The Logic Behind E-Tailers' Mercurial Pricing
Reprinted from the Harvard Business Review website.
The Wall Street Journal recently broke a story which revealed two surprises about the pricing practices of Internet retailers: Prices change often and widely. The Wall Street Journal highlighted, for example, the range of prices for a GE microwave. In one day, sellers on Amazon.com changed their prices nine times, resulting in prices fluctuating between $744.46 and $871.49. During that same period, rival Best Buy raised its price on the same kitchen appliance to $899.99 and then later dropped it to $809.99.
So what's going on here?
Internet retailers have discovered that the web is a perfect setting to optimize prices. It is almost costless for e-tailers to change prices, and it's equally easy to measure customer reactions. Given this fertile price-changing environment, Internet retailers are varying prices for 5 key reasons:
Determine the right price. Every business faces the challenge of determining what the perfect prices are for its products and services. Internet retailers vary prices to determine what is optimal — finding the balance between price and quantities sold that yields the highest profit. It is important to note this search for the perfect price is never ending as a product's value often changes over time. The right price for a lawn mower, for instance, evolves from high to low throughout the spring and summer seasons.
Seek pockets of opportunity. Varying prices and reviewing the resulting purchasing behaviors can identify time periods when less price sensitive customers shop. Customers making purchases during normal business hours (perhaps searching while at work) may be more price sensitive than, say, those who shop at night. If this is found to be true, e-tailers may consider raising prices after business hours.
Remain Competitive. If rivals change prices frequently, to remain competitive it makes sense to do so too.
Implications on Complimentary/Ancillary Sales. Determining the "right" price should also take into account its effect on other product sales. If a low price stimulates additional sales, now the challenge is determining how low the discount should be to maximize multi-product profits.
Segment Customers. Identifying who buys at the lowest and highest prices allows customers to be segmented by their price sensitivities. This segmentation can help in better targeting future promotions. Price sensitive customers may be offered low prices while others may receive promotions less focused on discounts (i.e., upgrade or better service opportunities).
The above five benefits help e-tailers optimize prices to earn the highest profits. It's fair to question whether these frequent price changes are ethical. After all, I'd hate to have purchased that microwave and later find out that its price dropped by over $100 on the same day. But before making a judgment, keep in mind that Internet retailers typically have low margins. For example, the Q2/2012 operating margins for Amazon and Best Buy were both under 1% (0.8% and 0.3% respectively).
So what can brick and mortar retailers learn from these pricing practices? They should vary their prices too — brick and mortar stores can reap the same benefits as their Internet brethren.
Sure, prices can't be varied as frequently and the data analyses won't be as clean — but occasional price changes can reap similar pricing related profit insights and benefits.
