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The Priceline Problem

(originally published by Booz & Company)

Dynamic pricing has been with us since the first farmer haggled with a customer over the price of grain in a village market. Although haggling went out with industrialization in most of the world, many believe the real-time interactive capabilities of the Web can revive it.

Still, not all Web-based dynamic pricing schemes have worked. Take’s now-defunct affiliate WebHouse Club. It seemed like a good idea when it was launched. Inc. had successfully developed its name-your-own-price technology to lure bargain-conscious travelers searching for cheap airline tickets and hotel rooms. Why not go after the rest of the consumer marketplace, starting with necessities like groceries and gasoline? On that theory, Priceline’s first progeny, WebHouse Club Inc., was born in November 1999. Less than one year later, in October 2000, WebHouse ran out of gas, groceries, and money. With as much media fanfare as when it began, WebHouse folded.

Why did Priceline’s pricing scheme work for one set of products but not the other? Because the success or failure of pricing depends on the product and who benefits:

First, there’s the nature of the product’s sales cycle. Airlines or hotels have an incentive to sell off unfilled seats or rooms at the last minute, because they’re “perishable.” That is, if a seat on a particular flight isn’t filled, or a hotel room on a given night isn’t used, the opportunity to sell them at any price is lost forever. And you can’t put them in inventory to wait until you find a customer. Consumer packaged goods and gasoline — the products offered by WebHouse — have no such limitation.

Second, selling inventory at a discount makes little sense if it must be replaced, possibly at a higher cost. Because airline and hotel operating costs are fixed, filling a seat or a bed uses capacity that is already paid for. Therefore, the cost of adding a customer is negligible, so almost any sale price would be profitable. Groceries, in contrast, have unit costs — related to manufacturing, processing, shipping, and maintaining inventory — that must be covered.

Third, there’s a difference between commodity products and branded goods — at least from the producer’s point of view. For airline tickets and hotel rooms, Priceline targets bargain hunters, in effect making the product a commodity. Customers for such services don’t care about carrier names or the inconvenience of changing planes. They want a flight to where they want to go at a price they can afford. And the airlines and hospitality companies, for all their lip service to the importance of branding, also treat their products and services as commodities, varying prices according to supply and demand.

The WebHouse model broke down because the match between price-conscious buyers and brand-promoting sellers was untenable. WebHouse needed the brand-name manufacturers. But they stayed away because Priceline’s permanent discounting was seen as a dangerous liability for their brand strategy, which is supposed to promote repeat purchases and loyalty.

Fourth, giving one buyer a lower price does not easily translate into providing discounts to the majority of buyers. Airlines can offer a lower fare to one customer who is willing to make last-minute travel plans, without cutting prices to others who want to book seats well in advance of their travel dates.

There is little flexibility to charge different customers different prices for manufactured items. You can sell day-old bread at a discount, but there’s no such thing as day-old gasoline. Differentiating products on short notice in other ways, such as design or function, is cumbersome and prohibitively expensive.

To assess a given dynamic pricing model, we recommend a few criteria as a starting point.

  • Information has to be an important component of the product or service. The Web can’t compress physical labor and other fixed costs; it can only make marketing and other information-intensive processes more efficient so there’s room to haggle.
  • To change the way buyers and sellers do business, there must be benefits for both. Self-interest has to be part of the system.
  • At a minimum, the broker must match the right buyer with the right seller (like eBay Inc.), and make a profit. If, as with WebHouse, the intermediary can only add value by burning investor cash to deliver a benefit to one participant in the transaction, the enterprise can’t succeed.

Raman Muralidharan,
Raman Muralidharan is a Cleveland-based vice president in Booz-Allen & Hamilton’s Consumer and Health Practice. He is a strategist focused on growth for companies in technology- intensive industries, particularly those firms trying to commercialize new game-changing technologies and/or build new business models.

Rhonda Germany,
Rhonda Germany is a vice president in Booz-Allen & Hamilton’s Consumer and Health Practice and leads the firm’s U.S. e-Business Core Team. Ms. Germany is a strategist focused on corporate and business-unit strategy for companies in technology- intensive industries, particularly those firms facing significant shifts in their value chains.
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