The results from my recent survey are in and in this series of articles we’ll be talking about some of the findings. We had a total of 118 respondents who shared their definitions of dynamic pricing, their thoughts on where dynamic pricing had the most potential, the potential challenges they foresaw. and talked about the likelihood that dynamic pricing would be adopted in the industry.
Before I begin talking about the survey results, let’s start off with the bigger picture. Dynamic pricing has become quite the hot term lately, but what exactly is it? When I go back and look at pricing from a revenue management perspective (something I’ve been doing for over 30 years), there are two fundamental pricing questions that need to be addressed: One, what prices should be charged? And two, how to determine who pays which prices? Answers to both questions are equally important, but I would argue that even if the prices aren’t exactly optimal, a company can achieve significant revenue increases from having a reasonable (as in OK) set of prices if they’re able to do a good job of segmenting their customers (as in determining who gets which price).
Let’s start off with what prices should be charged. That’s essentially what dynamic pricing is all about. So, what is dynamic pricing? I asked just that question in my recent survey. Over 100 people responded. Pretty much everyone thought that dynamic pricing means that prices vary based on demand, but they had all sorts of thoughts on what that meant. The responses ranged from quite general (“changing prices based on a number of factors”) to quite specific (“personalized prices … served up to a consumer”).
I decided to ask some of the dynamic pricing companies what their definitions were. Carl Orsbourn and Ashwin Kamlani of Juicer told me that “dynamic pricing is ensuring the right price at the right time for each sales channel to optimize a restaurant’s profitability and the guest experience,” while Colin Webb at Sauce explained that “dynamic pricing is the practice of updating prices in response to variable inputs.” Jana Zschieschang of Revenue Management Solutions stated that “Dynamic pricing is the process of adjusting prices based on customer demand.” Javier Espinosa of DynamEat said that they consider dynamic pricing to be a strategy in which every item on the menu is priced differently ‘depending on factors like demand level or customer profile in order to obtain the maximum profitability while driving demand.” Axel Hellman told me that Priceff considers dynamic pricing to be “fully automated pricing based on real time demand and available capacity.”
Essentially, dynamic pricing is all about prices varying based on demand. The concept makes sense, but how is it done? Specifically, one, how are the prices determined, two, how frequently do they change, and three, how are they communicated to customers?
How are Prices Determined?
Let’s start off with how the prices are determined. The dynamic pricing companies mentioned above tend to use a combination of forecasting and price elasticity to determine the “optimal” price for each menu item.
That being said, it’s not always 100 percent necessary to have the “optimal” prices. For example, up until a few years ago, hotels and airlines didn’t even have optimal prices, but instead had a range of prices that they systematically opened and closed based on demand. They were also extremely effective at using rate fences to segment their customers.
How Frequently are Prices Changed?
Opinion on the frequency of changes also varied. For example, in the LinkedIn poll that I conducted, 35 percent of the 274 respondents opted for hourly price changes, about a quarter for daily changes, about one-sixth for weekly changes and another quarter for monthly price changes. Similarly, in the survey, clearly, there’s a variety of opinion on this.
Theoretically, prices can be changed as frequently as a restaurant wants to change them, but in practice, they’re usually changing at most a few times a day. For example, with DynamEat, restaurants can change prices as many times as they want, but most opt to change them by meal period. At Juicer, prices change at most a few times a day, while at Sauce it largely depends on what the restaurant group wants. Priceff changes their delivery prices every 10 minutes while at Revenue Management Solutions, they typically change prices several times a year.
How are Prices Communicated to Customers?
Let’s go back to the fundamental pricing questions of revenue management. The first question was about determining which prices to charge (that’s what we just talked about) and the second is on determining which customers pay the different prices.
The answer to the first question is more based on math (forecasting, elasticity and the like) while the answer to the second question is more based on market segmentation and consumer psychology. This segmentation can be done by things like day of week, time of day, by meal period, by loyalty status and by frequency of purchase. Essentially these are the reasons WHY customers pay different prices (in revenue management, we refer to these as rate fences). When there isn’t a particular reason (other than high or low demand) why customers pay different prices, customers may view the prices as unfair and choose not to patronize that restaurant. I talked about rate fences in an earlier article, but as the airline and hotel industries have learned, the way that different prices are communicated to their customers so that customers have some control over the price that they pay is crucial for the success of dynamic pricing and revenue management.
In the next few editions, I’ll be diving into the details of the study. In particular, I’ll be reviewing the ordering and revenue streams that respondents think have the most potential for dynamic pricing, analyzing the potential challenges facing operators, providing an overview of what people have tried and discussing the likelihood of the industry adopting dynamic pricing practices.
Sherri Kimes is an Emeritus Professor at Hotel School at Cornell and specializes in pricing and revenue management. She is passionate about helping restaurants increase profitability. She can be reached at firstname.lastname@example.org.