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From auctions, to haggling, to group buying, retailers and consumers alike are becoming increasingly interested in retail formats where prices are determined on a transaction-by-transaction basis. With its ability to link buyers and sellers in a seamless web of communication, the Internet eliminates many of the costs that have made offline dynamic pricing expensive and unwieldy. But, clicks-and-mortar retailers must look beyond short-term business and revenue goals and consider the broader implications. For consumers, dynamic pricing is the opportunity to secure a better price. However, by providing such a discount offering, prestigious retailers could undermine their brand value. Other dynamic pricing models force consumers to make unwanted concessions in timeliness and selection.
A Mainspring eStrategy Direct consulting study on dynamic pricing suggests that ascending auctions, like eBay, account for more than 80% of dynamically priced purchases. In the absence of information on consumer demand, retailers usually guess what the appropriate selling price should be, often leading to costly inventory build-ups or money left on the table. By forcing consumers to compete for a limited supply of goods, ascending auctions ensure that the market clears and that goods are allocated to those willing to pay the most.
Putting the pricing strategy in consumers’ hands is risky, particularly for newly released goods, where retailers play a critical role in educating consumers of their value. As a result, auctions are best used to sell distressed items including excess inventory and open-box goods. What empirical results are available appear promising. Computer resellers using ascending auctions recover 60-80% of their costs on excess inventory, more than twice the amount they receive through liquidators. One apparel manufacturer recovered 104% of costs from auctions, versus the 30-40% recovery through liquidators.
Descending auctions are essentially a sale on fast-forward, with automatic price drops every few hours or every few minutes. This is particularly useful when traffic is insufficient to drive prices to satisfactory levels through an ascending auction. Broken lots, like those encountered in apparel retailing where the majority of sizes for a particular item are missing, are ideal for descending auctions. Because consumers must guess what others might pay, they may be inclined to pay closer to the maximum amount they would be willing to pay, and allow retailers to sell at higher prices. JC Penney and Lands’ End use this model on their web sites to sell closeout inventory including clothing, footwear, and jewelry.
The conditions when other dynamic pricing models are useful, including group buying, name your own price, and haggling are even more circumscribed. Group buying is best suited to selling products where target consumers are organized into close-knit groups and margins have enough room to allow discounts sufficient to motivate buyers to enlist their peers. Sites like Mercata.com facilitate customers’ recruitment efforts by allowing them to e-mail friends about a given product from the site.
Name your own price, as offered by Priceline.com and Expedia.com, is less about naming your own price and more about the ability for sellers to price discriminate between price-conscious and service-conscious consumers by limiting their choice of vendor and product/service features. Haggling is being used as a promotional platform where buyers can interact with entertaining personalities of their choice.
When selecting a dynamic pricing model, retailers must consider its long-term impact on brand value. Retailers will need to decide to deploy a dynamic pricing strategy under their primary brand, under a subsidiary/secondary brand, or selling through a third party. On the tactical side, retailers also must decide whether to purchase an off-the-shelf solution, build in-house or out-source site hosting to an ASP. Although the questions to consider are substantial, with forethought and planning, these models can help retailers squeeze more margin out of their operations.
Andy Schwartz is senior analyst at Mainspring Retail and Consumer Goods Practice based in Cambridge, Mass. www.mainspring.com.