Dynamic Pricing – the opportunities for retailers in the online market
Online retail in Australia is growing fast. There are many reasons for it, but price is regarded as one of the main motivations for consumers to buy online according to the latest ACMA (Australian Communications and Media Authority) report. Studies also show that nearly 40% of Australian retailers see low online prices as their biggest threat to their business as demonstrated by the widespread debate around the GST-free imports under $1,000. However, there are big opportunities in identifying consumers' maximum willingness to pay and establishing the right price mechanisms to optimise returns. Often the willingness to pay threshold is higher than current price levels, despite the bargain-driven attitude of many consumers. Technology in e-commerce offers opportunities that businesses that are off-line cannot realise. The challenge for businesses with bricks-and-mortar background is to establish the right pricing strategy as the internet is not destroying prices, it actually can create value.
The e-commerce market in Australia will expand considerably in the coming years
While traditional retail is undergoing challenging times, e-commerce has been growing annually by nearly 10% over the last three years according to a recent study by Paypal and Forrester. Research has shown that this is expected to be even stronger in the years ahead. This growth is driven by new players entering the market, increased customer interest in buying online and emerging enabling technologies, such as, improved mobile devices and increased internet access speed. However existing studies have not included the potential additional growth effects from a rollout of the NBN. Moreover, online retailing in Australia is coming off a comparably low base of ~5% of the total retail market. In comparison, leading e- commerce markets like the US or the UK are close to 10%. It is reasonable to expect that it is only a matter of time for Australia to catch up.
Pricing is a key driver for online success and online prices are becoming increasingly dynamic
We believe that a key success factor online is to have prices aligned with the consumer's willingness and ability to pay: low enough to be attractive for the consumer (and to exploit the company's lower cost to serve in the online market), but as high as possible to optimise profit for the company.
Consumers like to have maximum possible transparency, which leads to the success of online price comparison sites. Mobile technology supports this need by enabling the consumer to compare prices at home as well as the point of sale. This price transparency may result in the consumer's willingness to pay changing relatively quickly, leading to pressure on the company to adapt its prices at the same pace.
This is not a new concept. It is fundamentally the same as in traditional market places, where no fixed prices exist. E-commerce nowadays enables merchants to digitally bring this concept to the broad market in order to maximise their conversion as well as margins. While in traditional retail price changes of a large range of products are a complicated and potentially long process, online price changes can be made in an instant. Converting the shop visitor into a buyer can be influenced by the right price. At the same time technology in the background can make sure that overall margin goals are met.
This concept of "dynamic pricing" is not new to consumers either. The airline and hotel industry have been using it for many years Many online retailers have also been establishing it over the last decade and there continues to be new entrants: Ticketmaster is evaluating the option to have dynamic pricing for concert tickets; city councils in major US cities, such as San Francisco and L.A., let their parking metres adjust automatically due to supply and demand (peak parking prices might sore up to $18/hour, while at low traffic times city parking may suddenly be more widely affordable).
These cases have one thing in common: limited space and sales deadlines. However, physical goods can also be priced dynamically to maximise returns. Amazon is a prime case of a successful online retailer exploring and exploiting the opportunities of dynamic pricing.
Below are some dynamic pricing examples from Amazon and other online retailers:
- Dynamic reaction to competitor's prices and promotions: Have automated software that monitors competitor web-listed prices and adapts own prices accordingly. It has been observed that Amazon lowers its prices when major competitors publish new promotions. As Amazon top the online search engine rankings, they gain share from the marketing of their competitors, without spending on non-digital marketing at all.
- Dynamic offering of discounts: Calculate the likelihood of a purchase and only offer a discount if the likelihood of a purchase drops below a certain level. Not all customers will need big discounts to be convinced to buy. The online world gives indications of future buying behaviour by analysing data available for each customer (e.g. clickstreams, abortion of checkout etc.).
- Dynamic adaption by demand/supply level: Raise prices, when stock levels are low and demand is high.
- Dynamic adaption by product lifecycle: Introduce an automated price reduction scheme that lowers the price the closer a product comes to the end of its life cycle. This is a method to potentially avoid all old stock being sold at the biggest discount at the end of its lifecycle.
- Dynamic testing using consumer data: Leverage the increasing amount of data available online on the average customer purchase pattern per product and gradually test the best conversion/margin-maximising price
These are just some examples, with many more factors available to adjust and find the optimal price.
Given the complexity of the influencing factors and the fact that effects can be substantial, dynamic pricing needs a well thought-through pricing strategy to be effective. This strategy has to include a deep understanding of a company's customers and the dynamics in the competitive market. Once the strategy is in place, the logic of the dynamic price adaptions must be rigorously defined. This will allow the actual changes to price to happen automatically. In addition, a performance management system has to be in place to monitor the changes and the resulting effects. Alerts can be set to manually influence the pricing logic, e.g. when big changes are recommended by the software, and companies can also decide to set manual absolute or relative boundaries to the dynamic prices (e.g. in comparison with a competitor).
Retailers with bricks-and-mortar background cannot adapt prices as easily as pure online players
The biggest online challenge for established retailers with a bricks-and-mortar background is to educate customers that store prices and online prices may vary. It is a complicated process that may cannibalise in-store sales and profits in the short run. However, it is necessary to ensure that market share is not lost completely to new entrants and clever adopters of new technology. It is very likely that those companies that are quick to come up with a convincing pricing strategy across the multiple sales channels, offering the customer the benefits of each channel, will succeed and take significant market share from slow adopters.
For bricks-and-mortar stores there seems to be no alternative to having a convincing online presence as according to a study of AMP Capital in September 2011 46% of Australian consumers are already consulting retailer’s websites before making a purchase. We also see this trend increasing, with an international study on the German fashion industry showing that online is involved in two out of three purchases (48% get online information before buying in the physical store, 15% only using online for information and the transaction and 3% getting off-line information, but buy online).
These examples show the increasingly close interconnection between different sales channels. For companies in this dynamic market environment it means that implementing a successful multi-channel pricing strategy becomes imperative. Pricing cannot be narrowly constrained to specific segments. A holistic view on all channels has to be established, from a transaction, marketing as well as pricing perspective.
Download this E-Commerce Dynamic Pricing Featured Thinking article.
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