Dynamic Pricing On The Web

 

 

Date:

April 29, 2002

 

 

Prepared by Group 1:

Rachel Ball
Clay Bellew
Robert Brevelle
John Bush

 

 

 

 

 

 

 

 

 

 

1. INTRODUCTION

 

Dynamic pricing is a relatively new term that is being embraced by e-commerce firms and most consumers appear eager to support its use on their favorite Internet shopping sites.  This is ironic since dynamic pricing is essentially price discrimination [1], where different prices are charged to different consumers for the same product or service.  For example, consumers that are Internet savvy and have a good understanding of how to manipulate the algorithms to make themselves appear price-sensitive, dynamic pricing may yield them a lower price.  Or, the consumer may just be lucky enough to stumble across a good deal.  On the other hand, if an e-commerce firm has access to historical data suggesting the consumer has overpaid for items in the past, that consumer will be offered a higher price for the exact same product.  Depending on the perspective, this type of price discrimination may be viewed as unethical and illegal [2].  However, it is undeniably unfair since some consumers pay more just because of who they are. 

U.S. antitrust law covers dynamic pricing and its predecessor, price discrimination.  The Robinson-Patman Act of 1936 and the Clayton Act makes it “unlawful for any person ... to discriminate in price between different purchasers of commodities of like grade and quality ... where the effect ... may be substantially to lessen competition or tend to create a monopoly.”  Simply put, the Robinson-Patman Act “requires that sellers treat all competing customers on the same basis, unless there is some recognized legal justification for different treatment [3].”  In practice, these laws have not been vigorously enforced and have been plagued with loopholes favoring the behavior of large firms, such as those in the airline industry that have utilized dynamic pricing since the Airline Deregulation Act of 1978.   

Several characteristics will help identify a product or service that is well suited for dynamic pricing.  If the good is well defined, relatively standard (i.e. a commodity or near-commodity), perishable or time-sensitive, has a depreciating value (e.g. computer chips), or is scarce; the product may be a good candidate for dynamic pricing. [4]

While there are economists and consumers on both sides of the fence, advocates of “fixed pricing” point to successes such as Wal-Mart, Saturn, and Sam’s Club where prices are the same regardless of the location or who they are.  Supporters of dynamic pricing once pointed to the airlines, travel agencies, and to the thousands of e-commerce firms, but their recent financial demise has left them bewildered.  However, the Internet and e-commerce are obviously here to stay, and they will continue to foster the growth of perceived competitive practices, such as dynamic pricing, at least for the interim.

 

2. TYPES OF DYNAMIC PRICING

         There are several dynamic pricing strategies being used.  Several of these involve auctions, the most popular being English Auctions.  English Auctions are also known as ascending or oral auctions and involve an open auction where bidders continue to raise the price until only one bidder is left.  English Auctions can take place in person, over the telephone, a proprietary data network, or the Internet.  The person or organization selling the product can select a reserve price.  When a reserve price is selected, if the final bid does not meet the reserve price, the seller can choose not to sell the product.  The reserve price may be known or unknown.  A variation of the English Auction is the Reverse Price English Auction, often used in business transactions.  In this auction, a firm submits a request for quote or request for proposal and the winner is the firm who submits the lowest bid to supply the requested service or product.

    Yankee Auctions are quite similar to English Auctions with one distinct difference.  Yankee Auctions involve a minimum bid increment, which is determined at the beginning of the auction.  Bidders can only bid in multiples of the bid increment, even if they are willing to bid higher than the minimum required bid. 

    Dutch Auctions are a fourth option, with a process that is just the opposite of that used for the English Auction.  With Dutch Auctions, the auctioneer will announce a high price and slowly decrease the price until a bidder accepts.  A variation of this type of auction is the New Economy Dutch Auction where the seller specifies the lowest and number of items available at that price.  Bidders bid above that price for the number of items they want at that price.  When the auction closes, the highest bidders purchase the item at the price offered by the lowest winning bid. 

     First Price Sealed-Bid Auctions allow the seller to offer a good for buyers to consider bidding on, where the product is sold to the highest bidder after the bidding is closed.  In this type of auction, the seller can specify a minimum reserve price.  This allows the seller to choose not to sell the product if the bidding does not exceed the minimum reserve price.  The seller has the option of making this reserve price known to the bidders.  Priceline.com is an example of an online company that has used this dynamic pricing structure.

    Reserve Price Sealed-Bid Auctions are similar to Reverse Price English Auctions in that they allow a business entity to post an RFP or RFQ for potential suppliers to bid on.  The primary difference is that the companies bidding can only supply one bid and the bids are not known until the auction ends.  The contract is awarded to the lowest bidder.  This is the type of auction often used by federal agencies.

     A dynamic pricing strategy that does not involve an auction, is group buying.  This type of dynamic pricing uses a demand-aggregation, group-buying strategy.  In this structure, the price for the product decreases as the number of requests for the product increases.  The final price is dependent on the number of purchases made.  With this form of aggregate buying, the purchasers band together to get a group discount.

     Exchanges are a dynamic pricing strategy that involves bringing the seller and buyer together to make the goods exchange.  The electronic exchange acts as the "middle man" for the sale.  A percentage of the sale is the fee charged, by the electronic exchange, to facilitate the transaction.  This allows seller and buyers alike to participate in a global marketplace that may otherwise be unavailable.

 

3.ADVANTAGES AND DISADVANTAGES

 

Dynamic pricing allows sellers to use large amounts of information to assist in making a pricing decision.  This can be viewed as a competitive advantage in the marketplace since this particular seller can make a better-informed decision on what to charge.  This is beneficial to the seller when historical data is available on a buyer that is not considerably price-sensitive.  This allows the seller to increase the price within the threshold of the buyer’s upper limit, thereby increasing the profit margins for the firm.  For the same reason, this can be a disadvantage for the buyer.

If the potential buyer has a proven track record of being price-sensitive on online purchases and is well informed of the product’s market price, dynamic pricing should offer a better deal to this type of buyer.  This requires more involvement from the buyer, but the rewards are evident.  For example, two travelers, one elderly and one in his twenties, are sitting on an airline preparing for takeoff.  At some point, the topic of conversation turns to the airline ticket price.  The elderly traveler, who is on a fixed income and has limited experience shopping online, is happy to note that his ticket cost him only $400 since it was booked 21 days in advance.  The younger traveler, who is very Internet savvy and spends the bulk of his time purchasing items online, comments that he purchased his ticket for $100.  The airline and the young traveler may be happy with the results of their transaction, but the elderly traveler is unfairly charged a different price for the exact same product.  A similar example is how business travelers are charged significantly higher rates for airline tickets as opposed to their more price-sensitive travelers.

Dynamic pricing also takes into account other critical information such as the seller’s current inventory, supply chain issues, competitors’ pricing, and the recent events that may affect the price at that particular time.  Sellers are able to efficiently use this information to dynamically set the price of a product.  For example, an e-commerce firm specializing in high performance auto parts may discover that there is excess inventory in a particular tire size.  The firm may offer a discounted rate in the form of a group purchase for this product due to the excess inventory and the volume of the group purchase transaction.  In this case, both the seller and buyer benefit from this type of dynamic pricing.  This is common practice on www.corvetteforum.com and www.ls1.com where specialized markets and consumers are easily accessible by e-commerce firms such as Exit 28 Motorsports (http://www.exit28motorsports.com) and West Coast Corvettes (http://www.westcoastcorvette.com).

NexTag.com (http://www.nextag.com) offers a dynamic pricing exchange for over 3 million new and used products and services [5].  The benefits to the buyers is that they are in more control of the process, purchasing from any registered seller they select at the price they want to offer without having to pre-commit credit card or other type of payment information.  Buyers can instantly compare prices and other related fees across sellers, and buyers can also review what other buyers are willing to pay.  The benefits to sellers is more control of the process by enabling them to close a deal on their own terms quickly and without predetermined time limits or delays.  Sellers also have the capability to instantly accept or reject offers and automatically or manual provide discounts.  In the end, dynamic pricing can be viewed as a necessary practice on the Internet for e-commerce firms to remain competitive given the large, diverse consumer base, which has quick access to competitors’ offerings and prices. 

The Internet also facilitates the use of dynamic pricing in Business-to-Business (B2B) transactions.  According to Forrester Research, they predict that B2B auction sales will increase from $19.3 billion to $65 billion. [6]

 

5. TECHNOLOGY MAKES IT EASIER

Dynamic pricing is not a new concept, and some even compare dynamic pricing to the age-old practice of price discrimination.  However, dynamic pricing is much more feasible than age-old price discrimination through the help of technology.  With information provided by Internet users at a very low cost, companies can tailor pricing with very little effort.  

In the summer of 2000, Amazon.com performed “price tests” to determine how particular DVDs might sell at different price points by charging different customers different prices for the exact same DVD.  It’s customers quickly caught on to the supposed “price tests” and later received apologies and refunds from Amazon.com.  Only through the advancement of technology was Amazon.com able to perform this type of dynamic pricing.

Organizations like @themoment and FairMarket have made a business out of offering dynamic pricing solutions to meet any type of business objective.  This technology allows organizations to set automated price adjustments based very specific business rules.  If the customer demand for a product suddenly increases, the software can be tailored to raise or lower the price to meet the company’s business objective [7].  That may be as simple as to move dated inventory or increase profits.

 

7.   CONCLUSION

 

The question will remain, how long will consumers tolerate a dynamic pricing strategy.  As long as the consumer self-selects dynamic pricing through auctions or demand-aggregation, the consumer will be satisfied.  The airline industry has been utilizing dynamic pricing strategies for years, and the public has seemed to accept this practice and even know the guidelines to get the best price (Saturday night stay, fly in the evenings, and multiple segment flights).  Amazon.com found itself in trouble by testing random pricing tests that customers quickly became aware of and demanded a refund.  In summer of 2000, the U.S. Federal Trade Commission stepped in to urge online advertisers not to invade people's privacy by using personal information to individually match customers with advertisers or product offerings. “Most e-commerce sites right now need to charge as close to the suggested retail price as possible. They need the money,” Tom Wyman, an e-commerce analyst from J.P. Morgan said. “I think the days of deep discounts are done. And dynamic pricing really only works online when you're below the normal retail price”[8].  With the advancements of technology, will there be a point when we don’t even know about dynamic pricing?

 

9. SOURCES

 

[1] Krugman, P.  “What Price Fairness?,” New York TIMES, A35, Oct. 4, 2000.

 

[2] Weiss, R. M. and A. K. Mehrotra.  “Online Dynamic Pricing: Efficiency, Equity, and the Future of E-commerce,” Virginia Journal of Law and Technology, Summer 2001.

 

[3] Balto, D. A.  “Emerging Antitrust Issues in Electronic Commerce, Speech Before 1999 Antitrust Institute” (Nov. 12, 1999), Distribution Practices: Antitrust Counseling in the New Millennium, at http://www.ftc.gov/speeches/other/ecommerce.htm.

 

[4] Bob Gressons, “The Value Propositions of Dynamic Pricing in Business-to-Business E-Commerce.” http://www.crmproject.com/documents.asp?grID=183&d_ID=733

 

[5] NextTag Press Release.  "NexTag.com Launches First Dynamic Pricing Exchange for Consumers and Businesses," 1998.

[6] Forrester Research. “Anatomy of New Market Models.” February 1999.


[7] InfoWorld Reports Major Computer Makers Actively Testing Dynamic Pricing Models; Pricing Programs Would Affect Customers At IBM, Compaq, Dell and HP Online Sites. Business Wire, May 14, 2001.

 

[8] Amazon may spell end for 'dynamic' pricing. USA Today, September 29, 2000.