Apr 3, 2012

The Dynamic World of Pricing

The theory of economics teaches that in a free market, a price is the result of interaction between supply and demand. Supply and demand represent a theoretical model for price formation. In reality, however, the situation is less simplistic. A plethora of other important market factors affect prices. They include subjective values, marginal utilities, taxes, etc. Modern achievements in the field of information technology allow continuous monitoring of the marketplace and market participants to be able to adjust prices in real-time. Moreover the interactions between marketplace participants are highly dynamic; rendering prices volatile.

Another important sign of the age of information is the creation of a very unique type of marketplace. This kind of marketplace has no physical location and virtually any person with access to the Internet is able to transact. The largest operators of such marketplaces are eBay Inc., Amazon.com Inc., and Buy.com. These companies offer online platforms where buyers and sellers interact 24/7. eBay Inc. for example, grew so large that it evolved into a unique and significant ecosystem that is used in scientific research to validate properties of a free market.  Many online marketplaces offer services to both individuals and smaller online retailers. For many, online platforms like eBay have become the only place to conduct business online and being successful online is a matter of survival.

It comes at no surprise that the competition is furious in vibrant and highly dynamic markets. The ability to offer competitive prices and to react quickly is essential for success of any viable business, especially in markets as volatile as the Internet. These markets are already highly saturated and the only way to make up for low profit margins is to increase sales volume. Many online retailers offer hundreds or thousands of listings. With such a high number of propositions, price adjustments, for example, have become a difficult task to accomplish. But as someone said: “There’s an app for that”. A few online companies provide a new brand of software called automatic repricers. Some are standalone applications and some are included in larger frameworks called Marketplace Optimization Software (MpO). These services monitor the state of a particular market and adjust listing prices to match competition. MpOs offer a much greater spectrum of services for online retailer operating on platforms similar to the eBay model.  

Among all markets with highly agile price dynamics, travel related offerings stand out the most. Hospitality and rental businesses vary their rates greatly depending on a season, availability, last minute deals, etc. Air carriers employ a variety of highly complex algorithms to achieve quite a few goals such as to minimize the number of unoccupied seats, to retain existing subscribers, to lure passengers from competing airlines, etc. It has recently been discovered that flight search is a mathematical problem with a staggering depth of complexity. These elaborate pricing strategies often result in counterintuitive results such as flying from A to B is more expensive than flying from A to C first, and then from C to B, although fuel and time expenditures are much higher in the later case scenario. Situations like this one are quite common among airlines.

We live in an economy where prices can change by the minute. For an average consumer, it is difficult, if not impossible to monitor available rates and to choose the best deal. Hopefully, there will soon be a tool that would allow us to do just that. An aware consumer drives competition, and the competition is always good for the progress of our society and civilization.