One area of business that AI is transforming under the radar is pricing. After the supply chain disruptions in the pandemic, the resulting inflation, and now with tariffs coming into effect, nobody knows the right price for any product or service. This means that a significant undertaking of testing and learning the right price needs to be done. Using traditional tools like A/B testing, this can take years; however, with the latest AI tools, this can be done in much less time.
Delta Airlines recently announced that they are moving to using AI-powered pricing for tickets. This resulted in significant press coverage, regulatory inquiries, and consumer hand-wringing. However, the reality is that AI-powered pricing is an umbrella term that covers various technologies, not all of which fit every business.
From the press releases, it seems that Delta is doing pricing that is similar to personalized pricing. In personalized pricing, you provide a unique price that is optimized for every customer. You see this often in B2B pricing applications, where prices are often negotiated and carefully chosen to maximize revenue and conversion rates.
Dynamic pricing is another form of AI pricing. In this, the prices change (hourly, daily, or weekly)
but, at any given point in time, every customer gets the same price. AI-powered dynamic pricing has two goals: to test new prices and to optimize prices. It does this in an alternating way to ensure that the cost of testing is minimized while learning about new prices to find the optimal price.
Finally, AI-powered price discovery is a time-bound form of dynamic pricing that is often used when introducing a new product or finding the right price point for products with changed market dynamics. Take a product that has a 20% increase in cost. The merchant wants to understand how much of the cost they can pass to the customer versus how much margin they have to bleed the bill versus bleed dilemma. Price discovery is designed for this problem. The merchant needs to set an end date, say 90 days out, and the minimum and maximum price points for the product. Then the AI gets to work testing and optimizing the price so that at the end, the optimal price is set. Tools like a Shopify pricing app can be used to implement this for ecommerce businesses of all sizes.
All of these various forms of AI pricing are not just for setting regular prices, but also come into effect for optimizing discount prices, sending personalized promotions, and improving bundle incentives. However, just having the technology is not enough for successful business application. Prices impact the whole business; hence implementation needs to be done with care.
The PRICES Framework
To help our clients implement AI-powered pricing, we designed a framework called PRICES:
● Purchase frequency: If a product is repurchased often, e.g., milk, the price should be changed slowly. Conversely, if a product is not repurchased frequently, e.g., a living room sofa, the price can be changed regularly. This is because consumers notice the price changes of regularly purchased items.
● Range boundaries: AI is powerful but still requires human oversight. Setting price range boundaries enables guardrails to ensure brand positioning.
● Inform transparently: Communicate clearly to customers that prices may be changing and that they may get some benefit from this. In general, price discrimination is considered a bad word, but senior discounts or “children ride for free” are commonly accepted forms of price discrimination. Informing consumers about why and how prices change is imperative.
● Conservative thresholds: Advanced AI-powered tools can also configure the price change limit e.g., when changing prices, only move by a maximum of 5%. This minimizes the potential for consumer shock.
● Explain value: Pricing is tricky because of its dual purpose: to drive revenue and to project value to customers. Ensure that a human reviews the guardrails keeping this in mind. This is especially important for premium products.
● Strategic decreases: Due to AI-powered pricing, it is possible to find more price-sensitive customers. Strategic price decreases can act as a trial for your products or services and quickly expand market share at little additional cost.
Looking Ahead
As AI-powered pricing starts to be adopted by more industries and gains wider acceptance, a few different aspects will change. First, pricing impacts various other business systems e.g., in an ecommerce setting, a deep discount on a product will result in quicker inventory depletion and possibly affect economic order quantity. Changing prices can influence the conversion rate of traffic, and that in turn can change the cost of acquisition and require adjustment to the marketing mix. Hence, AI-powered pricing systems will need integration into other aspects of the business so that everything can move in tandem and enable business at the speed of AI.
