Dynamic Pricing: A Powerful, but Often Misunderstood Pricing Strategy

Part 1 – Dynamic Pricing 411 Series

Dynamic pricing has been in the news a lot recently, from Wendy’s to the Oasis Reunion Tour to Uber’s surge pricing. Much of the discussion has been fraught with misunderstanding and, in many cases, disdain. Dynamic pricing has become somewhat of a "boogeyman," particularly in consumer industries. "That theme park uses dynamic pricing—uh oh, we’re about to get fleeced."

The reality of dynamic pricing is much more nuanced. This blog series will address the definition of dynamic pricing and its evolution, some of the common misconceptions, detail the benefits and risks of dynamic pricing as a business strategy and explore potential options for integrating it into your business model.

Definition of Dynamic Pricing

Dynamic pricing is simply when a supplier adjusts prices based on changes in its perceived position within the market. These shifts can be triggered by factors such as fluctuations in customer demand, supply levels, costs, competition, or changes in the company's objectives or strategy. In some form, every company engages in dynamic pricing whenever they adjust prices, even if those changes are infrequent.

What has evolved in dynamic pricing today is the speed and sophistication with which these adjustments can be made. Historically, few companies had access to the data, expertise, or systems required to effectively implement more frequent and precise price changes. However, advances in technology and analytical models have made it accessible to a much wider range of businesses.

As more companies explore advanced forms of dynamic pricing, many misconceptions proliferate.

What are some common myths about dynamic pricing that we’ve heard from companies considering, but not yet committing to, making their pricing more dynamic?

Myth #1: The primary objective is to maximize profit from existing customers

This is perhaps the biggest misconception about dynamic pricing. The primary goal is almost always to expand the addressable market, not to squeeze more margin from existing customers. A simple example: the lowest price offered through dynamic pricing is almost always lower than before.

Take airlines, for instance. Think about all the places you can fly to at a relatively low price if you book far enough in advance or have flexibility with dates and times. In the U.S., there are many destinations where flying is significantly cheaper than driving. One international airline has regular customers who fly every day for work. Without dynamic pricing, there would be far fewer choices, and the market for air travel would be much smaller (less demand, less supply).

A key valuation metric for a company is its total addressable market. Companies that adopt dynamic pricing often increase their addressable market because they can offer a wider range of price points, product bundles, and services, appealing to a broader set of customers.

Myth #2: Dynamic pricing is all about price

Dynamic pricing goes beyond simply adjusting prices in response to supply and demand. It’s about delivering personalized offers that cater to individual consumer preferences and behaviors. By analyzing customer behavior and marketing data — such as browsing history, purchase patterns, and willingness to pay — companies can tailor both prices and offers to meet specific customer needs.

For example, a vacation provider offered bundled packages of various hotels, restaurants, and theme park options. By leveraging CRM data, shopping history, and a few preference questions, they were able to recommend the best-fit package for prospective customers at the time of inquiry.

Yes, the company dynamically adjusted prices based on supply and demand for its different package offerings. However, the main value came from better matching the total package offer (beyond just pricing) with the individual customers who were looking to buy at that moment. So, dynamic pricing wasn’t just about optimizing a static set of options; it was about increasing conversion rates through personalization.

This approach not only maximizes revenue but also enhances the shopping experience, creating a sense of exclusivity and value for customers whose needs are being directly addressed. As a result, dynamic pricing becomes a tool for personalized engagement, not just fluctuating prices.

Myth #3: Dynamic pricing is only applicable to a limited number of industries

Most industries today are becoming more dynamic. On the cost side, raw materials, labor, and logistics costs are shifting more frequently, forcing businesses across sectors to adapt quickly to maintain profitability. On the demand side, there is an increasing expectation for "optionality" and personalization from both consumers and businesses.

Take the following examples of companies that have moved to more advanced forms of dynamic pricing:

• A chemical company had to shift from monthly to daily price changes during the pandemic due to highly fluctuating (i.e., rising) input costs.
• A rental car company moved from daily price changes to changing price every 15 minutes on the day of rental to better match supply and demand.
• An auto repair company is transitioning to variable service charges based on appointment time and location to load-balance their repair shops.
• An electrical distributor moved from a static price list to dynamically changing prices based on regional availability, demand and costs.

Dynamic pricing is gaining relevance in industries beyond airlines due to increasing volatility in business input costs and rapid fluctuations in supply and demand. The proliferation of data and advanced technologies, such as AI, now allow companies to analyze customer behavior, market trends, and operational costs in real-time and dynamically adjust. As a result, many industries are adopting dynamic pricing to stay competitive and offer more agile, responsive pricing strategies that reflect changing market conditions.

The next blog article will dive in more detail on the potential benefits and risks of dynamic pricing.