Dynamic versus Static Pricing in the Presence of Strategic Consumers

The stochastic nature of demand suggests that firms can benefit from applying dynamic pricing strategies, where pricing decisions are postponed until information about demand is revealed. Many service providers, however, announce prices in advance and do not frequently adjust them as a response to market conditions (i.e., static pricing). This may seem suboptimal when demand is high and the firm can support a higher price. Yet, the firm may actually be better off with static pricing when consumers are strategic and consider whether to visit based on the firm’s pricing strategy. With static pricing, consumers face a rationing risk (they may not obtain the unit) whereas with dynamic pricing, consumers face a price risk (they may need to pay a high price) and it may be better for a firm to impose a rationing risk on its customers, especially when consumers’ valuations are dispersed. The problem with dynamic pricing is the firm’s inability to commit to always leave consumers with positive surplus. This provides an explanation for why firms commit to low base prices and may be willing to dynamically lower their prices but are averse to raising their prices, even when heavy demand suggests they should. In addition, we show that the advantage of static pricing relative to dynamic pricing can be substantially larger than the advantage of dynamic pricing over static pricing. Finally, the relative attractiveness of static pricing may be further improved by offering reservations or providing availability guarantees. We conclude that static pricing can be better than dynamic pricing and even better is a strategy that marks down the price if necessary and never marks up the price.