Even though you have never heard of dynamic pricing, it probably affects you and your finances almost every day. So it is wise to learn about this controversial business practice, according to Z. John Zhang, professor of marketing at Wharton School of Business at University of Pennsylvania. “From the consumer point of view,” he says, “understanding dynamic pricing helps you take advantage of it and afford yourself some discount.”
We asked Professor Zhang to take us through the basics—what dynamic pricing is…how firms use dynamic pricing…and how can consumers leverage dynamic pricing to get the best deals.
What Is Dynamic Pricing?
Dynamic pricing—sometimes called real-time pricing, demand-based pricing or time-based pricing—consists of frequent changes to how much a good or service costs. We’re used to that when it comes to things like gasoline, airline tickets and stocks. But with dynamic pricing, Zhang says, “You’re setting a price based on the customer’s changing willingness to pay. When people are willing to pay a higher price for a good or service, a business charges a higher price…and when people are not willing to pay a high price, it charges a low price.”
More and more companies are engaging in dynamic pricing these days, sometimes in unexpected ways. Example: In 2024, the fast-food restaurant Wendy’s announced a dynamic pricing strategy whereby someone buying a burger during the lunch rush would pay more than someone who waited till after the lunchtime peak. But when word got out that Wendy’s was doing this, hackles went up. “The media began running articles about rich corporations using dynamic pricing to squeeze the last ounce of value out of consumers,” Zhang says. Those stories, however, reflected a limited understanding of dynamic pricing.
How Dynamic Pricing Works
Dynamic pricing strategies center on three basic factors. As these three key factors change, they influence dynamic pricing…
- Supply—the amount of a good or service available to the market.
- Demand—the extent to which those products are desired by willing customers.
- Real-time data—the information that allows corporations to engage in revenue management by setting competitive pricing, often using automated pricing tools.
Businesses have two key considerations when it comes to price optimization…
Margin—how much profit you make with each sale. As your price per unit progressively exceeds your cost of producing the good or service, your margin increases. If you set your price too low, you’ll sacrifice margin.
Volume—how much of the product you manage to sell. Even at lower margins, if you sell enough of something, you’ll pull in lots of revenue. But if you set your price too high, you’ll sacrifice volume.
Dynamic pricing gives businesses the best of both worlds—they can charge higher prices to only people who can afford them and lower prices to those who can’t. “If a business does that,” Zhang says, “it doesn’t have to choose between margin and volume. It can increase profitability while increasing customers’ access to the product.”
Common Dynamic Pricing Models
Demand-based pricing: Under this model, the price for a product rises as demand increases. Example: Uber sometimes uses “surge pricing.” If real-time data shows that an area is experiencing a spike in demand, algorithms automatically increase ride prices. Those higher prices attract more drivers to the area, which increases the supply of rides. As supply and demand even out, ride prices drop back down.
Time-based pricing. Let’s look at the Wendy’s example. Company data showed that stores were consistently overwhelmed during the lunch hour. Workers were stressed. Wait times increased. Nobody was happy. So Wendy’s lowered its pricing for the period just after the lunch peak, hoping that a discount would lure some customers away from the lunchtime crunch. Wendy’s did not raise the price of a peak-lunchtime burger. Instead, it lowered the price at the off-peak time.
Competitive pricing. When the market starts seeing lower or higher prices, businesses rapidly adjust their own product prices.
Segmented pricing. Today’s business analytics provide companies deep insights into customers’ buying habits. The companies place customers into different segments based on whether they’re more or less likely to pay high prices.
A concept central to segmented pricing is price elasticity. A customer who is price-inelastic shows no drop in demand when a price goes up—perhaps because that customer really loves the product…perhaps because he/she has plenty of money…or perhaps both. A customer who is price-elastic is more likely to purchase the product if the price goes down, either because he is lukewarm about the product, has less money or both.
A business engaging in segmented pricing combines data on price elasticity with other customer information. How often do customers purchase the product? Do they switch to another brand when the price gets too high? Do they take advantage of coupons or discounts? When the business finds individuals or groups for whom special pricing could move the needle, it makes lower pricing available to them. Sometimes this entails a time element. Example: Grocery stores charge less for orange juice during weekdays, based on the assumption that 9-to-5ers can handle paying full price, while the unemployed or retired who shop during the weekday will seek discounts.
“This even happens at the individualized level now,” says Zhang. “If a customer shows a pattern of buying more when there is a promotion, a business can offer a discount more often to that specific individual.”
Benefits of Dynamic Pricing
Dynamic pricing gives businesses the opportunity to increase short-term profitability by making their products and services available to a wider swath of customers.
For consumers, dynamic pricing generally represents an opportunity to access lower pricing or a better shopping experience even if you’re not a direct recipient of the discount. Example: If your employer allows you a lunch break only during Wendy’s peak hour, you won’t get the savings, but at least the crowd will be smaller and the servers less stressed.
Risks and Controversies
Some people argue that dynamic pricing is unjust, since it allows some customers to pay less than others for the same product. But viewed another way, dynamic pricing appears more fair than fixed prices. “In the Bible, a poor widow gives two little coins to the temple treasury,” Zhang says. “Do those two little coins mean the same to her as they would to someone like Jeff Bezos?” Allowing more people a chance to get their hands on goods and services based on their ability to pay should be a good thing. Dynamic pricing usually simply amounts to dynamic discounting. Yet some lawmakers who insist on viewing it as “price-gouging” for those who don’t receive the discount would like to ban the practice.
Real-World Examples
Airlines are the real pioneers of dynamic pricing. They have long offered different pricing based on when you book. A family saving every dollar for a vacation will purchase seats months in advance to snag the lowest fares, while a businessperson traveling on the company dime might book at the last minute. The businessperson will pay a premium for purchasing so late, but he likely can afford it. More importantly, he/she can always find a seat, albeit at a higher price. The airline thus accommodates both types of buyers.
Hotels have followed a similar model, and even events such as the soccer World Cup have adopted dynamic pricing. Retail and ecommerce companies have done the same, with Walmart rolling out electronic shelf labels that will aid dynamic pricing based on demand, inventory and competition.
Bottom line: Now that you’re aware of dynamic pricing, watch for it as you shop. If you’re sensitive to high prices, you might want to pay more attention to changing prices and find ways of scoring discounts through slight changes to your buying behavior.
