Dynamic pricing: How consumer internet

companies change prices in real time with

sophisticated algorithms
- The Economic Times -

By ET Bureau | 15 Apr, 2016, 04.10AM IST

By Shadma Shaikh

Ever alighted from a swanky new car to buy fruits from the vendor at a market and
discovered that you are paying a premium compared to someone who arrived on foot?
If so, you were given a glimpse of what is known as 'DYNAMIC PRICING,' a craft when
the street vendor practices it and nearly an art form when it is determined by complex
computer algorithms.
Let us suppose friends are reacting to a group message that says "Let's plan a trip to
Ladakh in July." They all log in to their digital devices to check airfares, only to realize
that rates fluctuated by a few thousands rupees each time a new search was made for

flights. What was happening to the excited friends was that an algorithm detected a
spike in incoming requests for a particular flight, causing air fares to rise. In industry
parlance, this is 'price optimization' or the determination of fare based on real-time
demand.
Almost every product or service you buy online is subject to dynamic pricing, and
understanding how it works is important to make smart spending decisions. For
companies, too, it is smart to price dynamically because it helps them adjust to the
vagaries of demand and supply. "There is a misperception that dynamic pricing is an
exploitative pricing mechanism," says Kartik Hosanagar, a professor of technology and
digital business at The Wharton School, University of Pennsylvania, explaining that the
fact that supply and demand are not always perfectly balanced justifies resort to
dynamic pricing.
Demand and supply, actually, are just two of the variables that go into determining
price, as we saw in the case of the eager friends who were headed to Ladakh. In the
case of travel industry, apart from demand and supply, events such as festivals or
holidays, time of day and occupancy are also factors that can cause a change in fares,
says Sanjay Mohan, the chief technology officer of travel site
Makemytrip, which is listed on the Nasdaq.
While occupancy is a major factor determining fare in travel, the number of buses or
flights operating on the route is also considered. For instance, if there is only one flight
scheduled at 8 am across airlines, it is priced higher. But if another airline schedules a
flight at, say, 8.30 am, capacity is doubled and competitive pricing kicks in, says Ankur
Bhatia, a director at travel software provider Amadeus India.
Also in the travel industry, it's imperative to have a vigilant dynamic pricing model in
place since it deals with "perishable inventory," meaning if a plane flies an empty seat
there is no way to recover the cost of the seat.
Complex though that it might sound, the concept of dynamic pricing has been around
for years in the offline market.
The auto driver you approach to take you to your home at 6 pm asks for an "extra Rs
20," blaming it on traffic. The fruit vendor round the corner who sells strawberries
throughout the year raises the price of the fruit by a few hundred rupees in offseason.
You also pay a premium for passport size pictures that you get printed urgently.
With services migrating to online platforms, pricing them dynamically is now done using
sophisticated algorithms that list out an optimum price by considering more variables
that an individual can possibly include.
For instance, online classifieds portal Quikr uses one such algorithm to determine, say,
the ideal price at which to list that old car for sale. It helps sellers decide what it calls the
'maximum selling price' using an algorithm that takes into account active listings as well

as historical data and comparing these with attributes of the product, such as the
model's current price and year of manufacture.
"Delivery time, weather, market conditions are some factors that trigger an alert to
change prices in ecommerce," says Madhusudhan Rao, the head of India operations at
Boomerang Commerce, a startup that helps retailers integrate dynamic pricing
solutions. For cab hailing apps such as Ola and Uber that work on an on demand
model, ensuring that there is always a cab available on request requires dynamic
pricing to fulfill demand by providing supply. To do so, they resort to 'surge pricing,'
which has two effects: people who can wait for a ride often decide to wait until the price
falls and drivers who are nearby go to that neighborhood to make an extra buck. As
supply increases, or demand falls, prices head back to the normal equilibrium.
"For the duration that surge price is active, the algorithm reads demand data every five
minutes and updates the multiplier effect that determines fare," an Uber representative
said. A product that is a runaway hit can also command prices, as in the case of the
hardboiled candy, Pulse that Noida based DS Group launched last year. It became so
popular that local kiosks were asking consumers to pay a 50% premium to buy it.
While this might be a classic example of skewed demand and supply spiking product
price, there are also sly tricks by some online commerce platforms which are not shy of
discriminatory pricing. In what is termed by industry experts as a shrewd way of
targeting the well off, some of them quote prices depending on the devices from
which the requests emanate.
So, if you are checking from the latest iPhone, you could end up paying more than a
buyer who uses an old desktop. It's not all bad for the customer. Have you ever noticed
price variations in the same products on an online shopping portal? An algorithm makes
it possible. It cross-references features of products, matches common attributes,
compares price and triggers an alert if a similar product is charged at a different price on
a competitor's platform. A rule set in the algorithm decides whether the price of the
product needs to be changed to match the competitor's price. This means that if a seller
lowers the price of a popular product online, its competitor is highly likely to do so, too.
So while the friends planning their trip to Ladakh learned their lesson and booked their
tickets through one device in a single attempt, they also put their learning to use by
buying their winter wear at lower price in summer.