I went to get my car washed today in freezing weather, the day of a massive snow storm about to hit DC. Needless to say, nobody else was there. (Why did I do this? Because the car desperately needed to be waxed + interior cleaned, and I'm not in DC for long). The experience got me thinking about dynamic pricing and customer loyalty.

Businesses typically try to use frequent-purchase tactics to drive loyalty, like a "buy 9 get 1 free" card or, in the case of airlines, frequent flyer miles. But I believe there's a better way to drive deep loyalty while at the same time maximizing the revenue a business gets: Dynamic pricing, with a Hedge. Here's what I mean:

As I mention in the video above, to say it was a slow day at the car wash facility would be putting it nicely -- I must've been one of only a couple dozen customers they would have the entire day. It's expensive to keep a carwash open on a day like today, including paying at least 10 employees to sit around and do nothing.

Airlines suffer from the same issue: The plane needs to leave the gate on schedule whether it's half full or entirely full. Those empty seats are all lost revenue.

It's the same with most businesses: When they aren't running at their max or optimal capacity, the business is losing out on incremental revenue that would have a very low incremental additional cost associated with garnering it. Or to put it another way, the cost of water & soap at the car wash is only a few dollars, so if the car wash could have more cars passing through, any revenue above, say, its $10 variable cost base per vehicle (and that's being generous) goes right to the bottom line.

I paid $50 for the car wash service, which is crazy on a day like today. So what if the business introduced dynamic pricing? On a non-busy day, why not just price the car wash above the variable cost of offering the service. Maybe $15 or $25 instead of $50. That would drive more volume, which would mean more revenue, but more importantly, it would also mean that more existing customers would be interacting with the business and new customers would be trying it when they otherwise wouldn't have. Anytime a business can increase the number of touchpoints it has with customers, it wins because it's getting customers used to interacting with that business instead of a competitor's.

The same thing applies for airline seats -- if a seat is unsold three hours before the flight is due to leave, why not offer the seat at a deeply discounted price to fill it vs. having it fly empty?

I believe the reason dynamic pricing isn't used more often is:

  1. A fear that it will confuse or anger customers
  2. A fear that it will cannibalize future higher priced revenue opportunities
  3. A technological difficulty in implementation

Uber is a leading player in its use of surge pricing, where it raises fees when demand outstrips supply. And it's gotten plenty of negative press for that. But as Jeremy noted in this post, the use of hedging could help mitigate that.

And that got me thinking about how hedging could really drive deep customer loyalty.

As the technology behind setting prices becomes more sophisticated, I fully expect to see dynamic pricing to become more widely implemented. Reasons #1 and #2 above are based on fear, and fear is never a long-term strategy. The only justifiable reason prices have traditionally been static in the past is because we've lived in an analog world. It's been hard logistically to change the price on a bottle of soda when the price is printed on a sticker or on a store shelf. But that's changing, and some things, like stocks, have always been priced dynamically. So I consider dynamic pricing that equalizes supply to demand to be an unstoppable trend, and the businesses that lead with it will benefit the most. .

The problem with dynamic pricing is that humans are emotional beings. If you're used to paying $50 for a carwash, you'll be happy to get it for $15 on a snowy day, but that doesn't mean you won't be unhappy when it costs $75 on a sunny summer day when everyone else wants their car washed. This is where hedging comes in.

What if I could lock in a price (and my loyalty) at the car wash up-front by buying 10 car washes for $500? I'd be paying an average of $50 per wash. The business gets to pocket $500 up-front and keep the interest float on the cash before the service is rendered. When the actual dynamically priced cost of the wash is less than $50, like a snowy day like today, I don't use one of my pre-purchased washes. Instead, I pay the lower rate of $15. So I'm happy on a day like today. But when I show up on a summer day and the cost of a wash is $75, I use one of my pre-purchased washes. Heck, maybe I can still buy the 10 washes for $500 even on the summer day that a single wash costs $75. When I use one of my wash vouchers, I feel like a VIP. I just got a $75 wash for $50. I feel smart for having locked in a lower price. And the business is happy because it's already made $500 off of me.

In this way, hedging a high dynamically priced service could be a great way to create customer loyalty while locking the customer into the service. And using dynamic pricing, just above -- or even at parity with -- the variable cost when there's low demand keeps revenue coming in the door.

I'd love to know what you think. Why don't more businesses do this?