To answer this question, let’s take a closer look at the solution itself. Dynamic pricing is a form of yield management (also called targeted pricing, flexible pricing, tailored pricing or discriminatory pricing), which formally emerged in the mid-1980s as a means for airlines to capture some value from plane seats that would otherwise go empty by offering, for example, lower than published fares for customers willing to forego other benefits (such as the ability to change a flight date or cancel the ticket). This breakthrough science allows organizations to understand, anticipate and influence consumer behavior in order to maximize revenue or profits from a fixed, perishable resource (e.g. airline seats, hotel room reservations, etc.). In the case of the San Francisco Giants, dynamic pricing is being implemented to allow them to dynamically adjust prices by weighing ticket sales data, weather forecasts, upcoming pitching matchups and other variables to help decide whether the team should raise or lower prices right up until the day of the game.

The problem with dynamic pricing is that it doesn’t enable organizations to truly understand the needs, preferences and spending propensities of each and every customer they serve. For example, the problem I see with dynamic pricing for baseball franchises is that it relies on a basic set of variables (e.g. weather, starting lineup, etc.) to determine how to price to the masses, instead of focusing on – and pricing to – each customer’s specific needs. Let’s say I want to go to a baseball game on my birthday. Will the dynamic pricing system offer me a discounted ticket (or should it predict that I am more spendthrift on my birthday)? If my favorite pitcher is starting will the system recognize my willingness to pay more and increase my ticket price? If I regularly attend games throughout the season will the system consider my loyalty and offer me discounts to other games? The respective answers are no, no and no. The advantage here clearly goes to scalpers, as they can still adjust and negotiate prices with each customer they interact with directly. However, where I see the limitations of dynamic pricing end, the benefit of revenue optimization begins.

Revenue optimization technology can provide baseball franchises an accurate picture of demand down to the single customer-level, where the software can codify each customer’s preferences and adjust prices according to their needs, total amount spent and even longevity as a fan (i.e. brand loyalty). Baseball teams already capture tons of customer data through the MLB web portal, where fans can upload and track their favorite teams/players and purchase tickets and merchandise. All of this data can be mined to figure out each customer’s specific price point for every seat of every game! The technology enables baseball franchises to increase ticket sales volume for less popular games, reduce the number of tickets resold in the secondary market, and increase profits for every game. In addition, baseball teams can begin to cross-sell other items like concessions and merchandise to these loyal fans, or even optimize the sale of bundled tickets and/or merchandise. With this increased ability to effectively market to each fan, baseball franchises will become more adept at selling tickets than the scalpers and can soon “steal” their profits back – forcing scalpers to buy tickets if they want to see Major League Baseball’s most prolific stealers.

The problem many corporations frequently suffer from is fractured pricing policies where disparate departments within the organization have conflicting rules regarding pricing strategy. This is often a result of unimpeded change within each department, where every manager relies on their own gut instincts at pricing based on their limited view of the ever-changing picture of customer demand. In addition to this proliferation of pricing policies with the potential to impact the market’s demand, other departments in the organization are also making demand-impact decisions, such as advertising and product mix. These practices are often left to chance because most leaders A) don’t realize the problem exists, B) are currently surviving this economy with a meager profit that is most often derived from a “survivalist” measure like cost cutting, layoffs, and running tighter operations, etc., C) are consumed by the sheer volume and complexity surrounding marketing decisions due to the proliferation of advertising channels, products, customers, and supplier networks, or D) if they realize there is a problem, they aren’t aware of what solutions may exist. What these business leaders don’t realize is that they’re leaving enormous profits on the table all the while giving competitors the opportunity to lure their customers away with the “right” price.

To help shed light on the problems these business leaders are facing, I reflect on a quote from John Wooden – one of the most respected college basketball coaches of all-time with 10 NCAA basketball championships during his tenure at UCLA – where he said, “Before you can lead others, you must be able to lead yourself.” This brilliant insight by a legendary sports icon can also serve as an invaluable business axiom: you can’t lead your market until you lead your organization. Simply put, companies – especially those struggling in this economy – should turn their attention inward. Doing so will require new thinking, advanced technology and a change of focus towards effectively generating growth organically (as opposed to via manic serial mergers and acquisitions) for your firm. Forget about the credit crunch (i.e. insufficient investment capital, the dried up commercial-paper market, etc.), falling consumer demand and other external factors that you can’t control.

I believe that in order for companies to be profitable in this economy, they need to adopt both an enabling technology and decision-making infrastructure to help them determine the optimal prices, marketing mix, and product assortments that will maximize revenue and profitability. Successful implementation requires leadership from the executive suite and bottom-up support from the people who work in all functions throughout the organization. Technology is a necessary component and must be able to serve the firm across its organizational silos in ways that allow each part of the organization to achieve optimal productivity and profitability, taking into account both departmental and firmwide objectives. Visibility throughout the organization is also essential, where the stewards of each of the demand and supply levers in effect have the ability to discover previously unknown or misunderstood elasticities – this can lead to a virtuous loop of discovery and profit.

Times like these require business leaders to move past temporary measures to be successful in both the short and long-term – to not only help their companies survive this downturn, but also to be visionary and lead their market! The insight a company requires to effectively manage their marketing decisions should be robust and holistic – not only do they need optimal prices, but also recommendations on products for customer penetration (cross-selling), optimal deals and promotions and guidance to curtail customer churn. These organizations that are able to not only manage, but also execute their ever-growing array of marketing decisions will have the ability to drive their markets, rather than being driven by them, and will be better positioned to continue leading their markets when the economy returns with vigor, as they will be more adept to discover, view, analyze and act upon the opportunities present in their demand environment. I can only assume that the shrinking credit supply, weak consumer demand and other external factors will likely be with us for some time, but they are of little relevance to any business leader looking to grow their firm organically, and seek to embody John Wooden’s principles in the process.

And then there are those rare occasions where we encounter a street musician whose music soars so high that we are forced to refer to him simply as a “musician,” for using the adjective “street” would be nothing short of a criticism.  About 2 years ago, this is what I encountered at one of Washington D.C.’s busiest Metro (subway) stations during the morning rush hour.  It wasn’t until much later in the day that I discovered the musician in whose masterly hands the violin “sobbed and laughed and sang” was the great virtuoso Josh Bell.  In the middle of the morning rush hour, 1,097 commuters passed by and all heard soul-stirring music at a price of their own choosing that just a few days earlier fetched more than $100 a seat at Boston’s Symphony Hall.  Josh Bell played to a rush hour herd, and demanded no price for priceless music.

His income depended not on the value he provided to those 1,097 passersby, but the overwhelming value he provided – for, if he failed to stir, we listless commuters would feel no compunction to pause and forfeit even a meager fraction of our purse.  And stir he did, with a masterly performance of Bach’s Chaconne from Partita No.2 in D Minor.  Of the almost 2,000 pedestrians that filed by, only 27 gave money for a total of $32.  In other words, for a performance that was described by the Washington Post as “pearls before breakfast,” less than 3% of us offered any payment (for “a man whose talents can command $1,000 a minute”).  Did the service deserve such scant payment, or was there more to the revenue than just the greatness of the service itself.  This is a question that goes right to the root of just how complex the endeavor of pricing can be.

Beyond Josh Bell’s performance and the payment it merited, there is a litany of other factors that affected his earnings power (or pricing power if he were to charge a price).  First and foremost, there were 3 possible locations at which Bell could have positioned himself (see figure below):

1. At a location of high transient pedestrian traffic (between the entrance door to the subway station and the escalator bank that leads to the underground train platform).
2. At a location of stationary traffic waiting for a subway train to arrive (i.e., on the underground platform).
3. At a location where the acoustics of the Metro arcade would create the most perfect sound possible within the subway station.

Of the 3 possible locations, Bell perhaps chose the worst location to generate earnings.  No matter how good his music, rush hour traffic has no time to stop.  It wasn’t their purse that the commuters failed to contribute, but their precious time.

The attributes that govern your power to generate revenue transcend the product itself.  Bell’s performance at the L’Enfant Plaza Metro stop highlights several fundamental truths of pricing science:

1. Could being situated at one of the locations where stationary traffic was high have yielded more revenue?
2. Or, perhaps could being situated at a location where the sound would be even more magnificent have yielded more revenue?
3. What if the perfect acoustic spot had only scant stationary traffic?  Then, sadly, we can surmise his income would be lower even though the quality of the product would be it’s highest.
4. To complicate matters even further, what if Bell chose a different day for his performance?
5. What if he played on a sunny, spring day where spirits are higher instead of a dreary winter morning?
6. What if he played on payday (in the Federal government, payday typically lands on the 2nd and 4th Friday of the month) instead of an arbitrary day?
7. What if Bell advertised with a sign around his neck that he was indeed Josh Bell?
8. What if underneath the sign, Bell posted a requested donation of $5 for his performance?

By not focusing on these questions, and concentrating solely on his music (i.e., the tangible product itself), Bell failed to create a high market price for his product, and earned only $32 dollars from a 43 minute performance that in a proper venue would have earned 6 figures.   All of these factors would have dramatically affected the revenues Bell earned that morning.  But, identifying the 12 square inch box out of the 15,000 square feet of space in which Bell would have obtained maximum revenue (i.e., gotten an “optimal price” for his public performance) is an optimization problem of mind-boggling complexity, and simply cannot be solved without data and quantitative analysis.  After all, the analysis is not just about where Bell should stand to optimally balance sound quality with foot traffic, but also about how this optimal location varies with changes in any of the above 8 questions.  The lessons here are deep, and profoundly shape our responsibilities as pricing managers.

Before you jump to match your competitor’s price, you should recognize the market’s willingness to offer you payment that goes beyond the value of the product itself.  It is important for you to optimize the marketing attributes of the product in order to optimize the price of the product.  You are not at the mercy of the market. Through your actions you can greatly influence the market price of your product. As a pricing manager, you should not just view the setting of price as your only responsibility.  You have access to much data about your market and your previous sales and your customers, which you can leverage to determine the interplay between all of the marketing attributes of the product and the price of the product.  The price you are able to make is inextricably linked to the actions of your marketing managers, your category managers, and your product and sales managers.  And once those actions are executed, you can digest all of your data to pinpoint the optimal price you can charge in the market.  Last but not least, as a pricing manager, you are the final decider of the trade-offs your enterprise should make to maximize immediate earnings and establish a long-term competitive advantage:  Should you play your violin where it sounds the best but generates the least income or do you play it where it sounds the worst but stands to generate the most income because of high foot traffic?  If you do the latter, will those that pay you today have the loyalty to pay you again tomorrow?

So, before you give in to the seduction of lowering your prices to beat your competitors, remember to identify and carefully influence all of the attributes (i.e., don’t just make great music, stand in a great location) that will compel the market to pay you your just reward for the goods and services you provide.  The crux of price optimization is not about touching price at all, but touching all the other things that make a price.

Let’s say hypothetically that this printer has 10 different attributes like the ones mentioned above on which every buyer places a value, even it happens to be zero. There is a segment of the printer-buying population that wants all 10 attributes, including the HP brand name of the seller, and that segment is willing to pay a higher price. No other seller can satisfy all 10 attributes, giving HP a monopoly on that attribute set. But as a seller, HP operates within constraints since other sellers offer the same exact printer at a lower price in return for providing fewer attributes. Thus, HP cannot set its prices as a pure monopolist, because an excessively high price will drive too much of the market to the next lowest price tier. HP’s competitive position is what I call a micro-monopoly (or “Micropoly” if you prefer the conflation, as I do). The explanation for this price dispersion is that every seller of this printer satisfies a unique mix of attributes demanded by a particular segment of the market. For that segment, the seller has a limited amount of micro-monopoly pricing power.

When viewed from this angle, it becomes easy to see why it makes more sense to set prices based on what your customers value rather than what your competitors charge. The reason is that one firm may compete only tangentially with another firm that sells the same products. The obvious question then is what happens when two firms fulfill the same exact mix of attributes. At this point, firms would then compete on price, but I think this logical extension can be somewhat misleading. In the real world, no two firms ever truly occupy the same attribute space. There will always be at least some differences in the total experience and feel that the customer gets from making the purchase, and thus the potential for price differentiation exists. Multiple optimum prices for the same product can exist in the marketplace. A profit maximizing firm’s objective should not be to race to the bottom in a low price battle with competitors, but rather to understand very clearly what its price ceiling is.