Dynamic Pricing — A Practical Guide - 2023 For eCommerce And Retail

A Practical Guide - 2023 For eCommerce And Retail

1) What is Dynamic Pricing?
2) Eight efficient ways to increase revenue and gross profit with Dynamic Pricing.
3) How dynamic pricing prevents retailers' and eCommerce companies' losses.
4) Myths about Dynamic Pricing. How Dynamic Pricing works in retail and eCommerce in reality.
5) How Artificial Intelligence manages store prices.
6) An example of an advanced AI-powered dynamic pricing platform for retail and eCommerce.

What is Dynamic Pricing?

Dynamic pricing is a system of non-static prices that empowers a company to boost its revenue and gross profit, or helps a retailer reduce its losses (for example, during periods of instability and large fluctuations in demand).
How it works:

Algorithms quickly and agilely adjust prices according to market changes (changes in demand, competitive environment, supplies, etc.) and to changes in the company's internal factors (costs of goods, stocks, business strategy in a particular market).
Depending on set goals, the company achieves growth in profits, sales, customer loyalty, consumer traffic.

Dynamic pricing has two basic principles:

1 - Real-time sensing of demand, of current offers of competitors, of changes in the company's internal data, including the relationship of substitutes and complementary products.
2 - Automatic price adjustments based on actual data received. As a result, the company maximizes its profits under any conditions and in every market, or maximizes its sales volume, if it is the set goal.

How To Optimize Your Pricing — Eight Dynamic Pricing Strategies For Retail And eCommerce

Leading retailers and eCommerce companies began to leverage dynamic pricing more than 10 years ago.

We have highlighted below the most common ways to increase revenue and gross profit with dynamic pricing

1) Dynamic Price Segmentation

With the Price Segmentation Strategy (also called Segmented Pricing), a retail chain / eCommerce company may provide different prices for each segment of its customers.
Non-experts commonly link dynamic pricing exactly with the Price Segmentation strategy.
Most of the "dynamic pricing scandals" were a result of the imperfect or incorrect implementation of Segmented Pricing.
For example, on the Internet you can find some stories about how a regular customer of an online shop accidentally discovered that his "special personal low price" was much higher than the common price available to other customers.
Another story: two friends were booking flights and found out an Android user saw a lower price than an iOS user. There are similar stories about taxi customers.

Such practices are commonly called "price discrimination"; we will discuss the issue in more detail at the end of the article.
However, in reality Price Segmentation is usually not related to "discrimination".
Segmented Pricing is profitable to almost any retail or eCommerce company:

The better the price offer meets the personal needs of the client, the more this client buys, and the more likely this client will return for repeat purchases.
Special prices for each customer segment are highly relevant for:
  • For retail companies with a natural customer segmentation.
    wholesale buyers and retail consumers,
    individuals and companies,
    wholesale small and large quantities buyers,
    customers with a loyalty card and customers without a card,
    customers with loyalty cards of different levels,
    customers who have paid a certain amount within a period.
  • For retail companies whose clients have different price preferences.
    That is, some customers buy mainly expensive goods, while other customers prefer economical brands.

  • For retail companies selling highly competitive products with manufacturer's price restrictions: recommended retail price (RRP), MAP (minimum advertised price).
  • For retail companies whose strategy includes promoting a mobile application or increasing the number of purchases through a personal account on the website.

An online store of garden machinery has launched dynamic personal pricing in customers' personal accounts, named "Secret Prices With A Promo Code".

The website displayed the regular price, so competitors couldn't be informed about the "Secret Low Prices", and the promo action didn't create a danger of a "price war". Clients saw personal special offers only in their personal account, after entering the promo code from the invitation email.

A dynamic pricing solution was recalculating "Secret Special Prices" fully automatically, according to complex and agile pricing rules set by the store pricing experts.
For example, when inventory of a product ran out and the store got a higher-cost batch of goods, the "Secret Price" was recalculated based on the new cost of goods, to prevent the company's losses.
If the new price no longer looked attractive compared to the competitors, then the dynamic pricing solution automatically removed the SKU from the "Secret Sale". That was preventing conflicts with customers: "You offer me a regular price, not a special one! You are trying to charge me high by pretending it's a sale."

2) Dynamic Competitive Pricing

Dynamic competitive pricing is a method that provides you instant results: gross profit increasing and sales growth.

Competitive pricing impacts the growth of sales in the first days after implementation.
How Dynamic Competitive Pricing works in eCommerce / retail companies:

You identify key competitors in each market and determine the pricing strategy for this market.
You set up an automated gathering of competitors'prices.
You enter pricing rules into the dynamic pricing system.
When your competitors change their prices, the system automatically adjusts your prices, according to your price positioning in the market.

For example, in a certain city, for certain SKUs, your target price position is the second-lowest among your competitors. When your competitors change prices, you want to maintain your price at the target position. Modern advanced dynamic pricing systems perform this task easily.
Regarding software, dynamic competitive pricing requires three blocks of varying complexity.

Block 1. Competitors' prices collection (parsing); the simplest block. There are a variety of turnkey solutions and vendors, with tools for brick-and-mortar stores' prices and online prices gathering.

Block 2. Rule-based automated pricing. Efficient rule-based competitive pricing doesn't require sophisticated algorithms, but agility of settings is crucial.
In reality, any retail / ecommerce business operates with quite complicated pricing scenarios; you can study a few common examples of such scenarios here: COMPETITIVE PRICING SCENARIOS.
And here is an example of a dynamic pricing solution with high agility of settings: COMPETITIVE PRICING SOLUTION.

Block 3. Key competitors identifying.
Key competitors are retailers whose price changes have a significant impact on your store sales. Analysing data with machine learning algorithms, a modern dynamic pricing engine is able to automatically identify key competitors for each SKU. You can find more information about such algorithms here: Key Competitors Automatic Identification.
On the Internet, there are examples of unsuccessful implementations of dynamic competitive pricing.

"Two booksellers using Amazon's algorithmic pricing to ensure they were generating marginally more revenue than their main competitor ended up pushing the price of a book on evolutionary biology -- Peter Lawrence's The Making of a Fly -- to $23,698,655.93"
(a sourse: wired.com/2011/04/amazon-flies-24-million/)
One bookseller used a rule "the price of the book should be calculated according to the rule "competitor's price + 27%".
The second retailer set a different pricing rule: when the competitor's offer changed, the price was automatically recalculated and became 1% less than its current price. As a result, the price of the book rose until it reached $23.6 million.

There are warnings about price wars, as well, when several ecommerce shops start an automated fight for offering the lowest price. As a result, the profit margins of the entire market fall to zero.

However, good pricing solutions help avoid described negative effects easily.

Leading dynamic pricing services provide very agile pricing rules settings. With such service, to ensure against losses and erroneously high prices, you just need to set the upper and lower limits of the allowable margin.

The lowest price strategy is rarely necessary. Even for KVIs, the second minimum price is often sufficient; you can read more about it here: The optimal price position for KVIs. Therefore, the wrong strategy and incorrect setting of automated rules leads to price wars, but not dynamic competitive pricing itself.

3) Dynamic Zone Pricing

Zone Pricing is a pricing strategy that takes every location as a different market with a tailored pricing strategy.
Generally, Zone Pricing is essential for:

store chains, including multichannel ones and located in a few cities,
e-commerce stores, delivering goods within a few geographic areas, including those who have warehouses only in a headquarters city.

Without zone pricing, with the same SKU's price for each location, a retail or ecommerce company loses customers and profits. For most SKUs or even for the entire assortment, the market environment in two different cities generally differs considerably:
  • In city A, only you offer a product X, so you can sell it at a good markup.
    In city B, the same product X is sold by 10 more stores, besides you. Your price will be "in the market" in B with a minimum margin only.
    Charging the same price of X in A and B, you will lose profits in city A, in city B, or in both.
  • The list of competitors, the assortment intersection with competitors, competitors' prices of your goods or of substitute goods — all these parameters differ from town to town.
With Dynamic Zone Pricing, a retailer / an ecommerce shop can significantly increase sales and profits, considering in pricing rules the unique characteristics of local demand, supply, competition, logistics of each SKU in each particular location.
An online store of garden machinery had a warehouse only in a headquarters city, but delivered goods within a lot of geographic areas. The retailer began offering discounts to living far away customers, to compete more efficiently with their local stores. As a result, regional sales increased to 70% of total sales.
You can find more information about how to launch Dynamic Zone Pricing and how it works here: ZONE PRICING.
Zone Pricing
Leading optical retailer implemented Zone Pricing approach and increased sales by 32% with Imprice

4) Dynamic KVI Pricing

"Almost 70% of respondents prioritise getting the best deal when shopping either in-store or online."
PwC, December 2021 Global Consumer Insights Pulse Survey,
"More US consumers reported switching to different brands and retailers in 2022 than at any time since the beginning of the pandemic — and most of them say they intend to incorporate that behavior into their routines. Their reasons? With inflation at a record high, more people are looking for value; price is at the top of the list of consumers' motivations for switching."
McKinsey, May 2022, How US consumers are feeling, shopping, and spending—and what it means for companies, mckinsey.com/business-functions/growth-marketing-and-sales/our-insights/how-us-consumers-are-feeling-shopping-and-spending-and-what-it-means-for-companies
Today an attractive price is a key consumer motivation for buying in a specific store.
However, a strategy of the lowest price for each SKU is obviously dangerous, as it leads retailers to a crash.

To solve this problem, retailers and ecommerce shops build their low-price reputation and manage profitable growth with KVI Pricing Strategy.

KVIs (Key Value Indicators / Items) are a group of goods which can perform several essential functions for a store at once:
  • 1
    Shape consumers' price perception:
    Shoppers tend to notice, compare and remember KVIs prices.
    By KVIs prices, a consumer determines a price category of a store, such as "unfairly expensive" or "they provide great prices here."
  • 2
    Affect consumers' assortment perception:
    Finding or not finding KVIs in a store, a shopper determines the shop as "This is the right place, I usually find here everything I need", or
    "There is always only half of the goods I need here; I'll visit this store last."
  • 3
    Drive traffic to store:
    With the optimal price, KVI attracts new customers and increases conversion to purchase.
Reducing KVIs prices attracts new shoppers and increases conversion to purchase; consumers make decisions easier and faster with a low price. Thus, you increase your sales and gross profit.

If a retailer lacks some KVIs in its assortment, it loses its customers: shoppers switch to competing stores.
Where can a retailer (or ecommerce shop) recover its margin elsewhere in the assortment; on what SKUs can it charge higher prices? Such SKUs have the following characteristics:
  • Price varying of these goods is not crucial in determining to buy or not and where to buy.
  • Shoppers are poorly aware of the market price of these SKUs and their substitutes.
Сomplementary goods and impulse goods often have the potential to raise the margin.

Today the list of KVIs is no more static, like it was 10 years before, and has a tendency to change significantly in one week or even in one day. Due to the increased complexity of KVI Pricing, ecommerce companies and retailers have begun to invest in dynamic-pricing solutions.
How can dynamic pricing platform help in price efficiently KVIs:
  • Rule-based competitive dynamic KVI Pricing.
  • AI-driven automatic KVIs Identification.
  • AI-driven calculation of the optimal competitive price position for each KVI.
  • AI-driven Key Competitors automatic identification.
  • AI-driven automatic identification of SKUs, which prices can be raised to recover the retailer's margin.
You can find more information about how to launch Dynamic KVI Pricing and how it works here: KVI PRICING.
KVI Pricing
Supermarket chain turns to data-driven KVI pricing to add value to consumers and increase profits

5) Demand-based Dynamic Pricing

Dynamic demand-based pricing considers current customer demand and its fluctuations, and adjusts prices according to that data.
Demand-based pricing approach applies to the following parts of assortment:
SKUs without MAP (minimum advertised price),
"foreground" group — infrequently bought items, that do not drive price perception,
"background" group — rarely bought long-tail items, that do not drive price perception.

The approach is not relevant for KVIs.
Are you sure that the price of each specific SKU is optimal, and that your company gains the maximum possible profits each day in each market?

What if your consumers do not care if the item X will cost 1% more? In this case, your store will sell the same amount of pieces, but the margin of sales will increase significantly.

What if the price of the other item is too high for the consumers?
Your store should just lower the price slightly, and the sales will increase.
There are two approaches to optimizing retail prices of foreground and background items.

Approach 1 — Rule-based dynamic pricing.
If a retail / eCommerce company optimizes its pricing from a low base — for example, price calculations are based on a system of fixed markups and scheduled promotions — then, with an agile rule-based dynamic pricing system, pricing experiments can provide impressive growth.

How it works:
A pricing specialist identifies segments and groups of items with the profit growth potential, based on his experience and intuition.
He creates special dynamic pricing rules for those segments and puts the rules into a dynamic pricing platform.
He monitors the results, seeking for the optimum price.

Note that high agility of the rules settings and powerful analytics tools are crucial for pricing efficiency in this case.

Advantage of the method: the pricing specialist keeps the pricing process entirely under control and manages any changes.
Disadvantage of the method: with the rule-based approach, it is difficult to consider all the important factors that affect pricing efficiency, in particular, the relationship of SKUs within a category — product cannibalization, substitutes, complementary goods, traffic drivers, profit drivers.

Approach 2 — Machine learning algorithms for fully automated assortment-level dynamic pricing. Price optimization, based on demand sensing.

Assortment-level automatic price optimization maximizes a selected criterion — gross profit, revenue, or sales volume in pieces.
AI-driven algorithms find the optimal set of prices under current conditions. "Optimal" means, implementing that price configuration, the retail / eCommerce company achieves the maximum gross profit, revenue, or sales volume at the assortment level.

Machine learning algorithms evaluate goods' cross-impact and segment items by their roles in the consumers' basket: basket drivers, traffic drivers, profit drivers, complementary goods, substitutes, and others. Then each segment gets its optimal pricing strategy according to retailer's business goals.
Such solutions also allow retailers to optimize the prices of a specific category of goods and rapidly find optimal prices for new items.

Advantage 1 of the method: The approach helps to avoid product cannibalization within categories and to consider the cross elasticity of items.

Advantage 2 of the method: AI-driven algorithms help identify situations in which dynamic competitive pricing does not work. It's when all competitors make a mistake and charge prices which are too high from the point of view of consumers, so both the willingness to pay and demand disappear.
Algorithms help retailers find the new optimal price and reignite retail demand.

Advantage 3 of the method: Advanced pricing tools easily recognize short-term raises in demand caused by short-time shortages of goods or unforeseen rush demand. In such a case, the pricing solution quickly raises the price of the relevant SKUs, and keeps it before the moment when the demand normalise again.
This approach empowers retailers to significantly accelerate their gross profit.
You can study an example of such a success story here: CASE STUDY

Advantage 4 of the method: Assortment-level automatic price optimization increases profits significantly both in brick-and-mortar stores and in eCommerce shops.
Generally, eCommerce stores gain speedier growth in gross profit compared to offline stores, since an eCommerce company can change prices easier and faster than an offline store.

You can find more information about how to launch AI-powered Demand-based Dynamic Pricing and how it works here: AI-DRIVEN PRICE OPTIMIZATION.
AI-driven Price Optimization
Leading eBook retailer hits +8% growth in revenue
Demand-based Dynamic Pricing
Hypermarket chain automates pricing by leveraging artificial intelligence to stay on top of competition

6) Inventory Turnover Dynamic Pricing

The approach is essential for stores which have a wide assortment with a low turnover ratio and overstocking.
In a relatively short time, dynamic pricing helps reduce excess stock, remove unpopular items from the assortment, free up the capital for new items, while maintaining marginality as much as possible.
The retail company analysed its inventory balance and detected excess stock.

To get rid of overstocks, one store ran a "total sale", with discounts of 70% of the primary cost.

In another store, they implemented several gradations of discounts, depending on the period the item was in stock.
This store sold 85% of the items with discounts of 20%, 30% and 50%. They had to sell only the remaining 15% of the goods at the maximum discount of 70%.

Thus, the first store lost profit on 85% of the items.
Also, dynamic pricing solutions allow retailers to reduce the risk of overstocking. Analytics tools help to track inventory and identify the list of SKUs not recommended for reordering in the future.

You can find an example of dynamic pricing solution with Inventory Turnover Module here: DYNAMIC PRICING PLATFORM.

7) Stock-Based Dynamic Pricing

Some online stores and retail chains ship goods to consumers straight from suppliers' warehouses. Sometimes a few suppliers offer the same item, at the same or at a different price.
This type of partnership provides a lot of advantages and benefits, but there are some difficulties also.

If the items are available from several suppliers, it can be difficult to quickly choose the optimal under current conditions shipment warehouse.
When the product stocks of one supplier are over, and the store starts to ship from another supplier's warehouse, prices of the first and second suppliers can differ. If the second supplier price is higher, and the store remains its prices for consumers unchanged, it can significantly reduce the margin, up to selling at a loss, especially during promotional offers.
How Stock-Based Dynamic Pricing works:
  • The pricing system automatically updates data on inventory balances, receiving information from your ERP system.
  • Pricing system predicts how many days the stock will last.
  • When the inventory balance is equal to the set value, or when the warehouse is changed, algorithms automatically raise or lower the price to the optimal level, according to set pricing rules and restrictions, and then automatically upload the new price to your ERP and to your website.

    The criterion of the optimum depends on set goals
    remain the assortment until the next arrival,
    maximize profits,
    prevent a critical decrease in margin or sales at a loss.
You can find an example of dynamic pricing solution with Stock-Based Module here: DYNAMIC PRICING PLATFORM.

8) Time-Based Dynamic Pricing

What is Time Pricing:
A retail / eCommerce company identifies periods when short-term price adjustment sufficiently increases the company's sales or profits and efficiently exploits such opportunities.

The most common types of time pricing are as follow:
  • Markdowns, sales, promotions, Black Fridays.
  • Agreements with suppliers with specific time limits.
  • Bypassing suppliers' price restrictions.
  • Night prices. For example, from 23.00 to 6.00, prices automatically increase and at 6.00 switch back to regular prices.
  • Weekend prices.
  • Prices for a surge demand time.
  • Prices for a major city event period.
You can find more information about how to launch Time-Based Dynamic Pricing and how it empowers retailers to increase their profits here: DYNAMIC TIME PRICING.

Issues Of Dynamic Pricing. Price Discrimination

The most discussed type of "dynamic pricing issues" is psychological. It relates with negative reactions of consumers who faced so-called "price discrimination".

Price discrimination is a pricing approach that aims to sell the same product to different consumers at a different price, depending on the particular customer's characteristics, especially on their incomes and willingness to pay more.
Interesting fact.

In the 19th century, there were no price tags in stores and pricing was set according to each client and his/her supposed willingness to pay a given price.
As was mentioned above, people are not happy realizing they offered to pay more for tickets/ hotel/ taxi just because they are owners of an iPhone.

Customers of a popular Yoga app were quite unhappy about its subscription fee difference and left negative reviews on the App Store.
— I absolutely love this app, but... I use an iPhone, and my husband uses Android. Why is his yearly subscription fee 4 times less than mine? It's really unfair!
However, all people face various types of price discrimination and dynamic pricing, not leading to scandals or other negative effects. This is about social benefits and discounts for the less wealthy part of the population or about things that have become habitual.

Free or more cheap parking for locals.
Discounts for entering museums and parks for locals.
Ticket discounts for children, students and pensioners.
Additional price tags "for pensioners" with a lower price in some grocery stores.

We are not surprised when museum entry for foreigners is a lot more expensive than a ticket for local residents.
Note that museums usually wisely use the wording "special low price for citizens of [name of the location]", "discount for residents of [name of the location]", and the price for tourists is named "basic", "regular". It prevents conflict situations.

We don't get mad if we didn't buy conference tickets during presale at the cheapest price. As we understand how the system works, we will catch the best deal next time, if it will be important.
If your pricing strategy includes offering different prices depending on some characteristics of the customer, the hints below will prevent most conflicts.

The highest price of an item needs to be called "A regular price".
Other, lower personal prices, need to be a result of discounts given to customers individually.
A higher personal price may also exist and not cause resentment if it comes with special positive conditions or a set of services.

Anyway, obviously, dynamic pricing methods for retail and eCommerce companies, mentioned in that practical guide, are not related to price discrimination.
Bookmark the article for studying and implementing efficient pricing strategies!
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