Dynamic pricing in retail: where is this journey taking us?

Hauke Bremer, Junior Consultant at CAS AG, in conversation with Jens Scholz, CEO at prudsys AG. As part of his Master’s thesis entitled “Dynamic Pricing in Retail: Opportunities and Risks”, Hauke Bremer asked our CEO Jens Scholz about dynamic pricing in retail. The main objective of the Master’s thesis is to define the opportunities and risks of dynamic pricing in retail. Based on those definitions and by implementing a prototypical mobile “shopping companion”, the following research question is to be answered: How can retailing benefit from the opportunities provided by digitalization and dynamization – with mechanisms that have been used for years by online retailers to increase turnover?

Hauke Bremer: Why are bricks and mortar retailers (having to become) involved with dynamic pricing?

Jens Scholz: It is especially retailers in direct competition with online retailers like Amazon who need to concern themselves with dynamic pricing. Amazon makes excellent use of dynamic pricing, changing prices several times per item per day (driven by demand, supply and the environment). Retailers must assume that the Amazon algorithm creates a competitive edge with each price change. If retailers don’t react they are putting themselves at a clear competitive disadvantage. Dynamic pricing is becoming (and already is) a strategic competitive edge in retail. Depending on the retailer’s objective and product range, gross profit increases and turnover increases have been achieved. Disadvantages such as the fear that dynamic pricing could damage the retailer’s price image are relativized over the medium/long term. Ultimately, dynamic pricing is the fairest pricing on the market. Depending on the market situation, prices get either more expensive or cheaper for the customer. Dynamic pricing is driven by demand, supply and the environment. The fair market price is dynamically determined and automatically displayed for each item and for each sales channel at any given time. Dynamic pricing in bricks and mortar retail will become increasingly important with the comprehensive introduction of ESL (Electronic Shelf Labels) as the manual effort required for frequent price changes is minimized. In other words, dynamic pricing is fairer* than the stable price. This must be integrated into the retailer’s corporate communication and explained to customers.

* We are not talking about personal pricing but rather non-personalized dynamic pricing. But personalized pricing can also be fair if A and B customers are rewarded, in other words customers who frequently return and purchase a lot. In this instance the goal of personal pricing can be to retain customers and increase customer value.

Hauke Bremer: What possible applications result for bricks and mortar retailers?

Jens Scholz:

  • Fully automated dynamic pricing with different objectives such as increasing turnover, earnings and volume, sometimes even partially automated for price focus and base items, i.e. dynamic pricing suggests a price but the ultimate authority to make the decision remains with category management.
  • Life cycle pricing with the goal of optimizing earnings and inventory for seasonal, fresh and fashion items, in other words items with a limited life cycle. The ultimate goal is to reach “zero inventory” at the end of the season while obtaining the best possible price at any given time based on the target function “earnings”.
  • Personal pricing in the way of personalized discounts for certain target customers. These customers obtain personalized product recommendations (technical requirement: use of a recommendation engine) as well as a personalized discount. This promotes customer loyalty, develops the customer in terms of value for the retailer and can be used for upselling and cross selling strategies in order to promote certain items or categories.

Hauke Bremer: What do you think of these opportunities when using mobile devices?

Jens Scholz: Basically “mobile” is just one more sales channel that can be controlled with dynamic pricing. We discourage retailers from using personalized pricing based on whether a customer is purchasing on the go using an iPhone or locally using a Windows computer. This can easily be seen as a rip-off, creating a negative price image for the retailer. In addition, drawing conclusion as to willingness to pay based on the end device (mobile or local, iOS or Android) is a questionable practice.

Hauke Bremer: The prototypical application of my Master’s thesis merges the two channels: bricks and mortar and mobile. Using this shopping companion, retailers can reenact customer interactions as if in an online shop and react to them. This makes it possible to calculate individual recommendations and prices. Do you think that could be relevant for the future of bricks and mortar retail? What do you think customer acceptance would be like?

Jens Scholz: Success or failure here is in the details. The strategies that will be successful are those that actually generate relevant deals in the mobile app in real time, in other words an item or content that is actually interesting for the customer (recommendations in real time generated by the use of a recommendation engine) and with a discount tailored to that customer that rewards customers who return frequently and generate high revenues. This is a purchasing advantage for the customer and can be explained if another customer does not receive such a discount. Like with loyalty programs such as Payback. The more you buy, the more points you get. I would predict failure if a) product recommendations do not interest the customer and b) if different end prices are displayed for each customer, in other words not just generating personalized discounts but personalized prices. I think that would be difficult to explain to the customer.

Hauke Bremer: A survey that I conducted indicated that approximately half of all those end customers surveyed (total n=223) did not like personalized pricing based on shopping behavior. Just as many respondents would not use the app mentioned for that reason. How would you justify this response?

Jens Scholz: At the moment dynamic pricing and personal pricing in particular (still) have a bad reputation. Why? Because in other industries (e.g. online flight tickets) there are definitely practices that customers do not understand e.g. different prices depending on the end device used or on which Internet site the customer uses to find the deal.

On the other hand, customer loyalty models like Payback are very popular with customers. That is understandable. The more you buy, the more points you get.  This is nothing more than a personalized discount. Retailers that use dynamic and personal pricing should be open with their customers and clearly communicate what is happening and why it is necessary (competitive advantage). Communication should focus on the fact that dynamic prices are fair: in no way does it mean that customers are discriminated against, instead they are being rewarded for their loyalty.

Hauke Bremer: Keyword: incentives. The survey indicated that price acceptance is considerably higher when the customer receives a coupon or instant rebate upon completion of the purchase. Is this the way to entice end consumers to embrace dynamic pricing?

Jens Scholz: Here we can differentiate between two scenarios.

  1. Dynamic pricing – dynamically calculates a price that is valid for all customers at any given time and which is based on customer price acceptance depending on supply, demand and environmental conditions.
  2. Personal pricing calculates different prices or different discount amounts for each customer.

Checkout couponing offering relevant deals (recommendation engine) and a discount relevant for the customer (pricing engine) is definitely a tool used to retain customers and increase customer value and turnover.

Hauke Bremer: 47% of those surveyed indicated that they would not be willing to pay more for an umbrella just because it was raining and they needed one. Can dynamic pricing still function?

Jens Scholz: Good question… strictly speaking, charging a moderately high price for an umbrella when it is pouring out is in line with the market. Demand increases and supply decreases. According to the rules of the market the price increases. However, it is difficult to explain to the customer that he is better off buying the umbrella in the summer because that’s when it is cheaper. The customer is in dire need of an umbrella now and it is logical to assume that the retailer is exploiting an emergency situation. That is not received well. In other words, I don’t think short-term price fluctuations for umbrellas based on the weather are expedient. But it is certainly understandable and fair to have higher prices when demand is high (fall/winter) than when demand is low.

Hauke Bremer: Is the future of bricks and mortar shopping that each customer pays a price specifically tailored to that customer?

Jens Scholz: That is too much of a generalization. It depends on the strategy, competition and the retailer’s product range. As a general rule I think that fair pricing will win out in the end. By that I mean pricing driven by demand/supply/environment (dynamic pricing) but also personalized pricing that rewards customers that are loyal to the retailer.

Hauke Bremer: What opportunities and risks do you see when it comes to dynamic pricing in bricks and mortar retail?

Jens Scholz:

Opportunities:

Competitiveness!

Customer retention!

Gains in turnover, earnings and market share!

Reduction of inventory and markdowns!

Reduction in effort! (Prerequisite Electronic Sales Labels)

Risks:

Retailers should stay away from any strategy that discriminates against customers or that is not understandable to customers. Never jeopardize the customer’s trust. For example: We do not recommend personalized prices based on the customer’s end device (cannot be explained, discriminates against customers). Dynamic pricing boasts great potential for retailers without using discriminating strategies.