Did you know that when you buy stuff from a retailer, there may be other people who get a better price than you? Sure you did. You know that theaters and airlines offer discounts to seniors and children. You know that if you go to Mexico you have to haggle for the best price on that bracelet for Aunt June.
In microeconomic terms we call this phenomenon dynamic pricing. It also sometimes goes by the name discriminatory pricing. The word "discriminatory" here isn't necessarily a bad thing, it's just a technical description of the phenomenon.
Dynamic pricing is used to maximize profit by selling the most number of things to the widest group of people at the highest possible price.
Let's pretend you own a theater with 200 seats. For the sake of this example we'll assume that it costs you the same thing to run a film no matter how many seats you sell. What do you charge for admission - let's look at some ways to figure this out:
- At $10 per ticket you know you can fill half the theater. You also know that $10 is a bit steep for most students and seniors. At $10 only 10% of your audience is comprised of students and seniors. Your gross revenue is $1000.
- You institute a $5 student and senior ticket rate. Now, you fill the theater to capacity and 55% of your tickets go at the discount price. Your gross revenue is now $1450.
This is a very simplistic example of discriminatory pricing, but you get the idea. Generally you create a pricing situation that attracts the most amount of customers.
In my opinion, there are some dangerous ways to do dynamic pricing. Amazon tried this a few years back with DVD sales. They assumed (probably correctly) that frequent purchasers were less likely to shop around before making a purchase. If you bought a lot of stuff from Amazon, they actually started charging you more.
The problem is, they got caught. People comparing prices on a message board found that they had payed a dollar or two more per DVD then new shoppers to Amazon. They raised a bit of a stink and Amazon stopped the policy.
In my opinion Amazon went wrong because they penalized their best customers, and they assumed they wouldn't get caught and generate consumer resentment. In the cooperative era of the web, you have to be very careful.
If Amazon had instituted a "frequent buyer discount" and openly advertised it - I don't think anybody would have had a problem with it. In fact this is a pretty common model of dynamic pricing.
Sometimes online companies use dynamic pricing randomly to do price testing. The first visitor to their web site gets offered a DVD at $21.99 the next at $22.99. They test to find a good price point for their products. Again, this can be a problem when customers compare notes.
To use dynamic pricing well, I believe you need a few things:
- You need an identifiable customer segment (seniors, students, frequent customers).
- You need to justify your pricing. Nobody would argue with a new customer discount, a senior discount, or even a guy named Bob discount. It just has to make sense to your customers to prevent resentment.
- You need to prevent resale. You don't want a senior buying 20 tickets and then scalping them outside your theater.
Many businesses have successfully implemented a discount buying club. Customers pay an upfront fee and enjoy a membership discount. Sam's Clubs, BJ's and Costco are exactly that.
A local Harley Davidson dealer ran a $100 membership that gave people a 25% discount on clothing and accessories. They only sold 1000 memberships (so a $100,000 upfront fee). And I'm guessing that the discount probably served to get the people who belonged to increase what they bought over the next year. I don't know for sure, but I'm guessing the dealer made out well.
Another way to make dynamic pricing work is with tie-in sales. If you are selling copiers, you might offer a discount on the hardware when people purchase a four-year service plan. If you own a movie theater, you might offer a "buy 5 full-price tickets get one free" sale. Certainly lots of businesses create packages that are less expensive than buying each item separately.
For most small businesses, pricing is an aspect of their marketing strategy that receives less planning than it should. People are price conscious, but not necessarily looking for the least expensive option.
To benefit from this, look to ways that you can use pricing to entice new customers, keep old customers, and encourage people to buy more frequently.
J D Moore - Marketing Comet