Mobility Research

Fundamentals of dynamic pricing

[fa icon="calendar"] 06-Jun-2018 13:57:19 / by Mobiag

Mobiag

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Defining a pricing model is one of the most important decisions that a car rental or car sharing business has to make - as in any other business price strongly influences whether a customer will choose your business over other available options. It might not be the most important factor, depending on other advantages that your services bring to clients, but it certainly is one of the deal-breakers.

One of the most difficult parts of pricing model is determining the value that each customer is looking for. Some customers might be looking for short-time or short-distance rental, and pricing model would have to reflect this demand and balance it with your need to still be able to make a profit on short time rental, others might be looking for a long distance or several days rental. Obviously, two prices cannot be the same - if you charge a client that rents a car for two days, the same rate as someone who rents it for 10 minutes - either you will be overcharging the customer or not making any profit. The traditional answer to this dilemma is choosing one operational mode or another - some companies are renting their vehicles only long-term, while others only short term. This can be very limiting to your business, as you might be unnecessarily narrowing down your customer segment. While traditional car rental businesses continue to target their traditional customer bases, and the competition for those segments increases almost daily, new emerging customer segments are not often explored and often due to rigid pricing models that the company has in place.

The solution to this dilemma is a dynamic pricing model and adjustment of price based on usage and customer segment. This allows you to deliver the best value to each customer based on their priorities.

Dynamic pricing models are best implemented by software that an operator uses to manage its business. While it might be complex to implement at an initial stage, it is definitely one of the most important things you can do, to make your business profitable and keep your rates as low as possible. So how should dynamic pricing work?

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Time-based pricing

Most car rental or car sharing businesses will take into account the time that a car is being rented for to adjust the pricing. If a vehicle is being booked for just 10 minutes, the rate will be different, compared to the cases when a vehicle is being rented for 10 hours.

The easiest way to adjust the time-based pricing is to define price cascade in your car rental software so that the system automatically applies each rate at various times. For example, you can define that every minute costs 0,25 cents, but if a user rents a car for one hour, you don’t want to charge 15 Euros (let’s say because your competitor rents out cars hourly and charges only 9 Euros an hour), so you can apply a cap of 8,50 an hour - the software will charge the customer 0.25 cents per minute until she reaches one hour, after she goes over that one hour, it will charge only 8,50 Euros. You can apply the same cap for longer time periods - you charge 8.50 an hour, until the user reaches, for example, 3 hours, after that, you can charge a different rate - for example, 7.50 an hour. So longer a user used your service, less she pays for an hour.

For longer term bookings you can also apply more complex structures. Let’s say a user rents your vehicle and uses it for 26 hours and 45 minutes. Generally, your price is 0.25 cents a minute up to an hour, 8.50 for an hour up 3 hours and 7.50 up 23 hours, 120 for 24 hours. What the software will do, is break the time of rental into chunks, starting from the biggest one - in this case, the biggest package you have is 24 hours, so it will subtract 24 hours from 26 hours and 45 minutes, for the first 24 hours user pays 120 Euros; leftover 2 hours and 45 minutes is also broken up into chunks - there is no three hour part in this, so the system will go for an hourly rate 8.50 for each hour of two hours - 17 Euros and the rest of 45 minutes will be charged per minute - 11.25. In total the customer will pay 148.5 Euros.

Now, this calculation is complex not in terms of its application, but in terms of user understanding the calculation. It might not be so clear to the user how much she is paying for what (or why she is paying 11.25 for 45 minutes when two hours cost only 17). This is where you need to make sure that the structure is not only dynamic but also benefits the user and is simple enough and transparent for the user to understand every charge. Clear communication is the key here.

The calculation of how much you want to charge per hour or per minute and how you want to structure your pricing cascade depends on your business model and goals. It might be a little harder to calculate this amount, but that’s where your software enables you to experiment with different pricing models and see the effect it has on your customer usage.

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Distance-based pricing

Another factor that is often taken into account is the distance traveled using your vehicle. This is easier to implement and resembles time pricing cascade. You create various packages - up to 50 km, you charge one price, between 50 and 150 smaller amount per kilometer and from 150 to 500 even smaller.

You can apply distance-based and time-based pricing at the same time if you so wish - let’s say 8.50 an hour but only if it’s less than 50 km, however generally this complicates understanding for a client. So most companies will apply either distance based or time-based pricing.  

 

Location

Another important factor for your business might be the location of vehicles in your fleet. You want them where the biggest demand is, and also spread out in a way that the largest amount of clients have access to it. The location is one of the most important factors in terms of your business model - whether you run a round trip business, one way or free floating operation. Round trip model envisions that a user rents a car from a certain location and after finishing the trip, returns the car to the same location; One way operation offers additional parking places for rented vehicles, so it doesn’t necessarily have to be returned to the same location it was rented from; Free floating operation enables users to rent a car available nearest to them and leave it at any public parking.

Based on what type of operation you run, the location will play different roles and therefore different weight in your pricing. If you are running a round trip model, you need the rented vehicle to be returned where it was picked up from, so usually you don’t directly include location in your pricing, but offer an additional service of picking up the vehicle for a fee - if a user is not able to return the vehicle to the designated parking, you either apply non-voluntary penalty and retrieve the vehicle through one of your agents, while at the same time offering a service to be notified in advance that the vehicle won’t be returned to the starting location and you can pick up the vehicle for additional fee (usually smaller amount than the penalty).

If you run a one-way operation, location is one of the most important factors for you, as it offers you a way to regulate your supply at various points. Depending on where your parking lots are and variance in demand at those locations, you can either apply constant price for parking at the same places, or you can utilize dynamic pricing. For example, if your parking lot is in the center of the city, and you always need vehicles there, you can apply smaller fee or bonus, for parking in that location. Again, usually, your software applies these automatically, once you set it up. Alternatively, if you have a car parking lot near a concert hall or a conference hall, and you anticipate an increase in demand at certain times, you can offer a bonus to your users who bring your vehicle to the parking lot near the location before the peak hour starts. You can also apply special fees for picking up vehicles from locations like airports, where users will usually have just one-way trip.

Free floating operation limits your ability to charge extra fees for parking locations, except for very few cases, as users expect that they will be able to leave vehicles at any public parking. Usually, location limitation you can apply in this regard is defining area that you serve - usually the city limits, and then charge extra for any location outside the city parking. But you can still apply the same type of bonus system for parking at specific places.

The location is one of the most important factors that help you manage demand and supply. So its incorporation in pricing models will depend on its importance to your business, but it is one of the factors that you should definitely take into account and manage in an automatic fashion through your car rental or car sharing software.

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Customer segments

One of the strongest business tools is dividing your customers into segments. You probably already do this - you have business customers, family (small group) customers and individual customers. You probably offer various packages and prices to various customers. Business customers usually enjoy lower fees, while individuals pay a slightly higher price, and families and small groups fall somewhere in between.

Managing various groups and segments is also usually done automatically by your car rental software. Once you tag individual users as belonging to a certain group, the software automatically applies the price associated with that group. In terms of individual users, a lot of businesses also differentiate between various types of individual users - for example, drivers with less than 3 years of driving experience get a higher rate, or drivers with a lot of traffic violations also pay a higher rate. Once you define a user as belonging to one of the groups, the software automatically applies the corresponding pricing.

Applying various prices to various customer groups allows you to better take into account their priorities and best manage your risk associated with particular groups.


Vehicles

If your fleet includes various types of vehicles, of course, they might cost different amounts - sports car probably has higher fees, than an ordinary sedan. The software also automatically applies these amounts, based your definitions of vehicles in your system.

Differentiating between vehicle prices is a great method for managing supply and demand for individual cars, but also is great in terms of price anchoring. Price anchoring is a great tool and if you are not familiar with it, we definitely recommend you research the tool more, but shortly it allows a business to offer various packages for various prices and enables the user to understand the price in comparison to other options offered and makes the decision process easier. For example, if you offer three types of vehicles: a minicar, an ordinary sedan and a sports car, the customer takes into account the price of the highest and smallest prices, to better understand the price of an ordinary sedan (along with comparing it to other options). So if your sports car costs 80 Euros an hour and small sedan cost 30 Euros an hour, getting an ordinary sedan for 50 Euros an hour seems reasonable. Research also shows that the middle option will be the most popular choice in such cases.

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Simulator

One of the best things about using software for adjusting your price models is experimentation. Usually, your car rental software will offer options to have various pricing models at the same time as well as offering a simulator. In a simulator, you can test various pricing models without taking any risks. This is a great option to get a general idea how your pricing models will influence your cash flow. Of course, the simulator is no substitution for real world testing - the simulator cannot anticipate customer behavior, how they will react to various pricing models, how demand may change because of price adjustment or similar issues.


Communication

One shortfalling of dynamic pricing is its complexity - it’s complex to implement and calculate on the initial level, and if it is “too structured”, it could be very difficult for a customer to understand, leading to dissatisfaction. However, if you are not implementing dynamic price structure, then you are probably limiting your business to just one type of operation (e.g. short-time rental). If you are a giant company, like DriveNow operating in a big city, you can probably afford to limit yourself to just one segment, because that segment is huge and you have a big market share. But if you are not a giant market player, then you need to be able to adjust to various needs of customer segments.

You need to make up for this shortfalling of complexity with clear communication with your customer. As in all matters of customer relations, transparency is the most important. You have to ensure that your customer fully and well understands your pricing model. This transparency has to be reflected before a user rents your car and in billing. You have to keep in mind that most car bookings usually take place through a mobile app, and so you have to make sure that your price communication is short and precise.

 

Conclusion

Making decisions about the pricing model is one of the most important steps to your business success. It is easy to go with just one price but you run the risk of not serving various segments of the market that place value on different things. Your car rental software allows you to experiment and implement different pricing models for different vehicles, different locations, customer segments and adjust your pricing based on time used and distance traveled. You should take advantage of these features, as they allow to get an edge over your competition and deliver the best value to your customers. Along with issues discussed here, there are other costs, such as insurance and car cleaning, that you want to account for in pricing and fees, as well as price promotion methods that you can implement to encourage more usage and reward your customers.

The key to success is experimenting with various price models and observing how they influence customer behavior. It takes time to better understand what your customers truly value and to test your hypothesis about your prices, however, this is the only way your business can grow and keep your customers satisfied.  



Mobiag

Written by Mobiag

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