Dynamic Pricing Benefits Everyone - Part 2

By Scott Francis on Pricing Strategy / Post a Comment

canstockphoto1889694_gasstation.jpgIn my last blog post, Dynamic Pricing Benefits Everyone. Politicians Should Stay Out of It, I described the many ways in which dynamic pricing benefits us all.  As you can tell from the title, I also urged politicians to resist their natural desire to regulate things.  Within a couple days of my post, there was an article in the Wall Street Journal, Why Do Gas Station Prices Constantly Change? Blame the Algorithm that I would describe as anti-dynamic pricing.  The author was wrong.  Dynamic pricing is not the bogeyman.

The implication of the article is that by using artificial intelligence to optimize prices, retailers tended to follow each other rather than competing, with the result being higher prices to consumers.  In my opinion, the authors started with the view that oil companies are bad, and by using software tools, they are sticking it to the consumers.  However, if you actually look at their data and look at evidence at the gas stations in your own neighborhood, you will see it is much ado about nothing.

Let’s start with the chart in the article.  It showed that prices fluctuated by as much as $.03 per gallon during the week.  More specifically, compared to the average of the week, prices were up or down by 1.5 cents.  Even if gasoline was only $2.00 per gallon (it’s higher), that would only be plus or minus 0.75%.  Or, if an average fill-up is 20 gallons, it is plus or minus $0.30.  Does that seem like a bogeyman?  No.  And if that extra 0.75% enables the gas retailer to stay in business, that is good for us.

Next, the article pointed out that two competitors’ prices seemed to change by similar amounts at similar times.  That is not really anything new.  Gas stations in the US have posted their prices on large signs for years for customers and competitors to see.  Some stations, but not all, matched their competitors regularly.  Isn’t that the point of a competitive market?  Competition causes sellers to be efficient and not be too greedy with their prices or someone else might try to win the business with lower prices.  That results in very thin retail margins.  But when one competitor takes a chance with a slightly higher price (and 0.75% is very modest), it is logical for other competitors to reduce their own margin pressure.  If you follow a competitor’s price down, you certainly should follow it up.

Contrary to the collusion suggestion, the article also pointed out that the software recognized a time when it was unnecessary to match a competitor’s low price.  The competitor had lowered the price of gas, drawing long lines of customers.  The station across the street did not match the low price, but still generated a substantial volume of customers who were willing to pay a little more to avoid the lines.  To those customers, the value of not waiting in line was much greater than the $0.30 they would have saved on gas.

Now look at the gas stations in your neighborhood.  As I mentioned, prices are posted on large signs in front.  How often do you see the prices change?  Certainly, they change from week to week, but probably not nearly as frequently as the WSJ article implied.  Last winter I studied the posted prices at gas stations in Palm Beach Gardens, Florida.  The most frequent posted price of unleaded gas within a 3-mile radius was $1.99. DSC_0100.jpg However, the range was from $1.67 to $2.17, and they stayed steady for nearly a month.  I recently did the same price comparison in Jacksonville Beach, and prices varied by $.16 per gallon with a 1.5 mile radius. 

My last point is retail has always been a tough environment and if anything, it is getting tougher.  Margins remain razor thin and stores are going out of business due to insufficient margins.  Inflation has been benign for years and remains quite low by historical standards at 2.2%.  If the retailers were really colluding and driving prices higher, inflation would be higher.

Technology and software are big causes of low inflation and the challenging retail environment.  By all evidence, consumers have been the beneficiaries of that technology.  Retailers and others are smart to use it to try to improve their profitability.  Retailers provide service and bring value to their customers.  If they don’t make money, they won’t stay in business.  We are all a little better off if they can make a little money and continue to serve us.