Great uses for price optimization software.
1.1.1. Avoiding overcrowding. One optimal use for IT pricing software systems is when there is an
externality problem. A good example is road congestion pricing, where a city prices roads higher during
peak hours to deter drivers from driving then. This is also the case for water parks, theme parks and so
on. These are examples of goods that have a very high ﬁxed capacity and highly variable demand,
leading to congestion at certain times that they need to manage.
1.1.2. Avoiding spare capacity.
The most expensive thing in a restaurant is an empty table
Most ﬁrms want to operate at something close to full capacity whenever they can. By booking a hotel
room, I am directly preventing another customer from taking that hotel room. This trade-oﬀ between
pricing a room low and selling it now against waiting and potentially selling a room at the last minute for
a higher price, has given rise to the practice of revenue management.
Revenue can be improved by:
• Identifying new pricing fences
• Preventing arbitrage across existing pricing fences
• Improving customer perceptions of pricing fairness
Generally most success stories outside of industries with ﬁxed capacities rest on a better understanding
of price elasticities. Theoretically, optimization systems could optimize over cost schedules, but I have
come across no software systems that do this very well primarily because managers simply do not know
Some problems these systems have faced.
(1) Used a price management rather than optimization tool.
• Large departmentstore invested in expensive pricing optimization software. Merchandizing set
key commands on override and used it predominantly to manage the prices that they set using
their ‘super gut’.
(2) Limitations to the use of optimization software created for selling airplane seats in industries that
have no capacity constraints..
• Example of software that created artiﬁcial constraints in order to be able to say that it was
optimizing. Case Study: Google Adwords Pricing
A lot of these problems are caused because IT systems model people’s pricing behavior in the future as
being like it was in the past. They also assume that people will not try and outsmart the pricing software.
However, it makes a lot more sense if IT systems instead were focused on giving incentives so that
people were actually willing to tell the ﬁrm what they were willing to pay. This is what Google has been
able to do with its automated auctions for advertising search terms ‘Adwords’ system. By doing this,
Google has transformed itself into the market leader in the provision of advertising.
Adwords Pricing Process. First, a quick description of the Google search term auction mechanism:
• Firms enroll in Adwords
• They pick the particular s