dolution

The Ethics of Dynamic Pricing

In Casablanca, the classic romance drama film from 1942, Ilse, the character played by Ingrid Bergman, is looking at a set of lace napkins in a shopping bazaar when she mentions that she is a friend of Rick, the film’s lead character played by Humphrey Bogart. The merchant quickly replaces the original 700-franc price tag with one bearing a 100-franc price. “For special friends of Rick’s, we have special discounts,” he explains to Ilse. The message was clear: Different prices apply to different customers.

Companies now have access to more data on their customers than at any other point in business history, and many of these businesses use that information to serve their customers better, providing them with the goods and services they need just when they need them. One offshoot of this wealth of information is dynamic or customized pricing, a system in which companies charge different prices for the same products and services for different customers using the information they have collected about their customers. The principle is the same as that in Casablanca: Different prices apply to different customers. Movie theaters have used a simple version of dynamic pricing for years. Buy a ticket for an afternoon showing, traditionally a slower time for sales of movie tickets, and you get a lower price. Restaurants use the same tactic, offering “early bird” specials at off-peak hours. Airlines have used dynamic pricing for years as well, but their systems are much more complex. (When asked about the pricing strategies of airlines, the CEO of a major airline company said, only half-jokingly, “I don’t understand airline pricing either!”) Business travelers who fly on short notice on weekdays typically pay higher prices than those who book in advance and travel over weekends. Cities such as London, Singapore, San Francisco, and New York use dynamic pricing strategies, charging drivers on toll bridges higher prices at peak commuting times and lower prices during off-peak hours.

Many professional and collegiate sporting events now rely on dynamic pricing, charging higher prices for “high demand” games with arch-rivals or stellar matchups between star pitchers and lower prices for games that fans find less appealing or are subject to bad weather. Barry Kahn, CEO of Qcue, a small company that specializes in dynamic pricing for the sports industry, says dynamic pricing has enabled clients to increase their revenue by 30 percent by raising prices for high demand games between 5 and 10 percent and by reducing prices for low demand games.

The practice of dynamic pricing has created controversy, however. Is it ethical for companies to charge different customers different prices for the same goods and services? Many surveys report that customers believe dynamic pricing is not an acceptable business practice. However, empirical evidence shows that customized pricing benefits not only the companies using it but also customers, making purchases more affordable for many people. Uber, a company based in Silicon Valley, California, provides an app that allows people in 70 large cities worldwide to use their mobile devices to locate drivers of the company’s army of black cars; it uses dynamic pricing, charging higher prices when demand for rides is high and the supply of cars is low, typically on Friday and Saturday evenings, on certain holidays, and during bad weather. Bill Gurley, an investor in Uber, says the company is committed to being a low-price leader in its market niche (the company’s basic uberX rate is 40 percent cheaper than the typical taxi) and that its dynamic pricing strategy minimizes customers’ wait times and the frequency with which customers experience “no cars available” messages on their phone or tablet screens.

Ragged Mountain, a 49-year-old ski resort in New Hampshire, recently implemented dynamic pricing with the help of Cloud Store, software that gives managers the ability to change prices on lift tickets, equipment rentals, and lessons, depending on weather conditions, holidays, and other factors. A Valentine’s Day special, priced at just $14, produced a significant increase in sales of tickets and generated lots of positive buzz for the ski resort. On one occasion, as a big snowstorm approached the area, Ragged Mountain was able to increase its prices gradually each day and still sell out its capacity. Resort managers do not mind reducing prices when demand is low or when conditions are less than ideal because they know that bringing in more customers leads to higher sales of meals, snacks, and beverages.

Dynamic pricing has stood successfully against several legal challenges. Denise Katzman filed a class-action lawsuit against retailer Victoria’s Secret when she discovered that a catalog she received listed higher prices than a nearly identical catalog the company sent to a male coworker. She alleged that the company had engaged in illegal price discrimination by charging different prices for identical items to different categories of customers. Because Victoria’s Secret had sent the catalogs through the U.S. mail, Katzman claimed that the company’s discriminatory pricing structure constituted mail fraud. U.S. District Court Judge Robert W. Sweet upheld the validity of Victoria’s Secret’s dynamic pricing policies, ruling that “offering different discounts to different catalog customers does not constitute mail fraud under any reading of the law.” On appeal, the U.S. Court of Appeals for the Second Circuit upheld Judge Sweet’s decision. This case suggests that businesses can charge different customers different prices as long as the price differences are based on reasonable business practices, such as rewarding loyal customers and do not discriminate against customers for the race, gender, national origin, or some other illegal reason.

Dynamic pricing has emerged as a marketing strategy out of necessity. Entrepreneurs say the Internet has lowered the transaction costs of doing business and moves business along at such a fast pace that the fixed pricing strategies of the past no longer work. To keep up with fluid, fast-changing markets, companies must change their prices quickly. They must be able to adapt the prices they charge their customers on a real-time basis and to charge higher prices to those customers who cost their companies more to serve. Craig Clark, who operates an Amazon storefront that sells more than 2,600 items, recently began using FeedVisor, a service that uses sophisticated algorithms that take into account competitors’ prices, sales volume, a company’s costs, and other factors to adjust prices. Clark says that after FeedVisor reduced the price on his store’s Coobie bras by 10 percent, sales of the bras increased by 25 percent, resulting in higher profits for his company.

Question:

1. What are the advantages and the disadvantages of dynamic pricing to the companies that use it? To the customers of the companies that use it?

2. According to an old proverb, “The value of a thing is what it will bring.” Do you agree? Explain. Should companies be allowed to engage in dynamic pricing?

3. If you owned your own business and had the information required to engage in dynamic pricing, would you do so? Explain.