Can Dynamic Pricing Work?

Firms could avoid consumer backlash with pricing that works both ways, says Wharton’s John Zhang.

The controversy over plans by Delta Airlines to use AI for “dynamic pricing” of fares comes at a time of heightened price-sensitivity among consumers as higher import tariffs threaten to affect everything from orange juice to gasoline.

Dynamic pricing is not new, where firms fix prices based on shifting demand for their products or services. But the specter of higher import tariffs changes consumer sentiment in ways that embolden firms to use dynamic pricing to raise prices, Wharton marketing professor Z. John Zhang said in a recent episode of This Week in Business. (Listen to the podcast.)

Are Tariffs an Excuse for Dynamic Pricing?

“A lot of companies take advantage of what’s going on with tariffs and raise their prices,” Zhang said. “The reason is when tariffs go up, we as consumers tend to be more tolerant of price increases simply because we know that firms are struggling [with higher costs]. Their costs have increased, and therefore we probably cut them some slack. And firms know that.”

In a scenario where firms do not face external pressures such as stiffer tariffs, they avoid unilaterally raising prices because they would then lose market share to competitors who maintain prices, Zhang said. But in the current scenario where higher tariffs will increase costs for all firms, they are not as worried about how their competitors might respond, he noted. “They probably have more of an incentive in this environment to raise prices. [For firms that] have always been thinking about doing dynamic pricing, this might be their chance to use it.”

“A lot of companies do take advantage of what’s going on with tariffs and raise their prices.”— Z. John Zhang

How Firms Could Best Use Dynamic Pricing

Dynamic pricing could backfire if used unwisely. In the current environment, many firms “have not thought through the impact of dynamic pricing on consumers,” Zhang noted. Firms ought to “frame their pricing practices in a way that consumers are receptive” to changing prices, he said. He pointed to the fast food chain Wendy’s facing a consumer backlash when it attempted dynamic pricing last year. Wendy’s later clarified that it wouldn’t resort to surge pricing.

“Dynamic pricing doesn’t necessarily mean that you have to raise prices,” Zhang advised firms that may consider that route. “You could have a startup with a high price and offer dynamic discounts. Dynamic discounting probably would be a more palatable way to implement dynamic pricing.”

“[As a firm], you just want to make sure that when consumers are price-insensitive at a certain time, you charge a higher price,” Zhang said. “And when consumers are price-sensitive, you will charge a lower price.”

How Consumers Could Tame Dynamic Pricing

By definition, dynamic pricing ought to go both ways. “If you keep raising your prices over time, and never bring them down, that destroys the whole purpose of doing dynamic pricing,” Zhang said. In those cases, consumers could vote with their feet and walk away, “as they did with Wendy’s,” he added.

“[For firms that] have always been thinking about doing dynamic pricing, this might be their chance to use it.”— Z. John Zhang

Customers “don’t have to hate dynamic pricing” because it could go both ways, Zhang continued. “If you are really price-sensitive, you can become more vigilant and take advantage of low prices.”

Taking a step back, Zhang noted that dynamic pricing strategies are becoming more and more popular. The U.S. airline industry was the first to use dynamic pricing after deregulation in 1978, and over time, that practice has extended to hotel and car rentals, and so on, he added.

Despite the widening use of dynamic pricing, there isn’t a foolproof way to get it right. Delta’s move, for example, drew criticism from lawmakers over fears of “surveillance pricing” of consumers and potential breaches of consumer privacy. Delta has since clarified that it does not plan to target customers with individualized offers based on personal information.

This article originally appeared on Knowledge@Wharton.