What is dynamic pricing? A clarification (updated)

‘Dynamic pricing on websites: illegal or unfair?’, asks Éloïse Gratton on her blog. But the post confuses various pricing strategies, not all of which are ‘dynamic pricing’.

Dynamic pricing, also known as “adaptive pricing”, “dynamic pricing” or “discriminatory pricing”  or first-degree price discrimination, is defined as a practice where organizations attempt to perfectly exploit the differences in price sensitivity between consumers. Dynamic pricing is an old practice that has been around forever: for example, if you go to a flea market, the price for an item will change for each potential customer, depending on the negotiations of the parties and depending on what each customer is willing to pay at a specific time, in light of given circumstances (volume purchased, etc).

This practice is recently making a come back. With consumer profiling, consumers can be sorted as individuals or groups by retailers and this makes it possible for the retailers to create a pricing scheme tailored to individual customers based on their purchase or online histories.

No. Let’s clear up some terms.

Price discrimination is the practice of charging different prices to different consumers. First-degree price discrimination charges a different price to each individual consumer according to characteristics of that particular consumer (are they a tough negotiator? what have they looked at, or bought, online recently?). Second-degree price discrimination (for which I prefer the term indirect price discrimination) offers all consumers the same ‘menu’ of options – different prices according to quality, quantity, special extras, for example – knowing that consumers will essentially sort themselves into paying different prices according to their preferences over the menu options (just as restaurants exploit differences in customer preferences by having quite different rates of mark-up on entrees, wine and dessert). Third-degree price discrimination (for which I prefer the term direct price discrimination) segments consumers into identifiable groups (for example, students and non-students) and sets different prices for the different groups.

None of these three methods of price discrimination necessarily involves the practice of adjusting prices according to revealed strength of demand at current prices, which is what is meant by dynamic pricing.

For instance, it was reported a few years ago that Coca-Cola had tested dynamic pricing in vending machines where prices would fluctuate based on the surrounding temperature since soft drink may be worth more when it is hotter outside. Amazon was also suspected of using such practices in 2000, using cookies to identify the visiting consumers. Staples Inc.was found using dynamic pricing based on users’ locations and Orbitz has also been accused of price discrimination in the past, charging Mac users as much as 30% more than PC users for certain products. In the offline space, retailers could profile a customer in real-time (based on an RFID read of objects carried and by cross-referencing to past buying patterns) and they may offer differential service based on the “value” of the customer to the retailer.

The Coca-Cola example could fairly be described as dynamic pricing (though it works on anticipated shifts in demand rather than revealed shifts in demand). The Amazon case sounds like first-degree price discrimination, and the Staples and Orbitz examples are third-degree price discrimination, but none of them are dynamic pricing.

If we don’t sort out the fundamental differences between these very different types of price discrimination and dynamic pricing, we cannot begin to answer questions about illegality or immorality.

UPDATE: Another article, this time from Marketing, that completely confuses dynamic pricing with price discrimination – they are not the same at all, involving completely different issues.