curve, this will automatically increase the quantity to a higher temporary equilibrium level (Q2). When demand increases and supply stays the same, the new price in the market (P2) will be at a higher level than before.
A company that openly applies surge-pricing tactics and informs its customers about it, is Uber. Whenever there is high demand for taxis, often caused at rush hours or other peak periods such as special events or bad weather and not many drivers are on the road, consumers will see an increase in price. This price increase will have an immediate effect on demand, making sure that the ones that really need a taxi will get one and pay more, whilst people that can wait a little longer will postpone their journey until prices are back to normal. On the other hand, it could also affect supply, because more Uber drivers are willing to start driving when they can earn more per ride.
Uber applies a pricing logic of multiplying standard rates during these high-demand periods. These multipliers are calculated in real-time and change rapidly. In this example of Uber, the size of the pricing multiplier is based on the intensity of market demand due to for example peak times or bad weather. Furthermore, multipliers differ from each other based on geographical location.
By being transparent about the multiplier to consumers in the app, Uber takes away any ambiguity and lets the consumer decide upon their buying behavior without jeopardizing bad price perceptions.
source: business insider
Surge-pricing is often used as a pricing method in the following scenarios:
Why do companies decide to use surge pricing and to which commercial goals does it connect?
- High demand cannot be served and needs to be controlled.
- A combination of high demand, stable supply, and little elastic products result in higher margins to be gained
When high demand occurs and supply cannot be guaranteed, surge pricing can be used as a method to control demand and supply. Therefore, sellers want to shift sales towards the consumers with a higher need or a higher willingness to pay. When prices increase, consumers can make two decisions. Either they decide to still buy the product or service or they decide to postpone their purchase because the higher price does not fit their individual demand curve anymore. When their need is still high enough and the increased price will fit their willingness to pay, consumers will continue the transactions regardless of the price increase. Due to this natural filtering method, only a smaller group of consumers must be served and this is rebalancing the high-demand period.
Although the demand in retail does not fluctuate as rapidly as in the taxi industry, there are still many opportunities to use surge pricing on a daily basis in the retail sector. For instance, surge pricing is often used when stock levels are running extremely low or when delivery problems of the products occur. In these cases, high demand is preferably slowed down by increasing prices and therefore shifting demand to the consumers with a higher need or willingness to pay.
Periodically increased demand in combination with stable supply and products that are not highly elastic can result in temporary higher prices. When this opportunity presents itself in the market, organizations often want to take advantage of it and increase profit margins on their products.
Do note that surge pricing only works when the supply is limited and products are not very elastic. In case the supply is not limited, the overall stock is high or additional supply can be purchased, it is probably not wise to increase prices. In that case, customers will normally still have purchasing options at competitors and it is most often better to keep the prices stable and increase your turnover.
In retail peak periods such as the holiday season in December, seasonal advantages are always combined with surge pricing tactics. Furthermore, more and more retailers are using data to predict high-demand periods in advance and anticipate this by increasing prices. Applying a surge-pricing tactic when demand is high will help to achieve commercial goals such as maximizing revenues or maximizing margins.
Pros and Cons of Surge-pricing
Surge pricing offers benefits for your organization since it directly and dynamically adjusts prices upon market dynamics. Therefore, inefficiencies in your operations will diminish or not even exist at all. Anticipating higher demand by increasing prices will be advantageous for your company’s profits and logistics once a potential negative consumer price perception is taken good care of. Running out of stock could be prevented when surge-pricing is applied, and margins increase.
The challenge of surge pricing is not to harm your consumer’s price perception. When prices are surging too often or at unreal times, consumers might perceive your surge pricing tactic as insulting. This could result in less loyalty from your customer base, a negative effect on your reputation, and potentially cost you valuable sales. Surge pricing therefore should be combined with extensive market research and price increases should only be applied when data shows a similar move from your main competitors or when your internal data points, such as stock levels or other logistics, leave you no other room. Adding a pricing rule that sets a maximum price per category or product group will also limit risks of bad price perception but will enable you to get a better margin when demand is high. Furthermore, your organization should build in enough flexibility to be able to dynamically adjust prices downwards quickly when the effects of previously surged prices are not as desired.
How could you use surge pricing in your pricing strategy and implement it in Omnia?
Surge-pricing will become more visible in retail once the electronic shelf labels are more commonly seen in stores. Because of the possibility of changing prices electronically at every moment of the day, surge-pricing would be feasible.
Did you know that Omnia offers the opportunity to implement pricing conditions based on specified dates and times? More about these formulas and how to use them are explained in the following article. The most frequently seen use-case of time-based pricing is promotional pricing.
Furthermore, Omnia offers the option to set up a Google Weather API. This way, the weather forecast of a chosen city can be imported into Omnia and used for pricing purposes. More about this feature can be read in this article.
With Omnia’s flexibility of use, it is possible to set up distinct pricing strategies per channel or per country. By means of the various channels in your Omnia portal, your organization is technically enabled to create price advice per country.
For different countries, Omnia always advises creating a pricing strategy that is tailored towards the dynamics of that specific market and setting up a separate environment for each country. Our consultants can advise you on the preferred setup within Omnia.
Surge-pricing could be beneficial for your company whenever you would like to tackle high-demand peaks and take advantage of them by using different pricing tactics. Increasing your prices during favorable times, weather conditions, or other high-demand periods will drive profitable growth.
Feel free to reach out to our customer service or your CSM if you have any questions about this topic.