What Is Dynamic Pricing and How Does It Affect E-Commerce?

What is dynamic pricing?

Dynamic pricing is product pricing based on various external factors, including current market demand, the season, supply changes and price bounding. With dynamic pricing, product prices continuously adjust — sometimes in minutes — in response to real-time supply and demand. Amazon is one of the largest retailers that uses dynamic pricing and, undoubtedly, the way most consumers have been exposed to the practice; its algorithms continuously adjust and evaluate the prices online shoppers see on its website.

Dynamic pricing methods

There are multiple dynamic pricing methods. Here are a few ways companies can change their prices as needed:

• Peak dynamic pricing: Higher prices are set during a product’s peak seasons. For example, if you sell swimsuits or pool supplies, you can charge more for them during the summer. You can also charge more for popular gifts during the holiday season.
• Segmented dynamic pricing: Segmented dynamic pricing is based on geography. For example, you could charge more for your products in areas with a higher annual cost of living and higher-income customers.
• Inventory-driven dynamic pricing: Supply and demand can increase or decrease a product’s price. Naturally, you’d charge less for a product you have in excess and more for a popular product running low.

Dynamic pricing in e-commerce

Dynamic pricing lends itself more to e-commerce than brick-and-mortar businesses because it is based on real-time trends and supply chain factors. Since in-store prices are more difficult to change, these businesses tend to set prices that last for longer periods. In contrast, online businesses can easily change their pricing. For example, if stock for a particular product drops on an e-commerce site like Amazon, you’ll likely see a surge in the price within minutes. Walmart is another example of a major company that uses dynamic pricing online to stay competitive.

Online retailers with ever-increasing competition face the challenge of maximizing profits while keeping their prices competitive. Dynamic pricing is the ideal solution to this problem; it considers supply-and-demand changes to recommend optimal prices. If implemented for a sustained period, this pricing strategy can significantly boost your overall revenue and profitability.

What are the benefits of dynamic pricing in e-commerce?

If you’re selling online via an e-commerce store, it’s important to understand dynamic pricing and how it can benefit your business. Done correctly, this strategy can help you raise prices while keeping consumers happy. Below are some of the specific upsides of dynamic pricing.

Dynamic pricing gives you greater control over your pricing strategy.

A common argument against dynamic pricing is that it reduces your control over your products’ prices. In reality, it has the opposite effect. As a retailer using dynamic pricing, you’ll have access to real-time price trends across thousands of products in your industry and have the ability to make adjustments at will. You’re able to see your competitors’ pricing changes and understand a product’s supply-and-demand levels. This information will help you set the right prices for various products and maximize your revenue. 

“Dynamic pricing keeps you flexible to ever-changing market conditions, ensuring you always charge the right price at the right time,” Stephan Liozu, chief value officer at Zilliant, told us. “Once you know which events drive demand, you can build them into your pricing strategy and make the most of spikes.”

Dynamic pricing drives average order value and revenue growth.

When implemented correctly, dynamic pricing can help an e-commerce business increase conversions and revenue per order, improving its profit margins.

“Aligning prices with real-time demand or inventory levels can create demand for products. I’ve seen up to a 13 percent lift in average order value during peak sales periods,” said Windy Pierre, founder of eCommerce Manage.

Nabeel Siddiqi, founder and CEO of Moksha AI, the company behind Price Perfect, pointed out how dynamic pricing can help keep cash flowing even during times of disruption.

“For example, if the market demand for your product drops, dynamic pricing can reduce prices for a short period of time to keep your revenue and profits up. This can help stabilize and increase overall revenue,” he said.

Dynamic pricing allows flexibility without compromising your brand value.

Many e-commerce retailers shy away from dynamic pricing because they fear it will damage their brand value and diminish the customer experience. After all, consumers can easily mistake your fluctuating product prices for manipulation or even fraud, right?

The truth is, while frequent price changes may turn off a small number of customers, you can protect — and even strengthen — your brand value by instituting dynamic pricing and being honest about it. Pierre said that after he implemented a customer-facing disclosure about dynamic pricing for a midmarket, direct-to-consumer store, “customer satisfaction scores remain[ed] stable, indicating no negative fallout from the practice.”

The business also saw a “5 percent improvement in conversion among repeat shoppers, likely because they felt the brand was upfront about its pricing approach,” Pierre said.

Dynamic pricing helps manage your inventory more effectively.

While you may already use point-of-sale (POS) software or an inventory management system to track your inventory, dynamic pricing can help you manage stock levels more effectively, resulting in a greater return on investment.

“You can use dynamic pricing to aid with stock management and lower prices of lackluster SKUs [stock keeping units] to move stock out the door,” said Liozu. Pierre helps his clients optimize their inventory “by adjusting prices dynamically to clear items at the right time.” In one case, they “reduced overstock by 6 percent in one quarter.”

Furthermore, “dynamic pricing, when linked to inventory levels, can help handle the variations that inevitably arise in supply chain management,” Siddiqi said, explaining, “When stock for a product is low, dynamic pricing can slightly increase the price to slow the sales and keep enough inventory to not annoy customers.” He cautioned, however, that while “this can help smooth the inventory levels,” it’s an “advanced pricing strategy that may not work for all businesses.”

>> In the market for a point-of-sale solution for both in-store and e-commerce? Check out business.com’s recommendations for the best POS systems.

Dynamic pricing saves you money in the long run.

Dynamic pricing can also save your company money in the long run when it comes to your operations. Since web-based dynamic pricing software and applications monitor cost factors and perform all calculations for you, there’s no need to spend time and labor (and therefore money) on manual calculations and related administrative activities. 

“Checking competitors’ prices manually and repricing thousands of SKUs in Excel is thoroughly inefficient and an unnecessary waste of time considering dynamic pricing software can do the work for you and better than any human could,” Liou said. “Automating such processes saves time, money and reduces human error.”

With the right software, you’ll reduce overhead costs, adding to your company’s bottom line. However, dynamic pricing tools can be complex and challenging to use, especially initially, as discussed below.

What are the downsides of dynamic pricing in e-commerce?

While your e-commerce business has a lot to gain by using a dynamic pricing strategy, there are some risks involved as well.

“There are several downsides to dynamic pricing when it’s applied irresponsibly. Businesses must be careful not to focus only on maximizing profit margins or offering the lowest possible price,” Liozu warned.

Consider these potential pitfalls before committing to dynamic pricing.

Dynamic pricing can lead to customer backlash and distrust.

While it’s tempting to sit back and leave the pricing to the algorithms, doing so can cause a customer revolt. For example, Bruce Springsteen allowed tickets for his 2023 tour to be handled by Ticketmaster’s dynamic pricing system, but The Boss’s blue-collar, advocate-of-the-average-guy brand was seriously tarnished when midrange seats went on sale for over $4,000 each because high demand sent prices soaring. 

Fluctuating pricing can also confuse, anger and turn off customers. “The biggest drawback to dynamic pricing is potential customer backlash and damage [to] brand value. When customers see prices changing without any justification or reason, then they can feel taken advantage of,” Siddiqi said.

To mitigate potential fallout, Siddiqi recommended following Price Perfect’s “PRICES” strategy.

• Purchase frequency: Adjust pricing less for frequent purchases and more for occasional buys.
• Range boundaries: Set appropriate price ranges that align with brand positioning and profitability.
• Inform transparently: Communicate clearly about why and how prices change, focusing on the benefits for customers.
• Conservative thresholds: Start changing prices slowly. “Changes under 5 percent consumers often don’t notice,” Siddiqi said.
• Explain value: Maintain price as a value indicator, especially for premium products.
• Strategic decreases: Use price reductions thoughtfully to expand your customer base.

Dynamic pricing can be challenging to implement.

Manually monitoring hundreds of thousands of products and watching real-time supply-and-demand trends is highly difficult and beyond the scope of most e-commerce businesses. Fortunately, the best e-commerce platforms and dynamic pricing solutions take away the guesswork, automating the process to provide accurate data you can use to set optimal product prices. But even though automating the price-changing process generally saves time and effort, these tools have a significant learning curve for new users.

“Complex implementation requires a robust algorithm or software, which entails setup costs and ongoing tuning,” Pierre said. “Technical errors or misalignment with inventory data can wipe out margin gains if not implemented correctly.”

Siddiqi also highlighted the “complexity of implementation” considering all the variables involved in dynamic pricing.

“Ideally, dynamic pricing should be connected to inventory data, customer behavior data, competitor prices, etc., as inputs and [you should] be able to change prices in the e-commerce store automatically. However, all of this requires sophisticated systems, business processes and maintenance,” he said.

These challenges could make your team hesitant to embrace dynamic pricing, especially when there are simpler ways to set prices.

“Cost-plus pricing is straightforward. You know your cost; you know your margin — done,” Liozu said. “Value-based pricing and competitor-based pricing are complex and, although these strategies are very likely to reap long-term dividends, B2B [business-to-business] companies often feel unable to implement them due to a perceived lack of bandwidth or push-back from end-users.”

Liozu added, “For dynamic pricing strategies to succeed, it’s essential that all stakeholders understand and support the approach. Transparency in how prices are set and the benefits of dynamic pricing should be clearly communicated to sales teams and customers.”

Dynamic pricing can have mistakes due to poor data sources.

As with any technology-based forecast, there is potential for error in dynamic pricing algorithms. Since dynamic pricing is based on real-time data, the data must be as accurate as possible. Otherwise, you’ll end up with a “garbage in, garbage out” situation that can wreak havoc on your profitability and sales volume. 

However, even if the software’s proposed pricing is inaccurate, it’s still just a proposal. You remain in control and can review the pricing changes the application recommends. Human oversight is a critical component of ensuring dynamic pricing works for your business as it should.

It’s also possible errors will decrease over time. “The longer your dynamic pricing solution is running and, the more data it gathers and analyzes, the better quality its output will be,” Liozu said.

Dynamic pricing can alter customer behavior.

Once customers realize that prices change in response to specific factors, they may change their behavior accordingly. For example, they may hold off purchasing at peak times and delay until there is less demand. Dynamic pricing can also drive your customers to purchase from other businesses if they’re aware all the stores under consideration play around with their pricing.

“They’ll be more likely to shop around to see which ones are offering the best deals at the time of ordering,” said Liozu. “This could ultimately push customers into the arms of competitors.”

>> Learn More: Trends in Online Purchasing Habits

Dynamic pricing can reduce customer loyalty.

Customers may also switch to other brands if they’re confused about or feel taken advantage of by fluctuating prices, leading them to purchase from a competitor with fixed pricing instead of your business model. Finding out another customer paid less for your product than they did can also break their loyalty.

“If a customer discovers that they’re paying more than [others] for the same product or service, this can lead to resentment and subsequent bad reviews, complaints, refunds and chargebacks,” Liozu explained. “With customer loyalty lower than ever due to increased … e-commerce competition, it’s never been easier for a customer to switch to another supplier.”

To minimize the possibility of diminished customer loyalty, ensure an excellent customer experience that makes shoppers want to do business with you regardless of pricing changes. Reduce friction on your e-commerce site to make purchasing simple, offer free or low shipping prices and provide easy returns and exchanges with superior customer service.