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VCU INFO 658 - Dynamic Pricing

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E-commerce: The New Realities of Dynamic PricingE-commerce: The New Realities of Dynamic Pricing Frequently varying online prices in response to changing market conditions can maximize returns and create a potential new source of competitive advantage. So why are so few companies putting this strategy to use? By Ajit Kambil and Vipul AgrawalOutlook Journal, July 2001 It happens all the time. You walk into your favorite clothing store and discover that the jacket you just paid $155 for is now on sale for $79.99. Or even more painful, you go online and see that your new "state-of-the-art" laptop is not only no longer state of the art,it's $1,200 cheaper than it was when you bought it six weeks ago. Nothing brings on buyer's remorse in consumers faster than the realization that they've paid more than they had to. So after being frustrated enough times, some consumers get savvy and change their buying behavior to accommodate the new realities of dynamic pricing—a business strategy in which prices are varied frequently by channel, product, customer and time. These consumers make judgment calls. For example, they deliberate about whether there is more value in having those wool slacks all winter or just during the season's last two months, which would leave more money in their pockets. But have companies become as savvy as their customers? The Internet is reshaping the pricing landscape on the sell side and, because of increased competition and customer segmentation, is also mandating that firms adopt a dynamic pricing strategy. Yet a recent Accenture study of online pricing suggests that not enough companies have integrated dynamic pricing into their online pricing strategies; those that have are not taking full advantage of its potential. In other words, the Internet is causing companies that aren't effectively using dynamic pricing to leave money on the table. And, of course, that's not what was supposed to happen. Just think about it. Say that traditional margins are about 10 percent. If your company were to use dynamic pricing, it could add five percentage points to that margin, which would mean a dramatic 50 percent increase in profits. But too often, companies are not choosing the correct dynamic pricing model for their specific business strategy. Indeed, many seem afraid to change their pricing frequently, which would let them respond betterto market conditions.Consider, for example, how three major hotels in midtown Manhattan priced a similar room in April 2001 For a period of time, two of the hotels did not have rooms available for online reservations; meanwhile, the third hotel, which had availability, kept its price constant. By varying prices more frequently in response to changing demand, these hotelscould have increased their margins. Customized The benefits of dynamic pricing are twofold. First, it provides new opportunities for companies to maximize their return per customer. With lower menu costs (that is, the costof displaying prices to customers), companies can have multiple prices for different channels and product configurations— and can change those prices more frequently. Companies able to gather information about their competition and about customer needs and willingness to pay can customize their offerings and prices. This enables them to deploy dynamic pricing through the most appropriate of many channels. With dynamic pricing, companies can give their customers exactly what they want, at exactly the price they are willing to bear. Nothing is left on the table. The second, perhaps less obvious, benefit is that dynamic pricing can also bring better returns on deployed assets. For businesses with high fixed-cost technology infrastructures, periods of low demand and, thus, low utilization are expensive. Conversely, when there are inflexibilities in the supply chain for critical components, periods of high demand can lead to shortages and can both delay purchasing and damage customer relationships. But with dynamic pricing,companies can encourage demand in slow periods and discourage it in busy periods. Consider how Dell prices its high-end personal computers. Unlike many of its competitors, the computer maker changes its prices frequently, sometimes up and sometimes down. Because of its knowledge of its supply chain and the information it gleans from customer visits to its website, Dell can predict its near-term sales and adjust prices to maximize its revenues. It can also moderate demand so as not to overburden its supply chain, and encourage buyers to purchase systems built to order based on committed supplies. Strategic Options Low menu costs and the online distribution of prices allow companies to use, and sometimes combine, three different dynamic pricing strategies. Time-Based Pricing Time-based pricing exploits the different prices customers are willing to pay at different times. For example, early buyers are willing to pay more for the latest fashions, computerand electronics innovations, and newly published hardcover books. On the other hand, late buyers—those who like to keep their options open until the last moment—are willingto pay more for airline travel and hotel accommodations. And some products and servicesbecome more valuable as the number of customers increases over time. For example, as AOL attracts more content and more users, it becomes more valuable to all users, and thus it should be able to charge more.The two most common forms of time-based pricing are peak-load pricing and clearance pricing. Peak-load pricing is most appropriate when supply is inflexible, which allows suppliers to systematically increase prices with predictable increases in demand; this can occur with long-distance telephone service or utility usage, for example. Clearance Pricing makes most sense when demand is uncertain and products lose value in the eyes of the customer with time—they simply go out of fashion—or with the changein season. Companies that sell computers or other products with short lifecycles must lower their prices to clear out the excess inventory they built up to cover unpredictable spikes in demand. JC Penney, one of the largest apparel and home furnishings sellers in the United States, has made clearance pricing the signature feature of its "falling price" website. The Gap uses clearance pricing for seasonal goods, maintaining constant prices for its year-round slim fit jeans while marking down the prices of its sundresses toward the


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VCU INFO 658 - Dynamic Pricing

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