Living Economics

Flexible Pricing
The Internet has made it possible to replace fixed pricing with flexible pricing based on changing supply and demand conditions. Spot pricing will lead to a more efficient market with winners and losers.

In the U.S., the corporate headquarters usually fix most prices until they change them. Fixed pricing makes sense in big businesses dealing with mass-distributed, standardized products. Because it is expensive and time consuming to change prices, fixed pricing has effectively become sticky pricing. Except for occasional promotions and significant cost changes, most prices are fairly stable.

Today, streamlined networks make it possible to have competitive bidding on almost everything on a retail basis quickly and cheaply. In a sense, this communication technology has brought us full circle back to spot pricing. Unlike old-fashioned spot pricing through face-to-face haggling, electronic spot pricing is based on cheaply and quickly aggregating buyers and sellers. While haggling thrives on bluffing due to lack of information, electronic auctions force buyers and sellers to reveal information through competitive bidding. Before electronic exchanges, only big projects were subject to sealed bidding because of the hassle and expense involved. With electronic exchanges, even minor purchases can be offered for competitive open bidding. NexTag.com, for example, arranges multiple sellers to bid prices down to win a buyer's small purchases (The Economist 9/18/99).

Flexible pricing makes the potential of a more efficient marketplace suddenly realizable. When prices can vary constantly with changes in supply and demand at little cost, buyers can more easily find the price at which they are willing and able to buy. The binary choice of either paying too much or doing without is essentially transformed into a game of waiting to be notified when just the right price comes along. Similarly, sellers can practice perfect price discrimination by charging a different price for each customer and each item. This pricing flexibility is particularly compelling for perishable goods, such as airline seats, advertising time, long-distance phone minutes, or electricity. Because price changes can be quickly and cheaply communicated to masses of potential buyers, sellers can afford to wait longer before lowering prices for a fire sale (Business Week 5/4/98).

Although rebate coupons rather than across-the-board price discounts are a clever way to target price discounts only to those who are more price sensitive, they pale in flexibility and targetability compared with online flexible pricing.

Will buyers or sellers be better off with flexible pricing?

It depends on the supply and demand conditions. For commodities with highly elastic supply, easy price comparison will lower and level prices across sellers. This will tend to eliminate competitors who cannot use the new technology to cut transaction costs (WSJ 6/8/98). To survive, sellers may also make price comparison difficult by offering customers a unique bundle of products and services to better meet their needs (Business Week 4/10/00). Prices for unique products with inelastic supply, on the other hand, will go up due to a larger pool of buyers.

Even though flexible pricing is now technically feasible, it may antagonize customers. M. Douglas Ivester, the former Coca-Cola Co. chairman, found that out last year when he floated the idea of changing the prices of soda in vending machines depending on the weather. Imagine paying more for a Coke on hot days (Business Week 4/10/00).

Note:
  1. Editor's note: Originally published in now defunct ecomecon.com in 2001.
  2. Editor's note: Originally published in now defunct ecomecon.com in 2001.
References:
  • Cortese, A. "Good-Bye to Fixed Pricing?" Business Week 5/4/98.
  • Coy, P. "The Power of Smart Pricing," Business Week 4/10/00.
  • The Economist. 99/09/18. "Visible Hand."
  • Wysocki, B. "Internet Is Opening Up A New Era of Pricing," WSJ 6/8/98.
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