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Pricing Essay

6384 words - 26 pages

SUMMER 2007

V O L . 4 8 N O. 4

Arvind Sahay

How to Reap
Higher Profits With
Dynamic Pricing

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REPRINT NUMBER 48415

pricing

How to Reap Higher Profits With

Dynamic Pricing

S

un Microsystems Inc. chairman Scott McNealy forecast that
“With recent advances in wireless and information technology,
even our cars could … call for bids whenever the fuel tank runs
low, displaying a list of results from nearby gas stations right on
the dashboard.”1
It sounds far-fetched. But dynamic pricing — where prices ...view middle of the document...

Now
dynamic pricing optimization offers companies in many other sectors the
alternative of raising average realized prices in the face of increased pricing
pressures.
Four principal reasons are driving the increasing use of DP today:
■ More companies can now access and deploy the technology for DP at affordable prices in new product and service categories.
■ Recent research shows that with the right approach, consumers will accept
DP even if they are currently buying using fixed prices.
■ Increased pricing pressures and supply constraints in different industries
are driving companies to look at new ways of extracting value and reallocating demand.
Arvind Sahay is a professor of marketing at the Indian Institute of Management Ahmedabad. Comment on this article or contact the author through smrfeedback@mit.edu.

sloanreview.mit.edu

More and more
companies are now
able to change their
prices in real time
to capture the full
possible value of
goods and services.
Here’s how to do
dynamic pricing right.
Arvind Sahay
SUMMER 2007

MIT SLOAN MANAGEMENT REVIEW

53

pricing

In their continuing bid to increase efficiency, many companies
(having already integrated upstream supply chains with their
operations) are now turning to the downstream aspect, where DP
is a natural consequence.
Dynamic pricing, managed well, offers a feasible and attractive path to increase revenues and profits. (See “Why Dynamic
Pricing,” p. 56.) Implementing DP can improve revenues and
profits by up to 8% and 25%, respectively.3 But it’s not just that
DP offers greater profits. For example, for personal services such
as haircuts and public services such as road space in metropolitan
areas, DP can be used to reallocate demand to more suitable
times and manage a limited supply base. And where products
have a limited shelf life with a salvage value (for example, apparel), DP can be used to improve realizations from fast-moving
lines of goods by raising prices in real time or near-real time, and
similarly to push slow-moving goods by lowering prices. Also, in
formats such as Internet auctions (for example, eBay) and group
buying, DP can aggregate bigger audiences than is possible in a
physical setting. New, excess and reassigned inventory can be sold
for higher realizations using an auction format such as eBay.

F
orms of Dynamic Pricing: Posted Price Mechanisms
and Price Discovery
Dynamic pricing differs fundamentally from fixed pricing because it allows prices for the same good or service to change by
customer, time, aggregate demand and other situation-specific
parameters. There are two broad categories of DP: (1) posted
prices that customer can see; and (2) price discovery mechanisms,
in which customers determine prices through their own actions
during the transaction.
Fixed prices are a form of posted prices, of course. When companies fix the posted price of a product or service for a relatively
long period,...

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