By
Laura Iles- Senior Consultant, Integrated Insight
The
sheer volume of recent articles on the subject of dynamic pricing, spanning
publications from Forbes to Time to local news reports, underscores its success
in a variety of industries. As dynamic pricing makes its way from the travel
and hospitality industries into sporting events, consumers are faced with
fluctuating prices in more and more areas of their lives.
Unfortunately,
challenges linger and some customers remain wary of the strategy. Specifically,
consumers are often frustrated with what they perceive as a lack of fairness, a
system that is too complex, and the lack of transparency surrounding pricing.
Whether it’s a seat on a plane
or in a stadium, discovering that the person next to you paid half of what you
were charged will sour an otherwise enjoyable experience.
The
company that surmounts these obstacles and provides a dynamic pricing
experience which meets the needs of the customer, while still maximizing
revenue, will pull ahead of the competition and garner additional loyalty from
fans.
Cross-Disciplinary Solutions
In an
effort to find such a solution, two professors from Northwestern University,
Jeff Ely and Sandeep Baliga, have applied both economic theory and psychology
in a controlled experiment. They are testing a new approach to optimize pricing
and drive customer satisfaction, using a variant of dynamic pricing to sell
tickets to the university’s basketball games.
Ely
and Baliga employed a reverse auction, beginning with the highest price and reducing
it over time, to ensure they captured maximum value. A refund guarantee assured
buyers they could purchase with confidence.
In a
recent podcast with Sarah Green of the Harvard Business Review, Ely and Baliga
discuss their findings; the full podcast is linked at the end of this post. Future blog posts will contain discussion of
additional topics in the podcast, including the benefit of secondary markets,
such as StubHub; the pitfalls of price matching; and the challenges of pricing
to address both company goals and customer needs, but below, I highlight some
of the interesting and unanticipated results brought to light through their
experimentation.
An Innovative Test
How do
you test consumer behavior at a variety of price points without damaging
revenue streams OR upsetting the customer?
Their
solution: A reverse auction, starting at the highest price and moving downward,
and a guarantee to refund the difference between the price paid by the consumer
and the lowest price sold. Counterintuitive?
Yes. It’s also an extraordinary use of
psychology to encourage exactly the behavior the firm wants to see.
Customers
are given an incentive to purchase tickets at the precise moment the price
reaches their acceptable threshold – they receive better seats and still have a
guarantee of being treated fairly should the price drop. This also has the added benefit of reducing
incentives to use secondary markets, as the primary market is now more
attractive. The firm is able to observe
customer behavior at a variety of price points, zeroing in on the price that
will best support the firm’s goal. This strategy allows for flexibility, and
the company is able to focus on maximizing revenue or attendance as needed. Monitoring shifts in purchase behavior as the
price is reduced - little by little - generates an understanding of the likely
outcome of further shifts. This in turn prevents the company from reducing the
price too much.
Results
In the
control studies, the final price set by the reverse auction & refund
guarantee strategy matched the pricing suggested by the data based on the
secondary market (StubHub). While the
reverse auction approach may work in industries with event driven, one time
purchases, time will tell if the method has legs with less emotional based
products and services, and a more frequent purchase environment.
Take Away
No
strategy is a one size fits all solution, but embracing new approaches may just
gain you a competitive edge. The pricing
strategy tested by Ely and Baliga has the benefit of maximizing profits while
providing value to the customer through ease of use, transparency, and
fairness.
Chasing
revenue at the expense of your customers’ experience is a long-term strategy
for failure. If you don’t discover that optimal balance of great customer
service and profit-maximization,
eventually one of your competitors will.
Are you out-behaving your
competition?
Sources:
The
original podcast and associated transcript can be found here.
For
additional articles on the pricing experiments of Ely and Baliga, please see
the links below.
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