Unlocking the Power of Dynamic Pricing With Machine Learning

Dynamic Pricing has become an increasingly popular pricing strategy. This innovative pricing method involves adjusting prices according to various market and consumer factors. By doing so, companies can optimize their profits and stay competitive in a constantly evolving market.

So far, nothing new under the sun. In fact, you have probably heard about successful cases in tourism and aviation, sectors that were pioneers in its implementation. However, are we truly aware of its full potential?

However, technology has evolved significantly in recent years with the help of Machine Learning, a field in Artificial Intelligence (AI) and computer science that utilizes data and algorithms to mimic human learning, continuously enhancing its precision over time.

Unlike humans or traditional computer systems, these algorithms analyze a large amount of data to establish optimal prices in real time. This allows companies to not only increase their profits but also improve customer satisfaction by offering prices that are more in line with their willingness to pay.

In this article, we will delve into the Dynamic Pricing strategy, its advantages, and the benefits of combining it with Machine Learning. We will also explore the cases where its implementation is suggested.

What is Dynamic Pricing: Definition and relevance

Dynamic pricing is a strategy that involves adjusting prices based on real-time data about demand, supply, competition, consumer behavior and various other market factors. It enables pricing experts to capitalize on fluctuating market conditions and optimize revenue streams. With its ability to adapt to dynamic market dynamics, it has become a game-changer for pricing experts in the industry.

The key idea behind Dynamic Pricing is to determine the right price point that customers are willing to pay at a given moment.

Its algorithms use data to make pricing decisions. For example, when demand is high and supply is limited, prices can be increased to capture the willingness of customers to pay more. Conversely, when demand is low or there is excess supply, prices can be lowered to stimulate demand and avoid stock accumulation.

Benefits of Dynamic Pricing

A Dynamic Pricing strategy offers several advantages for companies. The following benefits apply specifically to the consumer goods and retail sectors:

• Increased profitability: Dynamic Pricing allows consumer goods brands and retailers to maximize their revenue and profit margins by adjusting prices based on demand and market conditions. They can identify price-sensitive customers and offer competitive pricing to attract and retain them.

• Improved competitiveness: This pricing strategy helps to stay competitive in the market by enabling brands to respond quickly to changes in pricing dynamics. They can adjust prices to match or beat competitors, attracting price-conscious customers and gaining a competitive edge.

• Optimal inventory management: These sectors deal with a wide range of products and inventory levels. Dynamic Pricing helps them optimize inventory management by influencing customer demand through pricing. They can adjust prices to sell slow-moving items or excess inventory, reducing holding costs and stockouts.

• Enhanced customer segmentation: Consumer goods brands and retailers serve diverse customer segments with varying preferences and buying behaviors. This pricing strategy allows them to segment their customers and tailor prices to specific segments. They can offer personalized pricing or promotions to different customer groups, increasing customer satisfaction and loyalty at the same time.

• Efficient resource allocation: A pricing strategy that not only focuses on profit but helps you use your resources more efficiently? Yes, it is possible. Dynamic Pricing accomplishes this by focusing on high-demand products and adjusting prices accordingly. As a result, consumer goods brands and retailers can optimize their production, marketing, and distribution strategies. This ensures that resources are allocated where they have the most impact.

There are other benefits of Dynamic Pricing, such as real-time responsiveness, that are achievable based on the specific business model of the company.

What is an example of Dynamic Pricing?

A well-known example of a successful Dynamic Pricing strategy is Amazon. This company stands as one of the largest e-commerce platforms, boasting over 300,000,000 active users. With access to vast amounts of data on users' purchasing habits and market trends, Amazon utilizes this information to dynamically adjust product prices every 10 minutes. Notably, it has been suggested that Amazon achieved a staggering profit increase of approximately 25% by effectively employing Dynamic Pricing strategies in 2016.

Imagining an example of Dynamic Pricing strategy in a retail company or e-commerce is relatively simple. However, its implementation in consumer goods companies is becoming increasingly common, and there are cases of its use that we experience in our daily lives without realizing it.

During the summer months, when the demand for refreshing drinks is high, does your favorite soft drink company adjust its prices? That’s Dynamic Pricing. Your preferred sunscreen lotion seems to increase its price during the same season. You guessed it right, that’s also Dynamic Pricing.

In a certain sense, this pricing strategy has always been there and has been instinctively implemented by many companies. However, as algorithms have become more sophisticated and new technologies have emerged, it has evolved to a new level, as we will see below.

The Role of Machine Learning in Dynamic Pricing

As Simon-Kucher explains about the role of Machine Learning (ML) in Dynamic Pricing, “engines can be built without the aid of ML. [...] However, the complexity stems from various factors impacting the price in different ways. Finding the right balance without aid of ML is challenging and ultimately, an impossible task.”

Another perspective on Dynamic Pricing is to view it as a technique for constructing a price architecture that ensures all relevant price drivers are fairly considered in pricing decisions. Machine learning models play a crucial role in identifying the weight and influence of each variable on the price. These price drivers can range across different buckets, such as market, customer, volume, and product.

ML helps to implement Dynamic Pricing strategies by analyzing large volumes of data and identifying patterns and trends. Its algorithms process data from various sources, such as customer behavior and market conditions, to uncover valuable insights related to the price drivers. This data-driven approach enables businesses to make informed pricing decisions based on a deeper understanding of customer preferences and market dynamics.

Furthermore, Machine Learning algorithms excel in adapting and learning from real-time data, allowing businesses to adjust prices dynamically in response to market shifts. They can identify price sensitivity among different customer segments, enabling personalized pricing strategies. Additionally, ML algorithms optimize pricing strategies based on predefined business goals, ensuring alignment with overall strategic objectives.

Machine Learning based Dynamic Pricing versus Traditional Pricing Methods

ML-based Dynamic Pricing is an advanced technique that aims to determine the optimal price at a transactional level. Compared to traditional methods, Dynamic Pricing offers numerous advantages. Primarily, it enables pricing managers to respond promptly to market conditions and establish customized prices that align with current market dynamics:

• Time factor: Dynamic Pricing powered by Machine Learning facilitates more frequent and real-time adjustments to prices, enabling managers to respond effectively to shifts in the market. This approach ensures that pricing decisions align with the prevailing dynamics, allowing for greater adaptability and responsiveness to changing customer behaviors and market conditions.

• Automated: Through automation, pricing engines play a crucial role in swiftly analyzing market trends and recommending optimized prices. This automated process enables pricing managers to efficiently leverage data insights, reducing the time and effort required for manual price analysis.

• Customized: Dynamic pricing tools offer a customized approach by tailoring pricing strategies to specific product and customer combinations within a given market context. Unlike traditional models that adopt a one-size-fits-all approach, these tools utilize a broader range of factors, including volume, shipment details, and urgency, to determine more accurate and relevant pricing.

• Ongoing margin impact: ML-based Dynamic Pricing has an ongoing impact on margins by ensuring that each transaction is conducted at an optimal price. Through continuous auto-tuning and self-learning, Dynamic Pricing systems adapt and align with the specific needs of the business, further enhancing their effectiveness.

When to use Dynamic Pricing strategy?

Even if Dynamic Pricing seems miraculous, it is not. As with most strategies, there are cases in which its implementation makes more sense for achieving the company’s goals. Therefore, we include a brief summary of when to use Dynamic Pricing based on the expertise of Simon-Kucher:

Be dynamic when…

• The inventory is perishable or there’s a clear capacity constraint: In consumer goods and retail industries, perishables seem to be easier to identify. However, a perishable product could also be a one whose exclusiveness has a strong influence on customers. For example, a limited edition of your children’s favorite shampoo that is branded based on the characters of the latest Marvel Cinematic Universe (MCU) movie.

• You can use it to balance supply and demand: For example, if there is an issue with production and you need to decrease demand, you can increase the price of price-sensitive products to reduce demand and avoid an out-of-stock situation.

• Your price is fluid, you’re elastic and it’s cost-efficient: According to Simon-Kucher, as sales increase, revenue grows, and there is an added cost benefit as supermarkets can effectively reduce waste. Thanks to the advent of digital price tags, companies can make around 90,000 price changes per day. By employing Dynamic Pricing, German supermarkets have achieved a 2.5% increase in revenue and a 30% reduction in waste.

• There’s seasonal demand: One example is the Christmas tree, a product that is highly popular during the Christmas season. Prior to Christmas, its price can be observed to be as high as double its normal price. This price increase is solely driven by the high demand during the holiday period, which impacts customers' willingness to pay.

Don’t be dynamic if…

• It doesn’t align with your strategy: You are not obligated to follow suit just because your competitors have implemented Dynamic Pricing. Your choice not to use Dynamic Pricing could be your unique selling proposition.

• There’s no seasonality or urgency but there’s full comparability: The Dynamic Pricing model should be used with caution and not taken to extremes. Customers have the ability to compare prices on online retailers using best-price tracker websites, and if they are not satisfied with the price, they can easily purchase the product from another retailer. This can result in suboptimal revenue for online retailers.

• You rely only on algorithms and neglect the human element: Tracking dynamic prices and implementing checks is crucial to ensure that prices remain reasonable and aligned with the broader company and pricing objectives. Neglecting the human element in Dynamic Pricing is a recipe for failure, such as selling a book for several million dollars. Yeap, even Amazon can get it wrong.

• There is a situation that can be deemed insensitive or as profiteering: Unregulated Dynamic Pricing can lead to negative publicity. It is essential to ensure that algorithms do not increase the price of a product associated with a recently deceased pop star, for instance. While price adjustments based on increased demand can be justifiable, customers may perceive such increases as exploitative, particularly in sensitive circumstances.

Take the Next Step to Implement Dynamic Pricing

In conclusion, Dynamic Pricing combined with machine learning has revolutionized pricing strategies in the consumer goods and retail sectors. By leveraging real-time market data and advanced algorithms, companies can optimize profits, enhance competitiveness, and improve customer satisfaction. However, it is crucial to strike a balance between maximizing profits and maintaining customer loyalty, considering factors such as perishable inventory, supply and demand dynamics, and sensitivity to customer perceptions.

For companies looking to harness the power of machine learning in pricing optimization, Kuona's Price & Promotion Optimization solution offers a valuable alternative. With Kuona, businesses can leverage advanced machine learning algorithms to analyze market trends, customer behavior, and competitor pricing data. This allows them to set optimal prices and tailor promotions that align with their business goals and market dynamics, ultimately driving revenue growth and maximizing profitability.

If you need a strategic partner to implement Dynamic Pricing, Kuona’s Artificial Intelligence platform is at your disposal. Please, contact us for further counseling.