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Ask The Experts: Making Sense of Dynamic Pricing

by John S Kiernan on April 16, 2014

dynamic pricingHere’s a riddle for you:  What all-American seats go up and down and all around, bringing strangers peanuts and proximity in nearly all weather?

The answer:  Tickets for an American Airlines flight and a Major League Baseball game.  You see, the airline industry and professional sports – American and MLB, in particular – have been innovative with their use of “dynamic pricing” in recent years, offering blueprints for other consumer-facing businesses to embrace the role of auction-based technology and big data in the modern buying-and-selling process.

Dynamic Pricing Primer

What, exactly, is dynamic pricing?  We’ll allow Alok Gupta, the Curtis L. Carlson Schoolwide Chair in Information Management at the University of Minnesota’s Carlson School of Management, to field that one.

“The basic principle of dynamic pricing is essentially the basic principle of microeconomics – that if for a given price the demand is higher than supply, then a higher price could be charged and vice versa,” he says.  “There are many subtleties.  For example when there is high uncertainty of demand/supply/quality, dynamic pricing can be used to determine the appropriate price.”

In other words, dynamic pricing is a mechanism that enables the price of a commodity to change over time due to fluctuations in demand.  And it can be used in a predictive manner to anticipate proper price levels based on models fueled by historical data that quantify the impact of myriad factors – ranging from the weather to a starting pitcher’s Q-rating – on consumer demand.  That’s how American Airlines first used the strategy back in the 1980’s, according to Gupta.

“American Airlines was probably the first one to start using dynamic pricing in the consumer-facing arena,” he told WalletHub, highlighting the company’s use of a strategy called yield management to predict demand and properly price commodities across different consumer segments. “Starting in the 1990’s, all kinds of travel-related services (hotels and other airlines) started using similar approaches.  The advent of the Internet in mid-90’s proliferated the use of dynamic pricing.”

Transforming Event Pricing

The application of dynamic pricing now stretches across industry, from travel providers to local governments.  “Many cities use dynamic pricing to access HOV lanes for single drivers based on traffic conditions,” Gupta says.  But perhaps the most interesting and fastest-growing use of dynamic pricing is in the sports world, particularly professional baseball.

In 2009, the San Francisco Giants became the first professional sports franchise to incorporate dynamic pricing, hiring the software-as-a-service data analytics firm Qcue to help boost ticket revenue in the face of the Great Recession’s assault on household budgets and technological improvements in the at-home viewing experience.  Revenues increased $7 million in 2010 – the first year predictive pricing algorithms were applied throughout the whole ballpark.

Those results aren’t out of the ordinary either, as Qcue reports helping clients increase revenue by an average of 30% in high-demand situations and 5-10% in low-demand situations.  That, of course, sounds pretty good for the corporations that use dynamic pricing, but what about me and you?

Unfortunately, dynamic pricing is a one-way street for many of the sports franchises that use it.  Ticket prices will rise as high as demand takes them, but they won’t fall below face value.

Ask The Experts:  Inside the Future of Dynamic Pricing

With many a consumer eschewing high prices at local stadiums, arenas and theaters in favor of the comforts of home, and dynamic pricing conferring impressive benefits upon its users, it’s fair to expect that the strategy will gain increased traction both in the sports world and beyond in the years to come.

Where might we see it applied next, and what does this mean for consumers’ wallets?

For insight into those questions and more, we turned to an esteemed group of experts in the fields of management, marketing, economics and information systems for insight.  You can get to know them and check out their thoughts below.

  1. Current Uses of Dynamic Pricing
  2. Future Applications of Dynamic Pricing
  3. Are Dynamic Prices Good for Consumers
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Alok Gupta

Curtis L. Carlson Schoolwide Chair in Information Management, University of Minnesota Carlson School of Management

Current Uses of Dynamic Pricing

Most companies use dynamic pricing in one form or the other in different activities. For example, even retailers such as Target, Best Buy, etc., have eBay channels to liquidate their aging inventory. Even the companies that do not directly want to use dynamic pricing use it indirectly via third parties (e.g., Priceline suppliers).

Most sporting franchises are using some form of dynamic pricing now. Many cities use dynamic pricing to access HOV lanes for single drivers based on traffic conditions. Movie theaters have started using a basic form of dynamic pricing by selling discounted gift cards through chains like Costco as well.

Many of the retail companies do not want to directly use dynamic pricing because of the ‘discriminatory’ nature of dynamic prices for commodities. For instance, if a customer finds out that someone else got a cheaper price than them, then the customers might feel cheated and may not want to shop at the same retailer again. Retailers, therefore, use other forms of price discrimination in form of discounts, coupons, price matching etc. For retailers, the biggest impact of dynamic pricing is on liquidation (of aging inventory) side and they do indeed use dynamic pricing for items that they do not intend to carry on the shelf anymore.

Future Applications of Dynamic Pricing

To benefit from dynamic pricing, any company needs to consider whether they can reach some customers that otherwise won’t consider purchasing. I do not see a benefit of dynamic pricing necessarily at movie theaters, however, perhaps (similar to sporting events) live theaters, orchestra halls etc. could benefit from dynamic pricing.

Are Dynamic Prices Good for Consumers?

When resources are constrained, appropriate dynamic pricing can result in the best use of resources and can benefit the consumers. However, in wrong hands it can result in losses for the customers.
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John Morgan

Gary & Sherron Kalbach Chair in Business Administration, University of California, Berkeley | Haas School of Business

Current Uses of Dynamic Pricing

The simplest version dates back to booksellers in the 19th century. They realized that, by delaying the publication of cheaper mass market editions, they could make more profit from expensive first editions. The practice gets going in earnest with airlines, shortly after deregulation. There, it goes by the name of “yield management.” This predates the Internet by many years. Post-internet dynamic pricing is used, in various forms, for just about everything that is sold there.

Future Applications of Dynamic Pricing

Event ticketing companies, airlines, even retail (Amazon) have dynamic pricing engines informing their decisions. Movie theaters are an obvious place that would benefit from adopting such practices, as would sports stadiums, and, especially digital content sellers like publishers and music distributors. The idea that all music should have the same price and that this price should not fluctuate with demand has always seemed completely crazy to me. Record companies have long complained that piracy is destroying their business, but, in my view, their problems have at least as much to do with nonsensical pricing policies as piracy. The same is true for publishers, although to a lesser degree.

Are Dynamic Prices Good for Consumers?

There is no single answer to this question – it depends a lot on the specific application. The key tradeoff is whether the main effect is to grow demand (i.e. make items available to consumers that otherwise would have been wasted).

For instance, selling the last 33% of concert tickets to fans rather than having an empty auditorium strikes me as a good thing. On the other hand, dynamic pricing reduces the surplus to those with high willingness to pay. So, in the concert example, super-fans suffer as a result of this scheme.

The net effect depends on how much the super fans suffer versus demand growth. In situations where the market is somewhat competitive, like retail, dynamic pricing is more good than bad. In situations where there is little competition, like Rolling Stones tickets, it’s probably more bad than good.
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Goker Aydin

ArcelorMittal USA Undergraduate Faculty Fellow, Indiana University Bloomington Kelley School of Business

Current Uses of Dynamic Pricing

Many different types of companies use some form of dynamic pricing – the differentiation is more in the extent to which they do it.

Airlines, hotels, and rental car companies have been practicing ‘revenue management’ for decades. The traditional revenue management paradigm calls for an increase in the price as the ‘date of use’ (departure date for airlines, check-in date for hotels) gets closer. However, this industry is moving towards truly dynamic pricing, where price can go either way depending on demand and supply conditions.

Many online retailers also use dynamic pricing, which takes the form of posting a list price and then offering a discount that is adjusted dynamically over time. Entertainment parks and movie theaters use peak versus off-peak pricing (think of matinee prices for movies), which is ultimately a form of dynamic pricing. However, these industries could probably do more.

For example, one can envision a movieplex offering discounts on less popular movies on a Friday night when all hit movies are sold out. Uber’s app for cab rides is an interesting example of peak pricing. This app connects passengers with cab drivers in the area, with the fares decided by the demand and supply conditions at the time.

Future Applications of Dynamic Pricing

There are many intriguing possibilities. One is the use of dynamic pricing by service companies such as restaurants or hair salons. There are already upscale restaurants that sell ‘tickets’ for patrons who want to dine there, and it is not farfetched to think that ticket prices could change depending on demand and supply conditions.

Another potential application is in the pricing of parking spaces. Smart meters could charge different prices depending on the availability of parking spaces in a neighborhood. Already, there are start-ups who offer similar solutions to cities. To the extent that brick-and-mortar stores adopt tools such as electronic tags or mobile coupons, they can do minor price adjustments throughout the day. For example, a supermarket using electronic tags could reduce the price of a perishable food item in the course of a day, or it could offer lower prices to select customers by sending them mobile coupons.

Are Dynamic Prices Good for Consumers?

The short answer is that dynamic pricing helps some consumers and hurts others. There will be times when the dynamic price will fall below the uniform price (that is, the price the firm would have charged in the absence of dynamic pricing), and there will be other times when the dynamic price will rise above the uniform price. Consumers who take advantage of low-price cycles will be better off, while others will have to pay higher prices.

One might expect that dynamic pricing would increase a firm’s willingness to serve more price-sensitive segments. After all, the firm could capture such segments during low-price cycles while continuing to capture less price-sensitive segments during high-price cycles. The caveat is, oftentimes, all customers will wish to take advantage of low-price cycles, no matter how price sensitive they are. In response, a dynamic-pricing firm may decide to increase its average prices, thus cancelling the benefits that customers may hope to gain from low-price cycles.
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Michael Lewis

Associate Professor of Marketing, Emory University Goizueta Business School

Current Uses of Dynamic Pricing

These systems were first used in the airline industry. The key characteristics are that capacity is perishable and that customers segments differ in terms of price sensitivity (business versus leisure). From its airline beginnings dynamic pricing/yield management spread to other industries with perishable inventory, such as hotels, rental cars and cruise ships.

One of the early novel applications was in selling advertising on TV networks (if you don’t sell a block of commercial time, then you lose out on earning any revenue). Now, of course, we are seeing a great deal of interest in the sports world (and performing arts). You can also make an argument that retailers’ promotions, such as clearance sales, are another related application. There have also always been ‘toy’ applications such as a barber shop offering discounts on low volume days such as Tuesdays.

Future Applications of Dynamic Pricing

This is a tough issue. On the implementation side, these systems require significant databases and sophisticated statistical models (to do right). There is also the possibility of consumer backlash.

For example, a grocery retailer might observe that consumers who shop right after work are less price-sensitive. This might suggest an opportunity to raise prices from 4 to 6 pm. But this is a frightening proposition since the retailer might (rightly) fear alienating customers.

Are Dynamic Prices Good for Consumers?

The standard line in the airline industry is that yield management ultimately helps consumers because maximizing revenues allows carriers to increase service levels. We can also argue that dynamic pricing creates more efficient economic systems sense the customers that purchase are the ones that value the products the most.

On the other hand, I think we can also view dynamic pricing system as a tool that allows firms to additional consumer surplus. So, on balance, these systems probably increase economic efficiency while reducing some aspects of customer satisfaction. advantage of low-price cycles, no matter how price sensitive they are. In response, a dynamic-pricing firm may decide to increase its average prices, thus cancelling the benefits that customers may hope to gain from low-price cycles.
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Abdullah Al-Bahrani

Assistant Professor of Economics, Northern Kentucky University Haile/US Bank College of Business

Current Uses of Dynamic Pricing

There are three types of pricing systems out there, fixed, variable and dynamic pricing. People often mistake the latter two, although they are very different. For variable pricing and in the case of sporting event tickets, the price of a ticket is determined before the season starts. The price would vary based on the opponent, and any information available at the time. With dynamic pricing, the price would continue to fluctuate till the time of the game and based on the customer. The use of dynamic pricing has become more popular as access to big data has increased.

Future Applications of Dynamic Pricing

As firms are able to better identify customers, and market conditions we will see a move towards dynamic pricing in most industries. From an economics perspective, we are moving towards firms being able to perfectly price discriminate. Discrimination means that each customer pays exactly what he or she is willing to pay for a product.

Are Dynamic Prices Good for Consumers?

Ultimately, dynamic pricing is an attempt to identify each consumer’s willingness to pay for a product. True dynamic pricing will extract all consumer surplus and transfer it to the producer.

Currently, if I value a Bengals ticket at $100 and the market price is $80, I paid $20 less than what I value it at. With perfect dynamic pricing, the Bengals will be able to identify my true willingness to pay and charge me $100 to begin with. We aren’t at that point yet – mainly because you want to insure that I can’t transfer my ticket to anyone else that values it more, but we are moving towards it. From an economics perspective, this is a good thing because it will eliminate all the cost of mispricing that occurs with fixed pricing or variable pricing and make the market more efficient. Currently, the consumer is already paying these prices but they pay it to scalpers, StubHub, etc.

The current system allows firms that sell tickets to regain some of the profits that StubHub and similar firms or secondary market sellers are making. Secondary market sellers are matching tickets with people that value you them at a price that is higher than the face value. Firms will now be able to make this match at the first sale and reduce the cost of ‘trying to find a ticket.’
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Keith W Weigelt

Marks-Darivoff Family Professor, The Wharton School of the University of Pennsylvania

Future Applications of Dynamic Pricing

All these teams are leaving so much money on the table. With dynamic pricing it will be price discrimination, and when people are willing to pay more they are just going to charge more.

Now, from the consumer's point of view, it's probably not that great. But for me teaching business – I would teach managers or my students to use dynamic pricing. If you want to increase your profitability, then use dynamic pricing. I would definitely advocate it. If you use dynamic pricing correctly you're going to increase your profitability. You're going to charge up people closer to their reservation time.
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Lakshman Krishnamurthi

A. Montgomery Ward Distinguished Professor of Marketing, Northwestern University Kellogg School of Management

Current Uses of Dynamic Pricing

Dynamic pricing makes sense when you have a perishable product: an empty seat at a concert, an empty hotel room, an empty airline seat, etc. Dynamic pricing attempts to match supply to demand at the highest price possible. Uber, the car-service company, charges more during periods of peak demand. Some call this surge pricing. There is great demand, supply is fixed, so charge more. If you add supply, it sits idle at non-peak times. This is called peak-load pricing which is a special case of demand pricing.

In countries like India where there is an electricity shortage, kilowatt-per-hour prices are different depending on when it is used. Movie theaters should price tickets for the first day or first few days of a new movie higher than at other times. They do, however, price tickets lower at certain times. Amazon uses dynamic pricing. The company varies the price of items depending on demand. As a buyer you may not notice it unless you check prices frequently.

Future Applications of Dynamic Pricing

Cities that make money of parking meters should implement dynamic pricing, and should not accept coins! The parking fee should be controlled by time of day, day of week, special holidays, weather, congestion, etc.

Toll lanes could use the same idea, where the amount you pay is automatically subtracted from your account.

Are Dynamic Prices Good for Consumers?

For the savvy consumer, it is a positive. But realistically, a higher price is only possible when there is excess demand. So, waiting is an option.

It is interesting that Microsoft or Sony do not charge higher for the XBox One or the Sony PS4 during the first few weeks when there is high demand. Some retailers might, but the advertised price by MS and Sony does not change. This is because they do not want to anger their buyers.

But the price eventually comes down to those who wait. Where it is a negative is when the consumer has no choice but to use the service, say taking the morning bus or train to work or parking in the morning, and cannot afford the ‘congestion’ price.

The rise of bots which scour the Internet for prices can level the playing field somewhat for some products. But if everyone waits to buy when the price is low, there will not be enough supply. So, customers will learn and adjust their buying behavior.
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Lynne Kiesling

Distinguished Senior Lecturer, Northwestern University Department of Economics

Current Uses of Dynamic Pricing

We see dynamic pricing in a few areas that I think are quite potentially valuable for managing congestion and resolving ever-changing scarcity efficiently: transportation (toll roads, parking meters, Uber's ‘surge’ pricing) and electricity (real-time pricing, critical peak pricing).

Are Dynamic Prices Good for Consumers?

Even though dynamic pricing makes both consumers and producers better off by giving firms an incentive to supply more and reduce congestion, consumers often resent paying higher prices at times when what they want is in higher demand and therefore more relatively scarce. See, for example, the complaints after New Year's Eve about Uber's surge pricing.

People naturally compare dynamic pricing to fixed pricing, and expect a lower price if it were fixed and get upset at the higher price period. But if the prices for electricity, for Uber rides, for toll roads were fixed across time, that price would be higher than what they'd pay in low-congestion periods, even though it's higher in high-congestion periods (to help reduce the congestion). That's often a difficult value proposition to communicate to consumers.
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Rachel Chen

Associate Professor of Management, UC Davis Graduate School of Management

Future Applications of Dynamic Pricing

The companies who are likely to use dynamic pricing are the ones with relatively fixed supply/capacity, such as airlines, hotels, rental cars, cruises, movie theaters, etc. This is because it is often costly, if not impossible, to expand supply when demand surges. Because it is difficult to adjust the supply, these firms are more interested in managing their demand via pricing.

Movie theaters could use more dynamic pricing, but it also depends on the cost structure of the industry. If most of the revenue from ticket selling goes back to the movie production company, then movie theaters may not have much interest in maximizing the revenue.

Similarly, it is unclear who benefits the most from dynamic pricing in sporting events or music concerts which rely on long-term support of fans for the sales of other related products. So people's perception on dynamic pricing needs to be carefully considered before implementing such a strategy. Some retailers are trying to do dynamic pricing, but people will develop expectations once they experience it. Online retailers are likely to implement this strategy because of the low cost of changing prices.

Are Dynamic Prices Good for Consumers?

It depends. For airlines, I think it is a net positive. Today more people are able to travel at a lower cost than in the past. Airline services are becoming a commodity due to the competition after the deregulation in 1978. Dynamic pricing allows better match of demand with supply. But it is also a headache to plan trips at least two weeks ahead of time, while in other countries the price remains the same no matter when you buy it.
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Nick Bontis

Associate Professor of Strategic Management, McMaster University DeGroote School of Business

Future Applications of Dynamic Pricing

Industries that should use it more often include auto retail, university education, and digital documents.

Are Dynamic Prices Good for Consumers?

Ultimately, dynamic pricing will always benefit the consumer.
John Kiernan is Senior Writer & Editor at Evolution Finance. He graduated from the University of Maryland with a BA in Journalism, a minor in Sport Commerce & Culture,…
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