Dynamic pricing and the race to the bottom

I see that online retailers have been admiring the yield management techniques used by airlines and hotels{{1}}. After all, what's not to like about profit maximisation? Consumer goods, however, are not a time sensitive resource who's value crashes to zero after a particular date. Online retailers might just be starting an arms war with customers that they cannot win. The result will be a race to the bottom as mounting pressure compresses already tight margins.

[[1]]Brian Proffitt (September 2012), How much will it cost you? With Dynamic Pricing, online sellers say ‘It depends’.., ReadWriteWeb[[1]]

More and more online retailers are experimenting with dynamic pricing, tweeking the prices of products in response to competitor prices and customer behaviour. This might be as simple as matching a competitor's price, scraped from their web site in realtime. It might involve offering a discount to customers who ‘window shop’ a few times without purchasing, in the hope that a discount will nudge them over the line. Or it could be as sneaky as charging a segment of the customer population higher prices, as Mac users found Orbitz doing{{2}}.

[[2]]Dana Mattiolo (August 2012), On Orbitz, Mac users steered to pricier hotels,The Wall Street Journal[[2]]

Retailers are working hard to ensure that their prices are as high as practical while scoping up as many customers as possible, optimising both revenue and profit in the process. There's even talk of tracking user behaviour, offering individuals lower or higher prices based on a personal profile, a trend called ‘identity-based pricing’. However, a retailer's product is fundamentally different from that offered by the airlines and hotels.

30 day history of the Canon SX40 HS, by price comparison site DigitalPortfolio

30 day history of the Canon SX40 HS, by price comparison site DigitalPortfolio

An airline seat or hotel room has zero value if is not occupied, so there's an urgency on behalf of both the retailer and customer to cut a deal. The customer wants to occupy the room (or seat) on a specific date (or, at least, within a narrow date range). The merchant wants to sell the room (or seat) as a potential profit will be quickly transformed into a cost if it's not filled.

Retail today is a little different though.

Back in the days of the shopping mission{{3}} there was some imperative to purchase a product on the spot. The customer might have invested a significant chunk of time – an afternoon traipsing though stores in a mall, for example – to search for a product which would solve their problem. Retailers would play on this, convincing customers to compromise style, quality or price rather than walk away empty handed, and be forced to invest in another shopping mission.

[[3]]As retail dies, who will be the winners?, PEG[[3]]

Today customers are more likely to skip across channels until a vague want is transformed into a concrete need, at which point they source the product from whichever retailer from around the globe offers them the best deal. On those occasions when they do head to the mall with a purchase in mind they have become what retailers call ‘mission shoppers‘: consumers with a clear picture of what they want to purchase along with an understanding of comparative prices from retailers around the globe, on a quest to screw the lowest possible price out of whichever retailer they choose to visit.

The power in the customer-retailer relationship these days is firmly with the customer. It's the customer who has all the information, and who can walk away and look for a better deal. Or, even better, the consumer can offload the this negotiation to a 3rd party service who actively optimises the deal for them.

Existing comparative shopping sites are unlikely to leave an opportunity unanswered, and will offer users something like a reverse auction: specify the product and what you think is an acceptable price. The service (or app) will pounce on the first offer that meets your requirements and buy the product on your behalf. These services might pretend to be their users, lying about their browser or platform, or using something like a VPN to appear to be coming from another region, to game the customer profile and be offered lower prices. They may even ‘window shop’ a few times before purchasing to help drive the price down.

From the user's point of view these services might involve little more than snapping a photo of a barcode, or clicking ‘buy now’ on a service supplied browser tool bar. The service does the rest, sending you a message when the product is purchased, with it arriving at your door not long after. It's just like a reading list or Netflix queue, but with shoes and cameras rather than books and DVDs, and the price guaranteed to be the lowest available, and the profit coming through an annual subscription fee. Is this the Amazon Prime of the future?

Retailers heading down the dynamic pricing route will soon find that they have created a margin minimisation strategy rather than a margin maximisation strategy.

The problem with any differentiated pricing strategy (such as dynamic pricing) where there is no compelling reason to buy is that you've just provided the smart customers with an opportunity to sit back and cherry pick the products they want at the lowest prices. Imagine trying to run a store where the customers will only buy your loss leaders. Something similar is already happening in consumer banking, with Bank Simple working with their customers to optimise how they place their funds and credit with partner banks, cherry picking the best individual products for the customer.

The way to avoid this trap is to either sell your own, unique, products, or to build a community around a shared interest. If you're selling your own products then its hard for customers to obtain something similar from another retailer. (Though this assumes that your products are something other than run-of-the-mill fare.) If you build a community around a shared interest then the sense of community outweighs the desire to drive the lowest possible price, making it pointless to buy the product elsewhere.

Posted under: Retail, The New Instability

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