Prices from large retailers are rarely static anymore.
More often, retailers make use of dynamic pricing: they use intelligent software to adjust prices multiple times a day. Prices may be automatically adjusted when, for example, stock levels at competitors are decreasing, when there is shown more interest in a product or when the weather forecast changes.
Large retailers such as Amazon change their prices as often as every ten minutes. The success of industry leaders like Amazon shows that Dynamic Pricing is critical when organizations want to succeed in the e-commerce and omnichannel retail industry. But how does Dynamic Pricing work? And is Dynamic Pricing equally relevant for all retailers, big and small?
Using a dynamic pricing strategy is not a new thing. It became popular in mainstream business years ago when the travel industry adopted the practice. Today, dynamic pricing is also common practice in the retail industry. Some of the largest retailers in the world, including Amazon and Alibaba, all employ the strategy in their e-commerce online stores. Dynamic pricing is also being used more and more in physical stores. Mediamarkt, for example, was one of the first retailers in the Netherlands to introduce digital shelf labels.
How does it work?
In short, dynamic pricing is a pricing strategy which applies variable prices instead of fixed prices, with the aim to increase a companies profit and margins.
New, optimal prices are calculated and recalculated periodically, up to multiple times per hour. Dynamic pricing uses multiple sources of data, including internal and external data variables to find the optimal price. Internal variables, such as stock levels and sales data are enriched with external variables such as competitor pricing and Google Analytics data by dynamic pricing software. As more data is analyzed, the right price at the right time can be calculated for each product.
Before starting with dynamic pricing, it’s important to have set a clear pricing strategy. An intelligent dynamic pricing software will combine your chosen pricing strategy with all the described data sources, to find optimal prices that fit your business pricing strategy; whether that’s market penetration, maximization of revenue or something else.
In general, dynamic pricing will yield a growth in contribution of 10-20%, compared to static pricing. However, there are notable differences in performance between the different types of dynamic pricing. A basic type of dynamic pricing is a rule-based pricing system. When dynamic pricing is used this way, prices are adjusted according to certain rules, such as: follow prices of competitor X.
Another, more advanced method of dynamic pricing, is a value-based pricing system. In a value-based system, price elasticity of products is an important factor in calculating the optimal price. The latter, more advanced type of dynamic pricing often yields better results than the basic, rule-based dynamic pricing system.
One basic way a rule-based dynamic pricing can add value, is to implement pricing rules based on stock levels. Such rules can help protect a retailers margins if a competitor should decrease prices, potentially caused by a surplus of stock. If stock levels are lower than the beforehand determined limit for stock weeks (stock / sales per week), it’s not necessary to follow the lowered price and thus lose margins. Conversely, the same is true: by implementing rules to decrease price as soon as stock levels exceed a set limit, a retailer can make sure they’re not losing sales.
Who benefits with dynamic pricing?
Whether Dynamic Pricing is relevant for a retailer is partly dependent on it’s competitors pricing strategy. Do competitors deploy a dynamic pricing strategy, but the retailer keeps its own prices static? It’s very likely the retailer is losing sales. An increasing amount of retailers, both large players and smaller niche businesses in different industries, are making use of dynamic pricing.
In order to quantify the potential added value of dynamic pricing, a retailer can start with systematically comparing its own pricing to the pricing of its biggest competitors, in order to assess if and how many times a day competitors are changing their prices. A retailer can also track to what extent competitors react to its own price changes. This may lead to the conclusion that one or more competitors are using dynamic pricing. If that’s the case, the retailer can benefit from taking action in dynamic pricing too.
An often-heard concern is that when all companies in the same industry would use the same dynamic pricing software, wouldn’t that result in a race to the bottom? Fortunately, this is not the case. Since both the commercial strategy as well as the input variables (e.g. purchase price, inventory) vary per company, there is no reason to end up in a race to the bottom. A retailer’s commercial strategy influences pricing, because the consumer is generally willing to pay a premium price for extra services such as fast delivery, customer service, or the possibility to pay by invoice. Often, the most optimal price is not the same as being priced the lowest in the market.
To answer the question whether it’s interesting for the smaller retailer to start with dynamic pricing? It depends on their competitors pricing strategy, the industry and their commercial strategy. In most cases, we know from experience that retailers can achieve quick wins by gaining insights in competitor pricing, and by implementing a basic rule-based dynamic pricing system with rules based on stock levels.
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Thijs Algra works as a consultant at Omnia Retail. Before coming to Omnia, he gained experience working as a Pricing Analyst at Bol.com and Rocket Internet. Thijs holds a MSc degree in Financial Economics from Erasmus University.