Demand-Based Pricing: Risk or Reward?

Recently, I have been wondering about the explosion of demand-based pricing algorithms used by a growing set of industries. Pricing strategies have certainly evolved since our founding thirty years ago, and it seems like demand-based pricing can be found more and more across industries in 2018. This pricing strategy has been used by the airline industry for many years, so the concept isn’t new, but the number of businesses that are adopting this strategy is increasing. Hospitality lodging has also used demand-based pricing quite a bit, but it seems to be extending into pricing diversity at a single property. Within a week, pricing for a hotel can vary 150%. A few years ago, golf courses began adopting this model, and now it is also used by the ski industry.

I’ve been thinking a lot about the adjacent and downstream impact of demand-based pricing. For adjacent industries, such as referral services like Trip Advisor and Yelp, there is a negative price impact associated with sharing the best places to visit. Knowing that the more people who visit locations or use services that we like disincentivizes us to recommend them. The more we advertise for these locations, the more the demand increases, and the more we will pay to visit these locations due to demand-based pricing algorithms. It will be interesting to see how demand-based pricing impacts the referral industry, and how this then in turn impacts the pendulum of demand and pricing at the locations. Newton’s Third Law comes to mind.

While the pricing model makes sense from a conceptual standpoint, it is a slippery slope to implement demand-based pricing because companies must raise their own service requirements. For the same service/experience, companies are charging people more, which equals a lower value result. The fact that the price is higher is predicated on the demand being higher. This inverse correlation pressures these businesses to increase their services to meet similar value experiences for their customers, which can be extremely difficult.

For example, on a ski resort’s busiest days, the resort will charge the most money for a lift ticket, even though it does not have additional lift capacity, lines will be longer and slower, and skiers and boarders will get in less runs. This will cause frustration to rise and perceived value to go down. For locations and services that can increase the staff or resources to provide a similar value experience to the lower-priced, low-demand days, this will result in a higher operating expense, and lower profits on the higher- priced days. Customer repetition/retention and profit margins will be significant concerns. Additionally, dissatisfied customers will increase negative referral communication if customers pay more and their experiences don’t match the glowing reviews that they found on Trip Advisor or Yelp.

If demand-based pricing causes this risk, then who can benefit? I believe the shared-services industries can benefit. I mentioned the airline industry was an earlier adopter of demand-based pricing, and I believe the success of services, such as NetJets and Wheels Up, are good examples. The higher-end cost air traveling population has expanded, and the increase in commercial first-class fares, based on demand, drove this emerging first-class traveling population to pay more for a higher net value experience through shared-service flying. Demand-based pricing is also working in shared boating programs and some parts of the ski industry. In the ski industry, mega-pass programs, such as Epic, Ikon, and The Mountain Collective passes, are targeting the root of the problem that demand-based pricing is attempting to solve – stagnant customer attraction in established businesses and services. These passes incentivize skiers to add on a few more pass days at new mountains by offering a ~50% discount on normal tickets. These discounts create a huge value experience for new visitors, resulting in higher repeat business.

The core goal of demand-based pricing is to extract more wallet-share from its existing customers at the same number of customer experiences or use of services. It is not about customer attraction or increasing the use count of existing customers. The creativity–gap on customer attraction should be the area of investment.

How about ride-sharing dynamics? As Uber and Lyft implement more and more surge pricing, where will the customers go? The risk here is that their customers could be paying more for the same service, which creates a lower value perception and shifts their customers to alternative options. The belief is it will drive an Uber or Lyft customer to not pay the higher price, choose a lower- priced service or a similarly priced higher-value service, and then equilibrium will come back to the standard service. Demand-based pricing doesn’t calculate the lost customer impact.

How can the state of the pendulum swing be identified? Voice of the customer engagement programs, mystery shop and experience studies, and competitive intelligence pricing studies can help us understand the dynamics that drive price differentiation at competitors. Experiences are about the action of a product or service. It is not just a UI analysis. It is cradle to grave from purchase ideation to product or service utilization. As we think about demand-based pricing at Fletcher/CSI, we have discussed how the demand-based dynamics are impacting B2B technology sales in the ‘as a service’ markets. If you want to drive prices up, you must drive the value up as well. If value stagnates, cross-selling implodes.

For more information about how Fletcher/CSI can deliver strategic insights and actionable recommendations to inform your pricing strategy, please reach out to [email protected] or 802-660-9636.

-Author: Jim Caldwell, Director of Technology Research