Dynamic Pricing and the Shipping Exchange
What will happen to the cost of shipping goods as information technology modernizes the industry, exchanges grow, and price discovery improves? It might not be quite what standard economic theory would predict.
In particular, two pieces of conventional wisdom about prices may need to be re-examined. The first is that an exchange will necessarily commoditize supply and drive down prices to the marginal cost. This may not be the case, which is good news for carriers. The second is that dynamic pricing facilitated by information technology will hurt buyers. In fact, the opposite may be true, and this is good news for shippers.
An economics textbook will tell you that perfect information leads to the greatest allocative efficiency. In other words, when everyone knows what everyone else knows about supply and demand, the value of a product corresponds to its marginal cost of production.
Yet historically in the shipping industry everyone –buyers, sellers, and middlemen- has profited from obfuscating information. In this “imperfect” market, game theory, the discipline dedicated to strategic interactions, may shed light on how buyers and sellers will behave. And modern exchange platforms, such as Uber or airline aggregators, may offer additional clues about how behavior and prices will evolve.
When marketplaces are separated by long distances, prices less than transparent, or goods differentiated, two buyers are likely to pay different prices. Artisanal Vermont maple syrup at a remote general store costs more than a gallon of Canadian bulk syrup at Walmart in town.
Typically, the creation of an exchange serves to reduce transaction costs, increase transparency and connect more buyers and sellers. These factors often cause prices to drop since buyers can compare the competitive bids of a greater number of sellers.
But will prices always drop to rock bottom? Not necessarily. Several things could interfere to keep prices higher. Sellers might collude to fix prices and drive up costs, although this is highly illegal. Or the seller might employ price discrimination, which means selling to each customer at the price he’s willing to pay, a method used by sellers all the time. An airline seat is a great example of this. Although everyone on board is going from point A to point B, some people end up paying more than others to get there.
In the shipping industry, carriers looking to avoid a race to the bottom may begin to target different niches or charge differently for last-minute shipments.
Will an exchange make prices fluctuate unpredictably for shippers?
Just as sellers may worry about a race to the bottom, buyers may be concerned about volatility. Prices for a product or commodity can fluctuate for many reasons: actual or perceived changes in demand, shortages, fears of shortage that lead to stockpiling, strategic moves by sellers to increase business.
Dynamic pricing refers to prices that adjust, often automatically, to changes in supply or demand. A broad swath of strategies, from the corner happy hour to Uber’s surge pricing, fall under the dynamic pricing umbrella, which is why the term is sometimes viewed with concern or skepticism. In certain cases, dynamic pricing has been used as a strategy to obscure prices and extract more from buyers i.e. by price gouging.
But just as often, dynamic prices can help buyers. A price sensitive traveler can fly when prices drop, instead of subsidizing other fares when prices are held constant. But the pricing structure must be communicated clearly in order for the buyer to feel he’s gotten a fair shake. This is where game theory offers useful intuition: clarity and fairness can move marketplace interactions from a competitive regime in which one side gains by hurting the other, to a cooperative interaction where transactions create value for both buyers and sellers.
The future for freight prices
Despite its importance, there’s nothing magical about a price. It’s just the figure that buyer and seller agree upon, individually or in a marketplace, to transcend the “double coincidence of wants” necessary for a barter system to function.
Future freight prices will be determined in part by factors unrelated to the exchange itself: the price of fuel and of labor, the supply of cargo space relative to the demand from shippers along various trade lanes. And some embedded behaviors of shipping will continue to play out in a modern exchange. Carriers may use analytics to better target niches in which they can make the most profit relative to their competitors, and to price customers at the rates they’re willing to pay. Shippers will benefit from more competition and lower prices, from a dynamic market and analytics to support decisions about where and when to ship.
Behavior may never go away, but a modernized exchange will benefit both shippers and carriers on price. Greater transparency will return surplus to both sides, and better information will improve decision making and reduce operational costs.