Demand-Based Pricing: A Comprehensive Implementation Guide

Demand based pricing is anything but new to this world, but the latest technology has made it far more accessible for many businesses. If you have no idea what this strategy is or don’t know how to implement it properly, read this article and jump on the bandwagon.

Demand based pricing is an approach to establishing prices through the lens of fluctuations in customer demand. It stems from the idea that customers may be willing to pay different prices for the same product or service in different scenarios.

Unlike cost-based pricing, this method doesn’t rely on the manufacturing cost, although internal factors may be considered. It also differs from other external-factor models, such as competition-based pricing, since the main focus is placed on how the value of a product is perceived by the customer, which is why the method is also called customer-based pricing.

Since the efficiency of demand based pricing varies depending on a company’s goals and its standing in the market, you will need to choose the strategy best suited to your situation. Here are five ways to leverage this method.

Consumer demand for a product or service tends to fluctuate according to local specifics. For example, some products and services may be rare in remote areas, which makes them more valuable in the eyes of local consumers. This creates an opportunity to maximize your profits by setting higher prices than those aimed at residents of big cities.

On the other hand, a lower minimum wage in regions with struggling economies also affects the perceived value of a product and can become an obstacle to price increases. In this scenario, price discrimination will mean establishing lower prices for emerging markets than for consumers in developed countries.

Obviously, this demand based pricing strategy works best for global companies, which can incorporate it into their broader geo-marketing efforts.

This method works by establishing the highest possible prices at a launch with a subsequent gradual reduction. It requires locating affluent consumers who have both the desire and financial muscle to pay an inflated price for a unique product and gauging the amount they are willing to spend correctly.

This pricing strategy allows for skimming profit off the hype around the product and recovering a good share of development costs. As the high-end clientele gets exhausted and new competitors emerge in the market, the prices are scaled down for the product to reach a wider customer base.

Price skimming is a go-to method for innovative companies that offer unique and cutting-edge products and services.

Yield management employs dynamic pricing to urge customers to buy products that may become unavailable over time. The main principle applied in this scheme is tying prices to a gradual decrease in non-replenishable inventory level — the less inventory is in stock, the higher its perceived value, and so are the prices.

This demand based pricing method is extensively used in the airline industry, hotel business, car rental services, and other sectors working with perishable inventory. For example, a cruise line can sell early booking deals at a discount while raising the prices as the dates get closer.

The mechanism of penetration pricing is exactly the opposite of price skimming. A company taps into a market with a product priced below the market average to beat established competitors and attract a wider audience, especially price sensitive customers.

As the brand gains recognition and acquires regular customers, the company has the option to pull up the price while adding some extra benefits to smooth the transition. Satisfied clients tend to appreciate added value even if the prices rise.

As it follows from the name, this method is suitable for companies trying to penetrate highly competitive markets.

Value based pricing aligns well with the previous strategy, as it factors in added benefits as they are perceived by the customer. Since the concept is rooted in what the customer believes to be beneficial for them, it doesn’t always refer to real improvements or extra features. On the contrary, it often implies enhancing the customer’s self-image or creating an unparalleled life experience with premium products and services that are priced well above their actual value.

For this method of demand based pricing to work, a company has to offer unique and valuable products of high quality and apply a customer-centric approach in its marketing strategy.

Just like not all the above demand based pricing methods are applicable to every industry, they don’t come with sheer advantages either. You should get a full picture of their pros and cons before trying to implement this approach into your business.

Although demand based pricing may seem complicated, it’s far more beneficial than sticky prices and also viable in combination with other dynamic pricing models. Despite somewhat limited applicability and the risk of causing customer dissatisfaction if not handled properly, this approach will serve your goals if you need to:

• Boost both profit and sales. As demand rises, you can sell more products at a higher price.
• Beat your competitors. Depending on your standing in the market, you can either knock off the price or raise your price tag to better adjust to the market situation and outperform the competition.
• Survive downtimes. Sales and discounts revive customer willingness to pay even during low-demand periods, so your business will be able to stay afloat.
• Improve inventory management. By providing discounts for overstocked products, you will make way for products that can be sold at a higher price.

We have mentioned some examples of demand based pricing above, and here are other real-life scenarios that show how versatile this pricing method can be.

• If you often use Uber services, you may spot different prices charged for your regular trips. That’s because Uber adapts its prices to demand alongside other factors, such as heavy traffic or a reduced number of available drivers.
• Not only do Amazon sellers use demand-powered retail pricing, but the platform itself prices its products and services in the same way.
• Starbucks marked up the price of their gourmet coffee to maximize revenue from their price-insensitive customers, giving a nice example of value based pricing.

Since demand based pricing offers a range of methods addressing different challenges, a business that cannot benefit from one strategy has a good chance to derive profit from another. For example, while commoditized items like keyboards or cloud-based apps are poorly positioned to adopt the value-based model, penetration pricing may still be advantageous for an emerging company offering such products.

However, you are less likely to succeed with demand based pricing if you sell:

• Products or services that are easy to trace and compare. You will lose customers to competitors offering lower prices unless you are able to back up your pricing with extra benefits.
• Products or services with contractually-agreed prices. Service agreements and subscriptions with fixed prices make it impossible to change the terms depending on customer demand fluctuations.
• Storable products. Household chemicals or food products with long shelf life are often bought on promotion, and it will be tricky to make customers purchase them at an increased price.

As with any strategy, demand based pricing requires a systematic approach to work as intended, which includes taking the following steps:

• conducting market research
• performing customer segmentation
• setting up a cap to avoid selling at a loss
• defining your goals
• establishing appropriate KPIs
• monitoring sales
• adjusting the prices to get closer to the target

Customer-based pricing is challenging to calculate but guessing or ditching the strategy does no good either. Luckily, advanced IT solutions designed to process big data and powered by smart algorithms and AI can ensure the highest possible accuracy and deliver actionable insights while saving time and resources.

Tools like Priceva eliminate the need to constantly keep an eye on changes in demand and manually adjust the price of every item in your inventory. This dynamic pricing software comes with powerful features that leverage segmentation, competitors’ prices, consumer demand, and other market factors to arm you with automated price recommendations.

Clearly, IT solutions cannot replace the expertise of decision-makers, and business intelligence should go hand-in-hand with properly trained staff, but it is the most efficient way to make customer demand work for the benefit of your business.

The most popular methods used to translate customer demand into higher revenue are yield management, price skimming, value-based model, and penetration pricing. Geo-based pricing and bundle pricing are less frequent but still effective approaches.

Customer-based pricing relies on the customer’s perceived value of products or services, which creates higher or lower demand and allows for attaching prices to demand fluctuations. Both names describe the key role of the customer in price shaping.

Since demand represents customers’ willingness to pay, consumer preferences play a major role in setting the right price. Other important factors include product quality, price elasticity, and supply conditions.

Cost-based pricing focuses on internal factors, such as the cost of research, development, and production. Unlike demand-based pricing, it considers neither customer demand nor competition.