Distributed Logistics for Digital Commerce, Article 6: Dynamic Pricing Control

Pricing and price strategy are the foundations of a successful digital commerce business.

Many shoppers admit that they turn to ecommerce and marketplaces like Amazon and Walmart because they are attracted by the promise of low prices. They choose products based on pricing comparisons. They select sellers based on the availability of “free” shipping – which is nothing more than the seller’s decision on how to price their shipping.

But pricing rules ecommerce in a much more fundamental way.

That’s because most businesses are in business to drive a profit. The right pricing strategy creates a steady, predictable stream of profit. That frees up resources for advertising and promotion, for investments in staffing and infrastructure, and for focusing on growing the business without working 24/7.

The concept of yield management is central to understanding distributed logistics. The goal of a yield management approach is to get the most profit possible at any point in time from the inventory you have available.  

That’s the point of dynamic pricing. It’s a tool for changing the price you offer based on changes to product costs and to market conditions in real time – but always with the goal of managing profitability on inventory available for that specific transaction in line with your overall pricing strategy.

There are three steps to implementing a dynamic pricing capability:

• Understanding product costs
• Understanding market conditions
• Understanding triggers that might call for a price adjustment

UNDERSTANDING PRODUCT COSTS

The first step in figuring out what to charge is knowing what the product costs. And that’s not as straightforward you might think.

Just a few of the components that needed to be factored into the product cost are:

• The actual product “cost” – but that can be complex since the product may be available from several sources or may be subject to sudden cost changes due to factors like seasonality, raw material changes, or tariffs;
• Fulfillment and shipping costs – these can often vary by location;
• Sales costs – sales commissions vary by sales channel and even by category within a sales channel. But this could also include costs such as long-term storage fees for slow moving products at FBA or at a 3PL;
• Packaging costs – for some products such as food that needs to be kept cool, these costs can vary dramatically depending on where the product is shipped and the time of year;
• Overhead costs – payroll, rent, utilities, insurance and other costs of doing business allocated to the product.

When you understand these factors, you are well on your way to establishing a “floor price” for the product. That floor price is the minimum price you are willing to charge in order to recoup your costs plus the lowest level of margin you are willing to accept to protect your margins.  

Floor price is critical to implementing your online pricing strategy since all the price adjustments you make will be based on the floor price.

(Since “floor price” is a key concept in digital commerce pricing strategy. I cover it in more detail in the video that accompanies this article.)

UNDERSTANDING MARKET CONDITIONS

The second step implementing a dynamic pricing strategy is to understand the market conditions that might affect the price you offer. Remember, we are talking about dynamic pricing – not “set it and forget it” pricing. The ability to change your price dynamically in response to changing conditions can be a major competitive advantage.

That’s because pricing strategy is about striking a fine balance between your marketing strategy and the desire the make a sale and your operations strategy and the desire to boost inventory ROI by increasing unit volume and minimizing the capital invested in inventory.  

Getting it right means that you are driving the highest possible margins from a given inventory stock at any point of time. You’re not just “optimizing” around an imaginary sales scenario or mindlessly charging what the market will bear. Instead you are reacting to individual shopper visits as they happen and making the best, most profitable pricing offer for the business at a whole. That means some of these pricing decisions will be based on strategic concerns, not just marking up your floor price.

A few of these strategic concerns could include:

• Protecting MAP pricing, even at the cost of losing the sale;
• Protecting other channels such as retail locations or authorized resellers by deliberating offering an uncompetitive price to drive the sale to them;
• Pricing to increase velocity by offering a more aggressive price in order to increase the sales unit volume. For example, this could be a factor if the inventory is moving slower than planned and you want to avoid long-term storage fees. Strategically you might decide that discounting the product to get it into a consumer’s hands is better than spending the money to pay marketplace fees.

UNDERSTANDING PRICING TRIGGERS

The third component needed to implement a dynamic pricing strategy is understanding what changes should trigger a pricing change. These could include:

• Changes in product cost;
• Changes in the competitive environment;
• Changes in sales velocity;
• Inventory age;
• Strategic objectives and opportunities such as percentage of “buy box” wins or supporting authorized resellers.

If all of this sounds complicated and complex, that’s because it is. And remember, it’s all happening in real-time. But fortunately dynamic pricing perfectly lends itself to automation. Once you have the data and pricing rules in place, automation can do the rest.

But if there is a risk in implementing dynamic pricing, that risk comes in the use of automation. Automation is nothing but data-driven decision making. It’s as great tool, but as we’ve seen in past articles and videos, it demands absolute date integrity, the ability to normalize data around a master SKU and a single point of truth to execute it well. Otherwise, if you make a pricing error, automation will just dig you in a deeper hole that much faster.

One final point for brands. I often hear from brands – especially those with a strong D2C selling capability – that they don’t need “repricing” because they have no head-to-head competition for their brand products.

But dynamic pricing is about more than just meeting or beating a competitor’s price. It’s even about more than just maximizing profit. It’s also about protecting the brand.

If the COVID-19 crisis has taught us anything, it should offer a valuable lesson on how fast market conditions can change. Suppliers can disappear. Demand can dwindle or skyrocket in hours. And sometimes, even the upside presents risks. Some sellers have been accused of price gouging when supplies of essentials dried up and their pricing engine kicked in to set the maximum price with no top end “fail safe”.

The future of digital commerce is changing in ways none of us can predict. That change is happening day-by-day and sale-by-sale. Dynamic pricing is a powerful tool for not only surviving these changes, but also thriving by maximizing profitably and offering a way to instantly react to changing market conditions as they emerge.

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You can learn more about dynamic pricing control and how it works in the video that accompanies this article: Distributed Logistics for Digital Commerce: Dynamic Pricing Controls. It’s part six of an eight-part series on Distributed Logistics. To get started with the series, click here to view the first video Distributed Logistics for Ecommerce: A Change in Paradigm and Why it Matters.