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FEATURE ARTICLE Theme: Dynamic Pricing Reaches
Most Industries |
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Dynamic Pricing, Models
that Work by Bennet Harvey The impact of this pricing revolution on the business community has also been profound. Companies have had to scramble to keep up with their competitors, invest in new technologies, reconcile or eliminate channel conflicts with agents and brokers, and slash overhead to protect ever-tightening profit margins. The change has been most humbling to major brands, which have found themselves competing solely on price against upstart companies that have not had to invest millions of dollars over generations to build their brand equity. The Internet has made the slope to commodity status very slippery. It all started with the migration of simple auctions to the Internet in 1996, and then the landscape of commerce began to change dramatically. Where once consumers called a travel agent and trusted them to give you the best fares (and paid a premium for the service) now they can go to www.priceline.com and use reverse-auction technology to define a destination, the preferred travel dates, and the price the consumer is willing to pay. Within 24 hours consumers receive an e-mail confirming that an airline will or will not honor their price on the day they wish to travel. The airline currently reserves the flexibility to define the time at which the consumer will travel, and Priceline does not guarantee direct flights. Even this new model is not immune to competition through innovation, however. The airline industry is moving online in a belated attempt to maintain control over their own pricing. In September a consortium of airlines plans to launch Orbitz, an online travel agency designed to compete with www.travelocity.com and www.expedia.com for leisure travel ticket sales, possibly improving on the Priceline model by allowing customers to specify flight times as well. In a similar mortgage industry model,
companies like www.lendingtree.com and
www.getsmart.com allow customers to enter
personal profile data and define the mortgage rate and points they want, and within
a matter of hours a selection of lenders will respond directly to the consumer
with either acceptance of the customer's terms or a counter-offer. In these new models, the customer sets the price,
usually having done previous research to determine what a good value would be.
In the case of an airline, the company then models the likelihood that
they will be able to sell the seat at full price and determines whether it is
in their best interest to take the lower fare now rather than nothing at all later.
Under this model, the airlines must respond using either automated systems
or dedicated teams of reservations agents to efficiently manage the volume of
inbound offers from customers. In
the case of mortgage companies, the decision of how to respond to a customer's
offer is more complicated. The company
must decide whether they can diverge from their standard underwriting policies
to accept the customer's offer, and still be able to sell the resulting loan in
the secondary market. Another new pricing
model is demand-based pricing. This
model is a new spin on the old concept of volume discounts.
Sites like www.mercata.com, and www.mobshop.com
allow users to commit to buy a product if the price drops at least to a specified
level within a time period, usually a few days.
When enough people have signed up, the price drops to the next threshold,
and then if enough people agree to buy at the new price, the price will drop again
to a third level. Eventually the
clock runs out and everyone gets the same price - the price associated with the
final number of people who committed to buy. Dynamic
pricing is not only about new pricing models, it is also about companies pushing
access to their pricing engines past the biased screen of middlepersons directly
to consumers. This can take place
directly on a company's own Web site, or through aggregator Web sites where consumers
can shop across multiple vendors. At
www.esurance.com, we collect information
on a customer's driving record, vehicles, occupation, marital status, age, and
geographic location and deliver an immediate online quote for auto insurance that
the customer can customize and buy online within minutes.
They can even print their proof of insurance card and policy on their home
printer. To reinforce our price positioning
we use a third party service to offer customers competitive quotes from other
insurers in their state so that our customers can feel secure that Esurance's
rates are indeed among the most competitive available.
Esurance also participates on insurance aggregator sites including www.quickeninsurance.com
where we are one of many companies offering quotes to customers.
Once the customer chooses us, they are passed directly to our Web site
to complete the purchase of their policy and continue their online experience
with Esurance throughout the life of their policy.
The customer controls the experience, and interacts directly with Esurance
by Web, phone, online chat, e-mail or fax.
An agent never gets in the way. Aggregator
sites serve the mortgage consumer as well, with the most popular sites including
www.quickenmortgage.com, and www.eloan.com.
These aggregator sites ask a range of very personal questions about income,
expenses, assets and liabilities, etc. without requiring customers to identify
themselves specifically. They compare
an applicant's data to a matrix of approval and pricing criteria, then deliver
to the applicant a list of providers and rates that has been dynamically built
for them. These sites link directly
to credit agencies while the customer is on the site in order to present a qualified
approval based on the consumer's credit history. Most
consumers have no idea of the calculations that are made in order to deliver this
dynamic pricing, and many are suspicious about how their pricing might differ
from that offered to the next visitor to the site.
This suspicion is unfounded, as the financial services industry, whether
on-line or off-line, is one of the most closely regulated in the U.S. economy.
Both the insurance and mortgage industries are governed by extensive state
and federal regulations, and are policed by regulatory agencies that license lenders
and insurers and require filing of underwriting guidelines and pricing plans.
In the mortgage industry, approval criteria include ratios of income to
expenses, credit ratings, property value, loan amount, property type and usage
and more. Insurance criteria include
age, occupation, claims history, property type and usage, etc. The B2B world is experiencing its own revolution,
where purchasing managers can now interact directly with vendors over the Web,
often finding vendors at B2B vertical portal sites like www.verticalnet.com.
In that environment vendors are free to segment their pricing as they see
fit in order to maximize profits. Variables
might include geography, the size of the client firm, the credit-worthiness of
the purchaser, and more. Business
purchasing managers can also take advantage of the demand-based pricing sites
just as consumers do. You can't play in the dynamic pricing arena without technology. Whatever your pricing model, you will need to invest in the technology to deliver differential pricing to consumers on a timely and reliable basis. Dynamic pricing engines must satisfy several basic requirements: Data collection - The engine must have a user-friendly interface that allows consumers to input the variables that will drive your pricing logic. Usability contributes significantly to conversion rate - the ratio of buyers to total visitors. Customer Segmentation - Your engine must be able to differentiate between customer segments and assign pricing appropriately. As discussed below in Regulatory Compliance, this segmentation must pass review by your industry's regulatory agencies, as well as by the Federal Trade Commission. Pricing Maintenance - You must be able to set up, maintain, and modify multi-dimensional pricing matrices based on the performance of your pricing scheme. It must be possible to modify your pricing on as close to a real-time basis as possible. Pricing decisions must be driven by careful pricing analysis of reports from your pricing engine. Reporting - A good reporting engine is critical to the success of your dynamic pricing initiative. You must be able to not only report on the sales performance of your pricing scheme according to your existing segmentation strategy, but you must also be able to cut your reports by additional variables to determine if your segmentation plan is optimal. Security - Dynamic pricing usually requires the transmission of personalized data between the consumer and the vendor. 128-bit encrypted transmission from behind your firewall to the customer's browser is industry standard. Scalability
and Reliability - You need 24/7 site availability if you don't want your customers
to go somewhere else. If your company
does not have a big technology budget or staff, look into the services of a new
breed of Web Operations Companies like Marc Andreesen's new venture LoudCloud.
They can set up your e-commerce site from start to finish, and maintain
it as you grow. The bottom line is that companies
in many industries are finding they cannot hope to optimize their profits or compete
based on price without mastering both the buyer and seller sides of the dynamic
pricing revolution. Among the biggest
issues companies must face when embracing dynamic pricing are: Channel
conflict - Many firms with captive agents and internal and external sales
forces have initially sought to offer the same pricing through their corporate
Web sites as has been available through their traditional sales channels. Amway chose to maintain pricing and to give their sales force
credit for each sale over their www.quixtar.com
Web site to one of their network of representatives. Merrill Lynch (www.merrilllynch.com)
had initially defended their sales force of financial consultants from the onslaught
of low-priced online brokerages. They
finally accepted reality last year, and now offer four tiers of investment services
and pricing for individuals, ranging from fully-discretionary asset management
by a professional investment manager to two variations of a one-to-one relationship
with a Merrill Lynch Financial Consultant to self-directed online investing through
Merrill Lynch Direct for $29.95 per trade.
Allstate Insurance (www.allstate.com)
has elected to cut loose their captive sales force of Allstate agents and re-position
their services around ubiquitous access to services over the Internet, by phone,
through independent agents, etc. Regulatory
compliance - The financial services industry, among others, must be ever vigilant
so as not to be perceived as varying pricing based on customer demographics like
race, gender, geography, education, etc.
The offline term for this issue, "red-lining," has been coined in the online
world as "Web-lining." Technology
- Web-based dynamic pricing requires robust back-end systems that can handle
large volumes of transactions with high security and reliability. Flaws in pricing systems can lead to lost revenue, regulatory
violations and public relations disasters.
Systems driving pricing for offline channels like brick and mortar sales
forces must be in synch with Web and phone-based transaction systems so as to
prevent customer services issues or arbitrage by savvy consumers. As you can see, fixed prices are a thing of the past.
If you're not providing dynamic pricing in your business, you need to. You need
to choose the model and implement it in a way to ensure success.
Bennet Harvey is Vice President of Product Strategy at online direct insurer Esurance, Inc. - www.esurance.com. Bennet's previous e-commerce experience includes building and implementing Cendant Mortgage's online mortgage strategy at www.cendantmortgage.com, and launching AOL's Classified Advertising service at www.aol.com or AOL keyword "classifieds". Bennet received an MBA from the University of Chicago specializing in new products.
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