Why Amazon Prices Change

An investigation into Amazon's dynamic pricing strategy and why they're so successful.

Just last week I bought a new bathmat for my apartment. Like most Amazon shoppers, I didn't think twice about the exact price: it was within my price range, the mat had good reviews and it would be delivered the very next day.

Great. I ordered it.

In hindsight, it turns out I got a good deal. At $12.99, the bathmat was the cheapest it had ever been.

As most Amazon shoppers are aware, prices on the platform change regularly. On average, Amazons' prices change every 10 minutes (Business Insider). This process is called dynamic pricing.

To understand why Amazon prices change so often, we'll break down dynamic pricing into 3 components:

  1. What is Dynamic Pricing?

  2. Benefits of Dynamic Pricing

  3. Downsides of Dynamic Pricing

After understanding all of the above components, we'll be able to conclude and understand why Amazon prices change every 10 minutes.

1. What Is Dynamic Pricing?

Dynamic pricing is a pricing strategy in which companies leverage real-time data to continuously adjust the price of a product or service. Most often, these are digital-first companies - which the type of company we'll focus on today.

If you've ever booked a holiday, you've most likely seen prices move day-to-day for flights and hotel rooms. The prices might even have changed by the time you reach checkout. This is an example of dynamic pricing.

However, successful dynamic pricing strategies require a tremendous amount of data. The more data a company has, the better it can understand customer's price elasticity and price products accordingly.

While dynamic pricing is common practice today, no company has been able to accurately predict a customer's price elasticity on an individual level. Instead, companies following a dynamic pricing model often pursue certain dynamic pricing tactics.

The three most common dynamic pricing tactics used by digital-first companies are highlighted and explained below:

A.  Segmented Pricing

B.  Peak Pricing

C.  Penetration Pricing

A. Segmented Pricing

Segmented pricing is the most common and intuitive dynamic pricing tactic - if you've taken a micro-economics courses, you're likely to have come across it. Simply put, segmented pricing is a pricing tactic which charges different prices to different groups of customers depending on their willingness to pay (WTP).

While willingness to pay cannot be measured per se, companies estimate consumers' WTP from a variety of socio-economic and behavioral factors such as income, location, type of computer, habits, number of times the webpage has been refreshed, etc.

A famous example of segmented pricing comes from Orbitz, the travel fare aggregator. In 2012, it was revealed that Orbitz charged Mac users more for hotels than PC users. Their price segmentation was based on the assumption that Mac users were more likely to spend more at hotels (Simon). According to Barney Harford, Orbitz's former CEO, the company found that "Mac users are 40% more likely to book four- or five-star hotel than PC users" (Simon). The company has since abandoned their OS-segmentation.

B. Peak Pricing

Peak pricing (or "surge" pricing) is simple. It's a dynamic pricing tactic in which prices are raised during periods of high demand, and lowered during periods of low demand (Hayes). Peak pricing is most commonly used by utility companies, who will charge a premium for utilities used when demand is highest (like cold, Winter afternoons).

Examples of digital-first companies that implement peak pricing are Uber and Lyft. When you order an Uber at rush hour, you're likely to see higher fares than you would for the same trip in off hours.

C. Penetration Pricing

Penetration pricing is a dynamic pricing tactic in which prices are purposefully set below market price in order to increase demand (Kenton).

Examples of companies leveraging penetration pricing are airlines, who will use penetration pricing in order to fill up empty seats on planes. Similarly, online event-ticketing platforms such as Ticketmaster will drop ticket prices to fill concerts that are not in high demand.

2. Benefits of Dynamic Pricing

The benefits of dynamic pricing to a company are three-fold:

A.  More Flexibility in Pricing Strategy

B.  Motivates Consumer

C.  Maximizes Profits

Let us analyze the aforementioned benefits through the lens of Amazon.

A. Flexibility in Pricing Strategy

Firstly, dynamic pricing gives Amazon flexibility over its pricing strategy. Being in control of the price of their products means they can leverage penetration pricing to attract more customers to a particular segment. For example, if Amazon Fashion sales are low and the company wanted to increase them, it could leverage penetration pricing to attract customers to that segment. On top of this, sellers (who are negatively affected by penetration pricing) would have no ability to complain because of Amazon's tremendous market power. Having control over, and being flexible with your pricing strategy is a unique advantage that Amazon leverages to meet their long-term strategic objectives.

B. Motivates Consumer

Secondly, dynamic pricing motivates the consumer to purchase. Indeed, consumers aware of Amazon's dynamic pricing may purchase immediately in fear that the product's price will increase. Macro changes such as a change in weather, season, temperature, and even events like the Superbowl or the holiday period may increase prices of certain items.

The chart above exemplifies the process of consumer motivation well. The prices of Tom Brady youth jerseys increased sharply right before the 2018 Superbowl. In anticipation of this increase, consumers may choose to purchase in early January rather than wait longer.

C. Maximizes Profits

Last but not least, dynamic pricing allows Amazon to maximize its profits. By analyzing consumer behavior, it can estimate the consumer's WTP for a product more or less accurately. In doing so, Amazon can change the prices of products in near real-time, allowing them to capture more of the consumer's WTP. While Amazon does not perfectly price discriminate, dynamic pricing enables them to get relatively close.

3. Issues with Dynamic Pricing

While dynamic pricing is beneficial in some cases, there are also a number of issues associated with such a pricing strategy. Continuing with the Amazon example, let's examine the three main issues of dynamic pricing:

A.  Customer Loyalty

B.  Algorithm Accuracy

C.  Increased Competition

A. Customer Loyalty

Customer loyalty is often adversely impacted when implementing a dynamic pricing strategy. For one, some consumers believe that dynamic pricing tactics are purposefully deceptive and unethical. As such, those consumers may choose to shop at more price-transparent shops.

Additionally, dynamic pricing may irritate consumers who feel cheated by price discrimination. The consumer may feel duped or cheated by Amazon, destroying the company's brand image. When done inappropriately, dynamic pricing can destroy a brand's image and incentive consumers to consider competitors (Hamel).

B. Algorithm Accuracy

A successful dynamic pricing strategy requires both a robust algorithm and extremely accurate input data. Often times, an algorithm may receive bad data or the algorithm itself can make a mistake. Algorithms cannot, by definition, account for all events that occur. They are limited by the assumptions made in collecting the data. As such, they cannot always be 100% accurate. Pricing too high could negatively impact sales and pricing too low could hurt profitability (Robles).

Worst of all, if a big mistake in Amazon's pricing algorithm goes viral, the company's brand image would be very negatively impacted.

C. Increased Competition

As mentioned above, dynamic pricing adversely impacts customer loyalty. As such, customers are incentivized to compare prices with that of competitors. Consequently, companies are forced to compete on price in order to convert customers. This cycle forces the companies into a price war, where their only point of differentiation becomes their price.

Price wars (and increased competition in general) benefit the consumer but hurts the company, as companies are forced to accept lower margins. More often than not, the companies engaged in a price war come out with a net loss.

Conclusion

Ultimately, Amazon prices change because the benefits of dynamic pricing far outweigh the potential downsides. As it is, Amazon's market power negates a lot of potential issues highlighted above, making a dynamic pricing a pure-upside.

First of all, Amazon has incredible customer loyalty and is close to invulnerable to algorithmic mistakes. A 2019 survey revealed that 89% of buyers agree that they are more likely to buy products from Amazon than from other e-commerce sites (Mohsin). Even though the pandemic saw the price of computer monitors, facial tissues, face masks and other pandemic-necessities increase by over 100% on Amazon (Lee), Amazon continued to grow throughout the pandemic. Amazon shoppers seem to be understanding of price changes on the platform. The company has such a strong offering and brand image that consumers will continue to shop on the website irregardless of price hikes.

As for the increased competition from dynamic pricing, Amazon is most often the price-leader amongst its competitors since it can offset losses on the Amazon marketplace by its other ventures. More often than not, Amazon is the competition companies fear.

With the potential issues from dynamic pricing accounted for, Amazon implementing a dynamic pricing strategy is a pure upside: it gives flexibility in pricing strategy, motivates the consumer to buy early and maximizes profitability.

In short, Amazon follows a dynamic pricing strategy because it makes them more money.