Algorithmic pricing is a business practice that exists today, of which most consumers are unaware. However, this method of utilizing advanced algorithms to determine the ideal pricing structure for products is now more popular than ever. What is algorithmic pricing, and how does it affect your daily life? Is it better for consumers, or is driving prices skyward? Here’s everything you need to know about algorithmic pricing
Traditional Price Setting Methods
For centuries, prices were set by the vendor based on individual factors such as their local demand and supply. This way of setting prices manually involved analysts and managers communicating their scenarios which later would evolve into automatic pricing algorithms and Excel spreadsheets.
Today, pricing algorithms are used by a massive selection of industries. These powerful systems provide businesses with the ability to instantly set prices based on various factors. As such, these protocols are now in use across a huge selection of markets including e-commerce, entertainment, advertising, insurance, sports, travel, and utilities markets.
How Does Algorithmic Pricing Work?
Algorithmic pricing takes several factors and combines the data to achieve preset goals such as increasing profit margins. These systems often utilize probabilistic and statistical information regarding market conditions as part of the equation. Additionally, these algorithms will monitor supply and demand, competitors’ pricing, inventory, holidays, and even weather conditions.
Pricing algorithms are easy to operate once created and they can be run at regular intervals throughout the day. For example, Amazon’s algorithmic pricing is constantly altering product costs based on numerous factors. In theory, this approach should lead to more competitive pricing. However, the market appears to be veering off onto another course.
History of Algorithmic Pricing
Algorithmic Pricing has been around since the 1980s. It was first introduced by American Airlines as a way to set seat pricing based on seating supply and demand. If you have ever taken a flight, then you have encountered this system in use. Notably, the airline industry pioneered algorithmic pricing which helped it to spread to other markets.
Source – Algorithmic Pricing Airlines
Many companies have experimented with algorithmic pricing in the past. However, the technology wasn’t the same as today, and the methods could seem a bit crude to consumers, who often felt like they were being unfairly taxed. A perfect example of this scenario was a failed venture by Coca-Cola, where they attempted to have a vending machine that charged more based on the temperature outside. Needless to say, the project was a huge flop that led to consumer backlash.
Nowadays, the online market is the powerhouse, and algorithmic pricing has found new life and capabilities in the digital world. Today’s large online retailers dominate the market. They all utilize some form of AI-powered algorithmic pricing to maximize profits. As such, there is growing concern related to algorithmic price collusion.
AI Changed Everything
The use of powerful computer algorithms helped pricing strategies improve greatly but nothing boosted the tech’s capabilities more than AI integration. Artificial intelligence systems such as machine learning algorithms are capable of monitoring massive amounts of data in real time, learning from the information, and providing unique responses based on the plethora of data computed.
Notably, AI integration has improved algorithmic pricing capabilities across several dimensions. For one, it’s now much cheaper to operate and integrate these tools. AI systems don’t require supercomputers to run. As such, they are readily available to businesses via cloud systems.
Additionally, these systems can utilize a massive amount of data, including supply and demand, competitors’ activities, delivery schedules, and even logistical delays due to weather conditions. All of this data allows the AI to determine optimal prices in real-time.
Benefits of Algorithmic Pricing
The benefits of algorithmic pricing are obvious. For one, it enables a company to set pricing using preset coding rather than human intervention. As such, it’s ideal for uniformity and response time. Additionally, the system can be set up to maximize profits based on demand and other vital factors, allowing businesses to set prices promptly, often leading to fluctuations throughout the day.
Drawbacks of Algorithmic Pricing
There are many reasons why algorithmic pricing seems like it could help to drive competition and lower prices for consumers but those factors are seen by many as simply a ruse. In almost every instance that an algorithmic pricing algorithm is introduced, the prices for consumers begin to increase. In some instances, products can double and triple throughout the day.
The integration of rival price checking has led many analysts to conclude that algorithmic pricing leads to price collusion. When AI algorithms monitor competitors’ pricing to set their own, it should result in lower costs for consumers. However, if all the competitors are using similar pricing algorithms, price collusion occurs as the system seeks out an equilibrium for the market.
Algorithms Go Wild
Another concern regarding algorithmic pricing is its inconsistency. There have been many instances where these algorithms couldn’t compute some unusual data point which resulted in insane price gouging. A good example of this occurring was the time when a textbook on Amazon saw its price rise to $24 million. Hopefully, it was a good read.
Spin the Prize Wheel
Perhaps one of the biggest drawbacks of using algorithmic pricing models is that they can make the consumer feel alienated. It is frustrating when prices fluctuate often and can lead to consumers becoming distrustful of the company offering the shifting prices.
No Oversight
Like most of the AI revolution, there’s a strong demand for legal oversight to prevent abuse. As more companies integrate these tools to achieve higher profit margins, there needs to be some consumer protection put in place to prevent a scenario where you pay $100 for bottled water during an emergency.
Is Algorithmic Pricing Good for Drivers and Passengers, or just Maximizing Company Profits?
When you examine all the factors surrounding algorithmic pricing, there are still many concerns that need to be addressed to prevent this technology from costing consumers. Already, there have been significant price hikes by online retailers who utilize similar algorithms. This abuse will continue as the e-commerce market has surpassed $4T for the first time recently.
The online market has gone from thousands of small competitors to major online retailers dominating the space. This shift has also affected the use and results of algorithmic pricing models. For these systems to achieve a healthy balance between profit and consumer requirements, there will need to be a drive towards a more competitive market.
Uber is the King of Algorithmic Pricing
Airline companies may have introduced algorithmic pricing, but Uber (UBR -3.55%) has taken the process to an entirely new level. Every time you request a ride from the ride-sharing giant, the system will automatically look at a variety of factors, including ride availability, time, demand, major events, and weather conditions. From there, the system will determine your ride fare.
This strategy seems to make sense on paper but has frequently sparked controversy from the company’s +93M users for its sometimes heartless methods. For example, there is a trend that Uber prices skyrocket during terror attacks. During the London Bridge stabbings, Uber prices saw a 200% spike. The same price gouging occurred during the 2017 taxi driver strike and many other incidents like the 2020 Seattle mass shooting.
In theory, Uber is doing nothing wrong as it is simply adjusting to the intense demand during these life-threatening incidents. However, the cold and methodical approach of these systems leaves compassion and humanity out of the pricing equation.
Uber
Uber is the world’s largest and most successful ride-sharing platform. The company pioneered the now popular decentralized ride-sharing business model and has spawned many copycat competitors. The firm launched in 2009 as UberCab and was later rebranded into Uber Technologies in 2010.
Uber Technologies, Inc. (UBER -2.44%)
Uber Technologies, Inc. (UBER -2.44%)
Uber has expanded its ride-sharing options to now include food delivery and logistics services. This expansion has opened the door for new revenue streams for the firm, sparking renewed interest in its stock. Uber has also begun testing autonomous taxis. These driverless vehicles could lead to more market exposure, higher efficiency, and additional profits for the company in the future.
Amazon
Amazon is another popular firm that integrated algorithmic pricing years ago. The global online retailer used its deep pools of data to price products leading to billions in additional profit since integration.
Amazon.com, Inc. (AMZN +0.34%)
Amazon.com, Inc. (AMZN +0.34%)
However, not everyone was happy with the algorithm’s performance and the Federal Trade Commission (FTC) recently launched a case to determine if their actions are price collusion.
Root Insurance
Root Insurance is a firm that uses algorithmic pricing in a manner that has proven to be conducive to customer growth and building trust. This insurance firm does away with the normal pricing matrix which includes factors such as your driving history, criminal record, employment, and credit score.
Root insurance clients utilize an app that tracks their driving. The app then feeds the data to a pricing algorithm which gives each person a personalized pricing matrix. According to company executives, this method has saved the firm millions as it has been able to eliminate bad drivers, reducing the amount of wrecks they need to cover.
Legislators Watching Algorithmic Pricing
The word is about algorithmic pricing, and as more consumers file complaints about price gouging and collusion, lawmakers have begun to take notice. Already, legislators have put forth 440% more AI-related bills in 2023 and 2024 compared to 2022. These bills examine how algorithmic pricing is used to gauge shoppers and reduce competition, especially in the housing markets where these systems are used to set rents, which have skyrocketed as of late.
Multiple private civil antitrust complaints were filed in federal court regarding the legality of these systems. In one instance, consumers question the use of these systems to set hotel rates, which has seen competitive pricing disappear in major cities.
The Future of Algorithmic Pricing
The future of algorithmic pricing will depend on two main factors: legislative concerns and AI integration. As AI becomes more powerful, its ability to correlate unrelated events and compute complex patterns will only improve. As such, you could see the price of products increase instantly when factors that will drive higher prices weeks in the future occur.
Additionally, legislators will come under increased pressure to help reign in the effects of these algorithms. Consequently, there’s a good chance that some legal precedents will be set in the coming months, which should help to reign in these powerful computations and their effect on consumer pricing models.
Algorithmic Pricing is Here to Stay
When you examine all the factors surrounding algorithmic pricing, it’s safe to say that the practice isn’t going anywhere soon. These algorithms are making firms billions in profits, and they are reinvesting these funds to improve their algorithms. Sadly, this cycle may continue until the human factors of the equation are completely disregarded. For now, it’s time to consider how these protocols affect the markets and if they are good or bad for competition.
Learn about other cool AI developments here.
