Dynamic Pricing: The secret weapon that helps small businesses get their revenues back
Highlights
- The world is opening up again, but it won’t be the same
- Social distancing requirements heavily reduce the available capacity/ revenues of consumer-facing small businesses — but the fixed costs remain the same
- Dynamic Pricing can be a solution to balance demand
- Yield Management makes sense for high fixed cost, low variable cost (=high gross margin) type of businesses
- Businesses can act today to overcome problems of Covid-19 induced capacity constraints
The past 14 months have been a nightmare for the restaurant industry. After being forced to stay within one’s own four walls, the world is finally reopening its doors and everyone is ready for a taste of normality. However, the retail shop, gym, hairdresser, and restaurant landscape has changed and most people working in these industries are longing for „normality“. The question is if normality as we knew it will ever come back or if normality means something different altogether. Easing confinement measures still means fewer customers and missed revenues, all while bills and fixed costs remain.
Social distancing requirements heavily reduce the available capacity of consumer-facing small businesses — but the fixed costs remain the same
The below curve shows the typical demand of a restaurant and the maximum available capacity. Other businesses like gyms and retail stores would experience slightly different utilization/ capacity curves. They may also differ by weekday and or season. But each of them have one thing in common: their maximum capacity is fixed and there are times when they cannot accommodate more customers and other times when they are virtually empty.
Due to the governmental restrictions, the available peak capacity is often heavily reduced and the absolute dine-in revenue potential may only reach 50%-60% compared to pre-crisis levels during peak times.
At the same time, fixed costs including rent for the retail shop, office, or restaurant space; staff working as shop assistants, sales personnel, waiters and chefs; and utility expenses like gas, water, and electricity remain almost unchanged and need to be paid by business owners. Consequently, it becomes even more important to leverage off-peak periods in the quest to attract enough customers. So what is the secret weapon to bring in more customers while following social distancing restrictions? Dynamic Pricing.
Dynamic Pricing may be THE solution to balance demand
Yield Management has developed to be the go-to tool to dynamically adjust prices based on customer demand and has thus also increasingly gained significance during the Covid-crisis. Do you remember booking the expensive flights for the last family vacation or how you struggled to find an affordable hotel room during a major trade fair? Exactly, dynamic pricing was added to the equation.
American Airlines was the first to introduce Yield Management in the 1960s as a variable pricing strategy to forecast or manipulate customer behavior to ultimately maximize revenues. Airlines charge different prices for the exact same flight depending on the time of booking which reflects the price-sensitivity of customers. The price adjustments are aimed at maximizing revenues with a positive contribution margin. Thirty years later, the hospitality industry adopted this approach in pricing hotel rooms according to varying demand increasing prices on weekends and public holidays in comparison to weekdays. Oppositely, at low demand periods, prices are decreased in order to attract additional customers. Similarly, e-commerce stores experiment with price adjustments to optimize supply and demand which is also based on the customers’ willingness to pay. By using Revenue Management, the airline and hotel industry are achieving much higher utilization than many other industries, for example, the restaurant industry. While revenue management isn’t new, it remains just as essential in today’s business landscape.
Yield Management makes sense for high fixed cost, low variable cost type of businesses
Sounds great you may say, but does dynamic pricing really make sense for my business? The answer is, you guessed it, “it depends”. For whom does it make sense to dynamically adjust prices based on demand? Basically for most consumer-facing industries with high fixed costs, comparably small variable costs (= high gross margin), and varying utilization throughout the day, months or seasons. Gyms, hairdressers, cinemas, spas, restaurants, and bars are just some examples where the above-mentioned criteria are met.
Businesses can act today to overcome the problems of Covid-19 induced capacity constraints
What can be done to mitigate the negative consequences of Covid-19? After ensuring a safe environment for staff and customers as priority number one, businesses need to be proactive to survive the upcoming post corona period. Yield management becomes a key tool to improve business’s weakened revenue potential. Restaurants for example with only 50% seat capacity, need to extend peak times into off-peak periods to leverage revenue maximization opportunities.
Easier said than done since customers’ behavior and eating preferences don’t just magically change according to the business’ needs. Hence, customers need to be incentivized to visit the restaurant in off-peak periods. That’s exactly where dynamic pricing comes into play. Dynamically adjusted prices allow businesses to influence customer demand. This is especially crucial for restaurants since every individual guest brings additional revenue while in the case of gyms only a monthly fee is paid.
How can tools help you to get customers in off-peak hours?
An easy thing to do would be to place a sign outside your business advertising special off-peak discounts. Good idea, but there is one big problem: Everyone pays less now. Even customers who would not have minded paying the full price now get a discount which means that you cannibalize yourself. An example of this would be cinemas that often offer lower-priced tickets for everyone in the afternoon or the typical ‘happy hour‘-signs of restaurants. But there are smarter ways to go about this.
Third-party tools can help to balance supply and demand by allocating lower prices to a certain capacity in off-peak hours but also limiting the available capacity (e.g. seats in a restaurant) that are available for these lower prices. The right combination of lower prices with the right capacity bears the potential to boost overall utilization while increasing profits.
Successful third-party tools can be found in the hospitality industry with HotelTonight (last-minute bookings of hotel rooms), in gyms with ClassPass (using fewer credits for classes in off-peak hours), and in restaurants with DiscoEat (discounted tables off-peak), for instance.
In the hospitality industry, hotels rarely reach 100% occupancy which translates to missed revenue potential. HotelTonight (acquired by AirBnB), is a mobile application that specializes in same-day, last-minute hotel bookings at a decreased price based on customers’ location. Customers benefit from exclusive time-dependent deals on high-quality hotels that are not available on other Online Travel Agencies like Booking.com. By adjusting the price for left-over capacity, hoteliers benefit from attracting additional customers and thus, additional revenues.
In the fitness industry, gyms are rarely filled to 100% capacity at all times missing out on potential revenue. Regulars will visit the classes at the full price anyway, but how can the left-over capacity be leveraged? ClassPass, a flat-rate subscription service for the fitness industry, allows customers to book classes with associated credits. In order to increase revenues for gyms, ClassPass introduced two smart tools: SmartSpot, an inventory management tool to predict the number of spots filled by regular customers for a given class; and SmartRate, a dynamic pricing tool that allows fitness studios to adjust prices according to demand to fill the empty spots in the class and ultimately increase revenues. Pricing all classes the same leads to overcrowded classes. Dynamically adjusting prices facilitates extending the peak-hour demand into off-peak periods.
In Europe, DiscoEat has brought dynamic pricing into the restaurant industry. The platform allows restaurants to adjust prices leveraging off-peak times to optimize restaurant capacity utilization and hence, revenues.
These solutions prevent businesses from cannibalizing themselves, as regular customers still pay the full price for the service. The value lays in adjusting prices to attract additional customers while increasing capacity and optimizing revenues.
But these are just a few examples — options differ vastly by industry and by market. Even if there are no platforms, you can still use simple tools like newsletters and signs outside — they are still much better than doing nothing at all. As long-term consequences of this unprecedented situation remain unforeseeable in their magnitude, for now, it remains vital to adopt proactive practices to engage with customers and leverage revenue optimization opportunities including off-peak periods.
Find out more / Sources
DiscoEat: Restaurant Info
DiscoEat: User Platform
Forbes: ClassPass “SmartTools” Are Driving Millions In Revenue To Fitness Studios
Techcrunch: Airbnb agrees to acquire last-minute hotel-booking app HotelTonight
Entrepreneur: Can Yield Management Change the Future of Food & Beverage industry?
