More than just a “nice to have,” dynamic pricing is essential to the retail industry. With cost pressures escalating, those on the sidelines could get left behind. For decades, retail subsectors, such as the travel and leisure industries, have used dynamic pricing to manage capacity constraints. Now, with new technology, abundant data, and growing acceptance among customers, all retail sectors have the perfect opening to experiment with and capture value by fine-tuning pricing.

So, given both the opportunity and the urgency, why do so few get it right? Success requires a deep understanding of the customer, investment in a cohesive strategy, and a rigorous commitment to a test-and-learn approach. Here’s how to combine these to stick the landing.

An evolving landscape

Though the term dynamic pricing refers to a wide range of tactics, including more static scenarios, such as tiered pricing by seat attractiveness at a movie theater, we’re focusing on the practice of continuously adjusting price in response to relevant internal and external changes. These include shifts in demand, costs, inventory levels, or customer behaviors as well as competitive moves.

Winning the dynamic pricing game requires ingesting information and making decisions at a faster pace, with increasing automation and more precise strategies for specific products or customers. It also demands a systematic test-and-learn approach to iterate and improve.

It is widely known that ride-sharing companies regularly change prices to match driver supply and demand and that airlines and hotels use inputs such as page views, weather, and competitor pricing to dynamically optimize revenue. Some factors, such as booking on a holiday weekend or close to the travel date, predictably impact the expense. Other factors are more mysterious, but no less expected by consumers.

Compared with the capacity-constrained examples above, dynamic pricing is less straightforward in situations in which customers receive the same product. Because of this, retail price adjustments based on competitor prices, changing input costs, or surplus inventory have only recently become more automated and frequent. These actions help retailers avoid being undercut by peers, reduce waste, smooth demand to help operating costs, and better capture customer willingness to pay—all of which make the investment in getting it right so important.

How leading companies compete

Third-party web scraping tools are table stakes for mastering dynamic pricing. Amazon is a best-in-class example, updating prices for its more popular items many times a day in response to competitors. The most advanced players do two things consistently:

• They continually experiment to create new pricing episodes along the customer journey.
• And they evaluate which competitors to prioritize and whether to be the lowest priced.

Beyond competitor pricing, another common trigger is automating inventory markdowns, typically at the SKU level, varying by color and size (e.g., Amazon). For example, newer third-party services such as Flash Food automatically mark down products based on their expiration dates for grocers.

Companies that manage multiple stakeholders, such as wholesale partners and franchisees, or those that have products that people buy regularly (e.g., Starbucks, Meijer) tend to focus on personalized offers vs. changing list prices. A company might email an offer for a product the customer had been browsing or drive customer lifetime value by extending a trial of a product category the customer hasn’t bought. These actions are an effective way to influence customer behavior without inviting claims of unethical price discrimination.

Customer perception

Not surprisingly, the term “dynamic pricing” can raise customers’ eyebrows. Many of us are familiar with instances of ride-sharing services that boost prices during bad weather or peak demand, or event companies that charge seemingly outrageous prices for popular acts. Newsworthy gaffes aside, dynamic pricing is an inherent feature of e-commerce—and often an inevitable trade-off for shorter wait times or less crowded spaces. What customers may distrust in principle, they often accept in practice, especially with the right communications and an understandable rationale, such as capacity constraints or scare inventory.

Retail has largely steered clear of the more controversial dynamic pricing tactics, such as changing prices based on personal attributes such as income, or intentional price gouging during crises. Even the most adept dynamic pricing leaders will show every customer the same item price at a given moment. It is becoming more common, however, for individual customers to receive unique offers based on their personal attributes (e.g., 20% vs. 30% discount based on inferred willingness to pay, or discounts on recently browsed items), which is harder to spot and therefore less prone to backlash. Further, any pitfalls can largely be avoided with the right guardrails and a test-and-learn approach.

Create a dynamic pricing machine

When retailers embark on their dynamic pricing journey, they often first ask us about technology. This question puts the cart before the horse. Getting the full benefit of dynamic pricing is not as simple as implementing a plug-and-play third-party tool. It requires developing a deep customer lens, investing in the cohesive strategy with a holistic view of processes and people, and embracing a test-and-learn. Our pricing experts can guide you through these critical steps.

Understand the customer

How well do you know your customers? When it comes to dynamic pricing, what would turn them off a purchase? What would they accept? We help you identify the questions to ask and then pinpoint the answers so that you can clearly assess the value and risks of your dynamic pricing strategy.

At a more fundamental level, ethnography is also critical. Who are your target customers, and in which segments do they fall? What are their purchase occasions? A deep understanding of these facets will inform pricing logic, including which items to bundle (and when).

Companies often believe they have a good handle on their customers, but blind spots are probable. Consumer behavior has changed dramatically over the past few years and shows no signs of stabilizing. New channels, access to new consumer experiences, and emerging technology are just some of the recent shifts that require retailers to reset their understanding of how customers engage with their products.

Primary research is our starting place for creating a crisp customer profile. Through customer interviews and focus groups, we start with a small sample size to refine the contours of the question. Insights gleaned at this stage inform the quantitative research that can be done at scale, and what’s captured helps put the appropriate pricing guardrails in place.

Bring the vision to life

With the who defined, we can move on to the why, where, when, and how. We help retailers quantify the size of the prize, then determine how to win it. Once again, technology should remain on the back burner until these questions are answered.

• Goals: How much should you optimize for price vs. margin? Which customers are you trying to influence and in which ways?
• Strategy: Which are the necessary defensive vs. opportunistic offensive moves (such as enhancing your brand perception through product scarcity)?
• Competitors: Which competitors should you benchmark or prioritize, and when does it make sense to have the lowest price?
• Architecture: How should you cascade the item-level changes to maintain price architecture and prevent cannibalization (e.g., private label strategy)?
• Omnichannel: Should online and in-store prices match?
• Products: Which products should you dynamically price, and how frequently should you update by tier?
• Triggers: Which dynamic pricing prompts (e.g., competitor price, customer demand, supply cost) should you prioritize?
• Guardrails: Should you set minimum and maximum prices for a given product?
• Pricing levers: Should you change list price, focus on personalized offers, or do a mix of both? How will you integrate these moves with marketing strategy?
• Data: What data matters most? How do you ensure your data quality is up to par?
• Communication: How should you position pricing changes (and benefits) to customers?

Build the engine

Once these questions are fully addressed, retailers can begin to shape their dynamic pricing offerings. Our experts combine the customer lens with the strategic road map to identify where dynamic pricing will have the greatest impact—as well as where roadblocks might lurk. To sharpen the design, we augment our approach with episode resets, leveraging deep experience in customer episode design.

Even when bolstered by the latest technology, the offering will only be as successful as its scaffolding: A thoughtfully designed operating model that considers all stakeholders is crucial. Retailers should involve merchants early in the algorithm design to build trust. They also need to look inside the organization to determine which team will decide pricing as well as its level of autonomy to move quickly.

Transforming pricing may also impact compensation and incentives—or specific job roles, as in the case of customer contact center teams who may take on new responsibilities related to customers’ price comparison. It’s important to keep change management and transparent communication top of mind as they pertain to all stakeholders.

Test, learn—and repeat

When it comes to building an industry-leading solution, a set-it-and-forget-it approach won’t cut it.

A test-and-learn approach will benefit both your strategic vision and your enhanced operating model. We encourage starting with a basic framework, then gradually adding guardrails and automation as information is received. For example, retailers can design pilots in just one product category or market to reduce risk, achieve quick wins, and build momentum. Because the technology supporting dynamic pricing solutions is well established, it enables nearly limitless experimentation to fine-tune willingness to pay and other factors. The key is to never stand still: Persistent experimentation with real data is essential to shaping and refining your dynamic pricing strategy.

Learn from the leaders

The steps above will lay the foundation for success, but retailers can also take a page from those further along on their journeys. Many of your competitors have made dynamic pricing a core differentiating capability both for their first-party listings and as tools for third-party sellers. What can you replicate?

• Keep your eye on the ball. One retail giant strategically ranks its six product categories by popularity. This tiering determines which items to dynamically price—with priority on those items that customers are most likely to price compare, such as an Xbox or coffeemaker—as well as how often it updates prices. The company also carefully considers which competitors to match, choosing to not always be the lowest-cost option.
• Sweat the small stuff. Leaders carefully define which items to price compare when they are not like-for-like (e.g., different color, five-pack vs. six-pack, etc.).
• Get credit for price decreases. While most companies don’t emphasize when a price goes up (unless the item is already in the cart), they do show the list price and price decrease percentage.
• Create an air-tight operating model. The most successful dynamic pricing leaders gradually build trust in their algorithms before making them fully automated, then put the burden of proof on the merchant team to explain if they overrode a pricing recommendation (typically just from catching an error). They augment this with leadership behaviors and accountability to make the system work.

Regardless of your retail subsector, pricing strategy transformation is the cost of entry to play in a competitive market. For many retailers, increasing their level of sophistication around dynamic pricing will be the best way to gain a leading edge. While the latest technology supports a wide variety of approaches and degrees of automation, it’s not the bedrock of success. To win, you must know the questions to ask, deeply understand your audience, and commit to ongoing refinement. With cost pressures, now is the time to harness this potent superpower.