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Dynamic Pricing in Action – Are You Getting a Deal, or Are You Being Ripped Off?

Oct 5, 2012 by Steve Mallory

As an economics major and avid shopper, I feel that there is a market trend coming around that should be on everyone’s radar: Dynamic Pricing! It sounds awesome—like regular pricing, but with more pizzazz! Well, not exactly. Let me explain.

Dynamic Pricing, also known as “Time-Based Pricing,” is actually a form of third degree price discrimination wherein customers are divided according to different demand curve segments and charged different prices. This practice allows a firm to increase profit margins, because it reduces the consumer surplus. In layman’s terms, this means that the company makes more money by prioritizing the consumers who are willing to spend more.

The most well known example of dynamic pricing comes from those Groupon or LivingSocial emails you get every morning. These are a win–win for consumers and firms, as people in segments that would not normally pay a premium for a service are able to purchase that service at an accessible price, and firms are guaranteed revenue in advance (with a percentage of proceeds going to the host, of course). There is also eBay, which allows you to bid on prices, or the new marketing campaign ofPriceline where you are allowed to name your price or essentially bid on how much you would be willing to pay for a seat on the airline—clearly the airline would rather accept a lower price than have a vacant seat, right?

While I’m very happy to get 63% off a vacation to Bali from Groupon, the use of this pricing scheme can have a negative impact on consumers. The most basic lesson in economics is that when demand increases without a shift in supply, prices increase. I came across an example of this model tying price to costs while using the highly touted car service Uber. This is a self-proclaimed “on demand car service” that starts with a basic pricing model—a base fare plus $0.75 cents per minute or $3.25 per mile—and rapidly increases from there at times of high demand. In fact, Uber’s prices can be 6 or 7 times higher during particularly busy times like New Year’s Eve. My ride in an Uber sedan wasn’t quitethat expensive, but still! I didn’t complain at the time, but after further research, I found on Uber’s website, underneath the pricing, a little blurb in 7.5 point type that reads as follows:

At times of intense demand, our rates change over time to keep vehicles available.

Yes, it’s literally that small; and while it doesn’t look like it means all that much, what it’s really saying is this: At a busy time (such as Saturday night in downtown DC) we can charge more because demand is higher, and those who are not willing to pay will choose a different method of transportation to get home. This will leave our cars free for higher paying patrons and will enable us to throw the former prices out the window (Ironically, DC is trying to make Uber even more expensive).

If you don’t use a taxi app or any of the group coupon sites, you might be wondering how this will affect you. Well, if you’ve ever tried to park on the street in the city, expect to see some changes! No longer will you have to stalk people walking to their cars or go around the block 10 times, since the goal is to almost always have a space available. Instead, you will have to pay more based on the demand for the spaces. With the new technology of electric parking meters, cities can use an algorithm that increases prices when more parking spots fill up, and drivers can check an app to see where open spaces are in real time—convenient, but pricy! The goal of this is to deter drivers from leaving their cars in one location for too long during busy times, and it will also take some of the satisfaction out of those “perfect timing” moments we occasionally have when looking for a space.

The experience of taking yourself out to the ol’ ball game will also now be different. If your team is winning, or if they’re playing a big game against a rival team, ticket prices are usually adjusted, up to a few days before the game itself; now, they will be changed up to the first pitch, and maybe even after it, should you come in a few innings late or if there’s a rain delay. Prices for box seats can go up or down based on demand, so going to the game will be a little different in future. This practice is taking off for professional sports arenas, and collegiate sports venues are doing it as well. One of the implementers of dynamic pricing, Qcue, “has seen clients increase revenue by an average of roughly 30% in high demand situations and approximately 5–10% in low demand situations.”

The last example I’ll throw out is Amazon. As one of the current “companies to watch,” Amazon has managed to become a top competitor of Google and Apple, growing its empire by shipping items quickly and selling them for low prices. However, with the implementation of dynamic prices, they have run into some problems: now, if you put an item in your cart but do not buy it right away, Amazon reserves the right to change the price! That means that the new iPod that you thought was a steal at only $110 can quickly become $150, because many other people noticed the great price, and because Amazon is tracking your buying behavior—they assume that you will still buy the iPod at the $150 price, especially if you didn’t know it was once listed at $110 (This leaves the cheaper version for someone with a different demand curve).

If you still believe that this won’t have an effect on you, just wait: dynamic pricing is growing in popularity, with new technology allowing analytics to track societal habits easily while giving firms, stadiums, or cities the ability to change prices instantly; after all, nothing is printed with ink anymore. Everyone wants to make more money, so the chance to capture the extra consumer surplus is a powerful incentive. If these examples do sound extreme, it’s because they are: price discrimination exists everywhere (e.g. a Dunkin’ Donuts in New York City will charge more for the same bagel than a Dunkin’ Donuts in Oneonta). If dynamic pricing models to take off in non-retail arenas, it will be almost unnoticeable to most people, because they’ll end up paying exactly what they would always have been willing to pay. Pretty tricky, eh?

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