What is Dynamic Pricing?

Dynamic pricing, also known as time-based pricing, is a form of price discrimination in which a company changes the price of a product or service depending on some set of factors. It is common among industries — such as the tourism and transportation industries — whose business increases or decreases greatly under predictable sets of circumstances. Dynamic pricing allows a business to maximize its profits because it is better able to assign prices that take into account shifting levels of demand and willingness to pay.

The tourism industry is one that makes frequent use of dynamic pricing. Different locations experience larger volumes of tourists at different times of the year. A beach resort, for instance, will experience much greater demand when it is summer in that location than it will during the winter, or if it is warm year-round at the beach resort, business might pick up when it is winter in other locations. A ski lodge, though, will have greater demand during the winter. Using dynamic pricing, a hotel will raise its prices during its peak season and lower them during the off-season.

Sometimes, the off-season price will be so low that it does not cover all of the overhead costs of the hotel. The hotel can take this loss, though, because dynamic pricing ensures that its increased prices during the peak season will generate enough revenue to compensate for the off-season losses. Many businesses in the tourism industry utilize these practices, and some of them make almost all of their yearly revenue during very narrow windows of peak tourism.

The transportation industry also makes frequent use of dynamic pricing. During rush hours, the demand for transportation increases tremendously. As a result, providers of transportation can charge higher rates at these times because the availability of transportation is limited, so consumers are more willing to pay higher prices. The transportation industry also can use dynamic pricing to increase revenue when demand increases for other reasons as well. For instance, if a city's bus system shuts down at a certain hour, taxi cabs will then be able to charge higher rates.

Dynamic pricing is most effective when an industry is able to accurately predict consistent changes in demand for a product or service. Dynamic pricing can be very difficult to implement when these changes are less predictable, or if it is easy for a consumer to change his or her habits to take advantage of the product or service when the price is lower. For instance, it is difficult for a retail store to successfully implement dynamic pricing, because it would be easy for consumers to adjust their shopping habits to avoid the higher costs.