In this article, we’ll discuss demand-based pricing: what it is, how to use it, and whether it’s right for your company.
What Is Demand-Based Pricing?
In this post, we’ll discuss demand-based pricing: what it is, common types of demand-based pricing, and whether or not the strategy is right for your brand.
With demand-based pricing, sometimes called customer-based pricing, the seller adjusts a product’s price (often in real-time) according to customer demand and the product’s perceived value.
So, what does that mean?
The term demand-based pricing actually represents a broad approach to pricing that can include several strategies. What they all have in common, and what sets this approach apart from other pricing methods, is that the product’s price is determined not by inward-looking factors (such as cost of production), but instead by consumer demand. Specifically, the seller attempts to find the highest acceptable price for its products, at a given time, that a given segment of its customers will pay.
Here are a few examples.
Common Types of Demand-Based Pricing
This type of demand-based pricing is sometimes used as part of a broader geo-marketing strategy, where a company’s advertising, promotional activities, and pricing will change according to the consumer’s geographical location.
A company’s market analysis, for example, might suggest that online shoppers visiting its eCommerce website from a high-wage area, such as New York City, will pay more for the same item than will consumers accessing the site from a rural region of the country. For some products, the opposite might be true: customers in less populated areas might perceive your product as more valuable — and be willing to pay more for it — because it will be a rarity or difficult to find where they live.
A seller using the price-skimming strategy sets a high price for its product at launch time, and then gradually lowers the price over time. The idea here is to capture the more affluent consumers and early-adopters, and have these high-demand buyers help the company recover its costs for research, development, government compliance, etc. — and then slowly lower the price to attract a greater share of the market.
A good example of this demand-based pricing would be flat-panel television sets. These initially cost many multiples of their average prices today, and only the affluent could afford them. Over time, manufacturers have been able to lower their prices and make flat-panel TVs more of a mass-market item.
For sellers of fixed, perishable resources — hotel rooms, for example — yield management is a valuable strategy of price discrimination that lets the seller offer the right items, to the right customers, at the right prices, at the right time.
This is why hotel rooms typically are more expensive the closer to the date of your stay that you try to book a room.
The Pros and Cons of Demand-Based Pricing
- With a demand-based pricing strategy like price skimming, you can both enjoy high margins for a short period (because you’ll be charging more to the early adopters), and your high launch prices can even help generate buzz and media interest in your brand.
- Geo-based pricing can help you take advantage of the fact that people in some regions will likely pay more for the same item than people elsewhere.
- Yield management, the strategy of continuously adjusting the price (up or down) for your goods as demand levels change — such as happens with airline tickets — has several benefits. First, it can help you increase margins according to growing demand. Second, it can also help you maintain better customer service, by increasing the chances that some of your fixed inventory, like plane tickets, will still be available as the flight date approaches.
- Geo-pricing can create a lot of additional work to manage if your team needs to continually review market data across various geographical to determine where to set your products’ prices in each area.
- Price skimming will also require a lot of work and research to determine where to set the product’s relatively high launch price, when to begin gradually lowering the price to widen the product’s market, and at what time intervals and price increments these drops should take place.
One way to overcome both of the above challenges to demand-based pricing, and to determine whether it might be a viable strategy for your company, is to automatically gather as much data as possible about your own retail pricing across the internet, as well as your competitors’ pricing so that you set price strategies, based upon the realities of the broader market you intend to penetrate.