One notable example of this is the ride-sharing giant Uber. On several occasions, Uber’s dynamic pricing algorithm has caused rates to skyrocket during moments of collective anxiety, such as after terrorist attacks or mass shootings. In some cases, fares have jumped as much as 500%. This has consistently sparked criticism from the company’s 93 million active users.

While an economist might applaud Uber’s pricing engine, as it reflects the basic principles of supply and demand, customers find the pricing structure unpredictable. This is an issue that plagues many companies across a variety of industries, including advertising, e-commerce, entertainment, insurance, sports, travel, and utilities.

Coca-Cola, for example, experimented with temperature-sensitive vending machines in the late 1990s that would increase the price of a beverage on a hot day. However, after public outrage, the company quickly abandoned the project. Other companies have also experienced algorithmic pricing snafus, such as Wayfair’s $14,000 cabinet and Amazon’s nearly $24 million textbook.

One major issue with algorithmic pricing is the psychological impact it can have on customers. Seeing a product with an excessive price tag can activate pain centers in the human brain, causing potential customers to feel alienated and even angry. When companies ask for money, it shifts the focus of the customer relationship from aligned interests to reconciling opposing interests.

In the worst cases, algorithms turn the already delicate task of asking customers for money into an experience that drives them away. (HBR)

Root Insurance, which sells auto policies in the United States, provides an example of how pricing algorithms can improve customer relationships. The company offers drivers a smartphone app that measures their day-to-day driving behavior and calculates individual safety scores. Root then bases insurance premiums primarily on how well drivers perform, while avoiding factors like credit scores or education that could introduce bias. By weeding out bad drivers, Root can reduce the expenses associated with accidents and lower the price of insurance for all its customers.

Creating trust through algorithmic pricing

The key to success with algorithmic pricing is making customers understand the mutually beneficial nature of the process. Transparency about the factors that go into pricing, like Root’s personalized driving data, can help customers feel more comfortable with the price they pay. Customers want to know that they are paying a fair price for a product or service, and algorithms that reflect that can lead to improved customer satisfaction.

However, implementing algorithmic pricing systems also requires proper oversight and management. Companies need to determine which business unit should own the effort and set parameters to limit the potential for misuse. If implemented correctly, these systems can maximize revenue while also making customers feel like they have paid the appropriate amount for a product or service.

Bring it together

While algorithmic pricing can be beneficial to businesses and customers, it also has the potential to cause harm. By making the pricing process transparent and mutually beneficial, companies can create a more positive customer experience. But, companies must also exercise caution and establish proper management and oversight to avoid algorithmic pricing snafus that can turn customers away.