Surge Pricing - The Pros and Cons to Consider Before Using this Strategy in Your Small Business
June 14, 2023
"Surge pricing" models once represented a relatively limited strategy — the kind of thing that only certain companies and industries used regularly. Think Uber, airlines, or concert tickets.
However, today, conditions have changed. Improving technology and wider acceptance among consumers has broadened the utility of this powerful pricing approach. Thanks to these dynamics, more firms are implementing this strategy. As outlined in a recent Wall Street Journal article, businesses as diverse as bowling alleys, restaurants or gyms have experimented with the approach.
Given this environment, does surge pricing represent a good choice for your small business or startup? This blog answers that question. We'll shine a light on this pricing strategy, outlining the pros and cons, giving you the information you need to determine whether you should take a closer look at this opportunity.
What is surge (or dynamic) pricing?
Probably the most famous surge pricing comes from Uber. The ride-hailing service uses complicated algorithms to make real-time supply/demand calculations, based on the number of drivers available and the level of current customer interest.
This has led to some unpleasant situations. For instance, in 2022, a subway shooting in Brooklyn led to a jump in demand for Uber and Lyft in the area of the attack. This, in turn, prompted a sharp short-term rise in local pricing, prompting complaints that the companies had taken advantage of the tragedy for a brief bump in revenue.
While a string of headlines in recent years have made Uber the poster-company for surge pricing, the general concept is relatively uncontroversial. Rather than representing some new concept developed in Silicon Valley as part of the gig-economy revolution, the basic strategy has long been part of standard business practice across a number of industries.
The fundamental concept is known as dynamic pricing. At its heart, this refers to a company's ability to change its prices based on variable supply/demand conditions. Here are a few common examples that you might not think about as examples of dynamic pricing:
- Hotel pricing for off-season versus on-season
- Airline tickets
- Cover charges for weekends at clubs and bars
- Utilities charging more during particular months
Generally speaking, these examples fall into a handful of discrete categories. Here are some of the major forms of dynamic pricing you can consider:
Time-Based Pricing: Pricing in this structure relates to when the product or service is delivered. As an example, beach-side hotels become more expensive in the summer.
Peak Pricing: A more targeted version of time-based pricing, this method uses data to identify moments of highest demand. This category epitomizes surge pricing as practiced by Uber and others.
Segmented Pricing: Here, the pricing changes come based on the type of customers. Think military or student discounts.
Competitive Pricing: Rather than responding just to your customers’ behavior, this approach also considers the broader market landscape. It takes your competitors into account, looking at other prices to help you optimize yours.
Penetration Pricing: In this scenario, you add an additional element of strategy. You purposely set pricing at a level aimed at capturing market share rather than maximizing short-term revenue.
Why are more businesses and industries implementing dynamic pricing now?
As we noted, some industries have long used some version of dynamic pricing as part of standard practice. Time-based models are well-established in the travel segment, for instance. However, the strategy has seen broader acceptance in recent years, expanding into new areas and fresh market segments.
The fundamental concept is known as dynamic pricing. At its heart, this refers to a company's ability to change its prices based on variable supply/demand conditions.
This wider implementation has been fueled by improving technology. As evidenced by gig economy stalwarts like Uber, the ability to receive and analyze data in real time opens up the possibilities for dynamic pricing. Faster data processing makes approaches like peak pricing and competitive pricing easier and more responsive.
How does this affect your business? A broader application of these techniques means that you might have opportunities that weren't available even a few years ago. As such, you should regularly review the possibilities and take advantage of chances to improve your business.
Start by considering dynamic pricing in general. Think about the potential upsides you can see for your startup or small business. With that in mind, here are some of the benefits of dynamic pricing:
Maximize Revenue: Get the best selling price for any given situation. Over time, this ensures that your revenue reaches its highest possible level.
Take Advantage of Tech Improvements: As noted, the expansion of dynamic pricing has come in part as a result of technological advancements. This strategy lets you leverage these enhanced abilities, letting you get the most out of the tools available.
Avoid Shortages and Scheduling Snafus: It's Econ 101. The right price means an efficient market. In this way, you can actually provide better service to your customers, giving them price breaks when conditions are right and preventing long waits or shortages at times of high demand.
While it comes with significant potential upsides, there are challenges to consider as well. Here are some of the drawbacks that can come from dynamic pricing:
Can Require Strong Data/Tech Backbone: A dynamic pricing model requires an investment. To get the most out of the endeavor, you’ll need to devote resources to data mining and creating a strong tech backbone.
Potential Customer Backlash: Given the possibility that variable pricing can lead to discontent, it's important to be transparent about your policies and manage potential pushback from your customers.
Getting started with dynamic pricing
Now you've seen some of the pros and cons of the dynamic pricing model. If you're interested in moving forward with the strategy, it's important to know how to get the most out of the endeavor. Here are some tips to help you get started:
Engage a source of expertise
A lot goes into a successful dynamic pricing structure. You'll need detailed expertise to get it right. This includes both creating the optimal algorithms for determining price changes and the operational procedures necessary to roll them out on a day-to-day basis.
As a small business, you might not have the resources for an internal team. To start, you can consider outside consultants and software providers to get the process going. From there, you can decide whether (and how quickly) to hire staffers to oversee the project.
Develop your tech backbone
Along with know-how, you'll also need to incorporate the right tools. Data analysis and day-to-day implementation of your pricing policy will require the right technology in place. Install the necessary backbone to make your dynamic pricing work as seamlessly as possible.
Where should you deploy your dynamic pricing? What will be the specific rules? Answers to questions like these come from data analysis. As such, build a robust process for gathering and parsing information about your customers and how they use your offerings.
Identify key opportunities for dynamic pricing
The data you collect will provide the raw material for the decision-making process related to dynamic pricing. The next step involves using this information to discover specific scenarios that could benefit from this strategy.
Review and update
Your dynamic pricing policy should be just that — dynamic. A structure that works in today's market environment might become suboptimal as conditions evolve. As such, you should create a process to review your policies and update them as needed.
The right price means an efficient market. In this way, you can actually provide better service to your customers, giving them price breaks when conditions are right and preventing long waits or shortages at times of high demand.
Understanding the value of dynamic pricing
More and more businesses are loving (and implementing) dynamic pricing. However, many consumers have qualms about the model, raising the risk of a potential backlash. How can you balance these forces?
Use the information provided here to get started. Consider whether you should start using this strategy in your small business or startup. From there, weigh the best way to minimize the risks and maximize the value of this powerful approach to pricing.