DYNAMIC PRICING:
PARADIGM OR PARADOX?
A White Paper on Dynamic Pricing practices and methodologies, and their
applicability to e-commerce strategies.
Copyright
©
2000-2006 Pricedex Software Inc. All rights reserved
www.pricedex.com
Dynamic Pricing: Paradigm or Paradox?
Introduction
There is much discussion with regard to Dynamic Pricing in today's e-commerce models,
and much of the focus has been on the dynamics of Auction Pricing. But, in the world of
informatics and business to business transactions, the application of Dynamic Pricing
methodologies has become a paradox, inasmuch as conventional business transaction systems
are not modeled to handle all the variations and iterations of pricing that such a transaction
methodology requires.
This paper will show the reader how to deploy and integrate a Dynamic Pricing strategy
into existing informatics systems, networks, and the World Wide Web. Additionally, this paper will
suggest applications for a Dynamic Pricing model that can be employed in more conventional b2b
and b2c transaction environments.
Dynamic Pricing - Today's Definition
What is Dynamic Pricing? Simply put, Dynamic Pricing is a price determination by the buyer and the seller at the time of a transaction.
Dynamic pricing models abound in day-to-day transactions. The best examples of this are Real Estate and Stock Market transactions, and those on e-Bay. In these circumstances, decisions are made as to what to 'bid', and when the point of resistance is met on either side, a decision is made to buy, to sell, or not to transact.
Another example is Auction Selling and Buying. In the Auction model, both the Buyer and the Seller have notional 'Ceiling Prices' and 'Floor Prices' (what they would like to pay/receive, and what they are prepared to pay/receive), and; usually through the use of an intermediary (the Auctioneer), buyers and sellers can bid for the purchase and/or sale of goods, with the intermediary generally setting the increments between bids, which changes, at the intermediary's discretion, premised upon the bidding activity. In these circumstances, time is generally the determinant as to when bidding closes and the transaction occurs. Certain rules may apply at the onset of the negotiation as to what the minimum acceptable transaction to the vendor may be, and this is referred to as a 'Reserve Bid'.
But what of the world of business transactions beyond these examples? 'e-Auctions' exist today and provide a component of Dynamic Pricing practices, and technology, to business. But e-Auctions provide only one part of a total solution. What are the models to provide dynamic pricing to the marketplace through other selling methods and channels? How does a business maintain essential profit and loss control in a dynamic marketplace, and what are the informatics models to deliver that control?
Dynamic Pricing - Today's Barriers and Risks
In order to rapidly deploy an e-commerce capability, business is partnering with Market Makers and Exchanges which offer a more dynamic presence to the marketplace. Businesses are moving their respective goods and services through these New Economy business brokers, and new sales channels have been established as a consequence.
The reason for this move relates primarily to the need to have an immediate e-commerce presence for a company's products, with little or no financial risk (to business) in the underlying technology to deliver the selling service. But there are risks, nonetheless.
The Exchange model may prove to work well with commodities, and provides a highly cost-efficient selling chain. But for other products and services, for which there are branding values or other market value perceptions and considerations, the risk of price erosion over time becomes high, indeed, as the buyer is encouraged to pursue 'best price' for like products. The dynamics of the Exchanges relate to the interaction between the buyer and the transaction system, and not to true dynamics in pricing.
There are other inherent risks to this approach as well, and industry watchers are now warning business to consider these exercises, and to maintain and pursue other sales channels and technology options. Some of the other risks, aside from price erosion, that should be of concern to business are those that relate to their conventional selling and fulfillment model:
(ii) Long-term over-dependency on the new channel, which, through its developed purchasing power, reverses the Pricing Model and dictates the price, thus creating a new pricing paradigm in which the seller has little or no control. (iii) Short-term risks associated with the economic viability of a particular Market Maker, or the merger with an 'undesirable' partner.
(iv) The added burden, and associated costs, of managing different data types for multiple Market Makers competing in similar market spaces.
Business needs to look at its own operations and strategies, and to which elements of the direct Selling Chain it can 'e-enable' into a Dynamic Pricing regime.
Dynamic Pricing - New Definitions, New Models
In order to develop a Dynamic Pricing strategy and model for comprehensive deployment, the first step is to broaden the definition of Dynamic Pricing to read: "To enable a price determination by sellers and customers at the time of a transaction".
The next step is to recognize pricing as a strategic function, and to recognize the need to integrate this strategic function into business operations and systems.
Lastly, Managers must define the transactions which require Dynamic Pricing, the sellers and customers for which Dynamic Pricing will be enabled, the conditions in which Dynamic Pricing will be useful and meaningful, the rules
which govern Dynamic Pricing in each of the conditions, and the delivery mechanisms for Dynamic Pricing for each of the conditions.
Table 1, below, provides an example of an analysis of Dynamic Pricing Requirements:
Transaction
Type
Seller
Customer
Condition(s)
Rule(s)
Delivery
Mechanism
Contract Negotiation
Direct Institution Major supply contracts in competitive environment
-Validate Competitive Information -Analyze Historical Volume -Analyze Projected Volume -Analyze Manufacturing Capacity -Perform Profit Analysis -Validate Terms of Payment -Calculate Ship-to Destinations -Apply Floors and Ceilings -Produce Commission Calculator -Select Pricing Curve
-Seek Approvals for Exceptions
-Quote (Paper/ Electronic/ On Line) Inventory Rationalization
Distributor End Users -Product Overstock -Supersession
-Perform Lifecycle and Supersession Analysis -Analyze Inventory Levels and Locations
-Apply Opportunity Cost Rules
-Offer (Paper/ Electronic/ On Line)
Promotions On-line End User -Competitive environments -Incentives to purchase -New product launches
-Perform Competitive Intelligence -Validate Inventory
-Validate Promotional Cost -Validate Purchase History Rules -Validate Time of
Day/Week/Month Rules -Calculate Promotional Price/ Quantity Rules
Promotions, Campaigns -On line Offer
Available-to-Purchase
On-line End User -High transaction E-store
-High product demand
-Third party products
-Validate Inventory/ Location -Validate Purchaser Location -Apply Inventory/ Location Rules -Calculate Shipping Cost(s)
-On line Pricing Variant
Store Pricing Point of Sale On-Line
End User Competitive landscape
-Validate Competitive Intelligence -Apply Leaders, Matchers, Stock Price Rules (ABC Pricing)
-POS System -On line Store
Table 1 - Example Dynamic Pricing Requirements Analysis
Of course, there are a range of variants, conditions, or even transaction types to which Dynamic Pricing methodologies could apply, but the biggest barrier today remains a means by which to dynamically produce anddeliver this pricing to the marketplace while maintaining the information for core business information system requirements. What
is required is an infrastructure by which a business can deploy Dynamic Pricing practices, while retaining informatics and financial control.
The IT Barrier to the Deployment of Dynamic Pricing Strategies
As previously suggested, there are major obstacles to deploying Dynamic Pricing practices within business information systems. These issues relate primarily to the lack of infrastructure to tie strategic processes to operating systems. This section will highlight some of the issues to be considered.
Front Office Issues
New technologies have afforded some level of dynamics by reducing the paper flow of the finished product; but the manual workflow involved in 'rolling up' this information still remains a significant time-to-market barrier. Some Customer Relationship Management systems can capture and analyze buying patterns and motions, offer buying suggestions, and can even identify a product as 'Available to Purchase'. Some Content Management technologies can enable the rapid deployment of a catalog or product information. And some Web Transaction Storefront Systems can handle multiple prices for the same SKU, and validate based upon user/customer parameters. On the whole, these remain operations-based systems, and do not embrace the strategic elements of pricing; rather, they rely on post-analysis parameters and post-calculation pricing data in order to function.
Back Office Issues
In the context of business and MRP/ERP systems, the number of variant conditions, and the calculations required to perform the analysis required is beyond the system architecture. Working around these limitations would be highly resource and time intensive, and, at worst, would require significant process and custom software recoding and modification. While some efforts are being made to provide more dynamics in later phases of MRP/ERP system implementations, the prime focus of the major vendors has been to develop hosted CRM and Market Maker solutions which integrate with the first phase implementations.
This move appears to be a concession that their respective Front Office initiatives are either months, or even years away from product launch, or that those initiatives have been abandoned entirely. Alternatively, this may be a simple reflection of resistance to the significant level of investment required to own and operate these solutions.
That being said, there remains a serious gap which leaves established business in the risky position of outsourcing their respective sales channels, or investing heavily in customizing their own proprietary technology solutions, with their inherent high cost of ownership.
Dynamic Pricing - The New Paradigm: Infrastructure before 'e'
In order to rapidly deploy a Dynamic Pricing strategy and workflow, it has been suggested that; somehow disparate sources of information, and disparate practices, must be consolidated and integrated with business and marketing systems. Table 2 is an example of some of the key components of a consolidated Dynamic Product Pricing Information system, and the functional areas/systems in which this information typically resides.
Functional Area of
Responsibility
Information/Data
Functional Area of
Responsibility
Information/Data
Marketing/Sales Areas/Systems
Business Systems Competitive Landscape Competitor-Location
Price SKU/SKU xREF Date Source Main Product Information SKU Cost Price Description
Product Information Product graphics Product marketing Descriptions Cost(s) Price(s)
SKUs/ Part numbers
Order Entry
Customer-Product Information
Customer
Customer-Product price
Sales Channel Information Commission Rules/Terms Reseller/Distributor Discounts/Terms International Pricing Billing Customer Information Location Purchase history Contract/Payment terms
Sales Intelligence Customer - Product purchase projections
Inventory
Product Inventory Information
Inventory location
OH/OO (On hand/On Order Min/Max
Lifecycle status
Table 2 - Components for a Dynamic Product Pricing System, and sources of information
In an ideal world, and an ideal corporate IT environment, the next stage would be to create the required integration between the various Information Systems. But many of the functional areas are paper or spreadsheet-based, especially those areas which fall in the domain of Finance, Marketing and Sales.
What is required is a new, middle layer of information system. The role of this system is to capture and absorb crucial sales and marketing intelligence and marry it with actual business system data in order to establish a master Product Information Management (PIM) database from which to drive Dynamic Pricing throughout the organization. The establishment of such a middle layer can potentially yield significant additional benefits, as the middle layer would be capable of supporting and driving other business and marketing requirements, and eliminating duplicate data and data entry processes. Such a system is considered a Dynamic Pricing and Product Information Management System, and provides a solid infrastructure to draw from and provide data and content to front and back office systems.
Figure 1 - Integrated Dynamic Pricing and Product Information System
Figure 2, below, provides an overview of functions utilized in a Sales Management System, which would, in turn, integrate with a conventional e-Commerce transaction system. The Sales Management System delivers dynamic pricing and product information to the Selling Channels and Customers from the Dynamic Pricing and Information System. Input from the e-Commerce and Sales Management System can be passed through the Pricing and Product Information Management System to calculate, and analyze data.
The Sales Management system integrates tightly with both the e-Commerce and Dynamic Pricing and Product Information Management Systems, which integrate data with the Back Office business and operations systems.
Summary
• Dynamic Pricing models abound in conventional business transactions, such as Real Estate and Stock Market transactions. In the world of e-commerce, Auctions exist but provide only one part of a total Dynamic Pricing solution.
• The primary barriers to deploying Dynamic Pricing are the lack of models, infrastructure, and software functionality to enable an IT initiative. This leaves a functional gap in organizations, which, by virtue of the manual processes in place to address the gap, is also a barrier to implementation of an infrastructure to enable dynamic pricing practices.
• Defining the transactions, the sellers and the customers which require Dynamic Pricing, and the conditions and the rules which determine how and when to apply dynamic pricing, form the basis of a Dynamic Pricing model.
• In an e-Commerce initiative, the sales management system is the delivery mechanism for Dynamic Pricing and Product Information.
• A Dynamic Pricing and Product Information Management System, acting as a middle application layer between Back Office business systems and Front Office e-commerce and sales management systems, provides the infrastructure that enables the Dynamic Pricing model to be applied and integrated through the business organization.
