Dynamic Pricing — Statistical Arbitrage

Dynamic pricing, as the name suggests, is a pricing strategy/tactical system where prices are adjusted or modified to maximise margins without losing business. Aka improve the bottom line while keeping the top line the same. In the best cases, grow both the top and bottom line if well optimised. An approach that allows one to price products appropriately.

Dynamic pricing is already a known phenomenon in certain industries/verticals like the airline and hotel industry, but is now being adopted by the retail industry as well. Based on my experience working on these models. It’s a fantastic tool/approach when leveraged the right way. Mixing up the right strategy with appropriate tactical Data Science or machine learning models. Also called AI in 2025, given that all ML/DS work is being clubbed under this umbrella term.

Why do Airlines/Hotel Industry use it?

Both these industries run on selling a time-bound inventory that needs to be exhausted or consumed before the event, aka either a specific flight or a hotel stay on a specific day. Since the inventory is perishable, not pricing it correctly results in loss of business in terms of occupancy!

To add to the challenge ,you have multiple sites selling this inventory at multiple different prices and so on! The prices can vary significantly, and there are plenty of platforms that are built to do price comparison across multiple platforms/options.

The Challenge

In retail space, where it’s still a new concept, dynamic pricing can be challenging to implement, given that people are not used to fluctuating prices, especially for staples and key goods, except when it comes to perishable ones like Fruits & Vegetables!

Similar to the hotel/airline rooms & seats, fruits/vegetables expire after some time, thus making managing their inventory a challenge and a need to involve dynamic pricing as a lever to manage the inventory to maximise both margins and the business.

• Too low prices: we fail to make enough money on each SKU
• Too high prices: we fail to sell our goods

Online retailers have an advantage whereby tracking their inventory and throughput of sales, they can dynamically adjust their prices to maximise their margins ,and they should if they are not already doing it!

How to maximise margins without hurting the business in the long run!

Customer Perception

Along with dynamic pricing, the counter challenge to take care of is the long-term customer perception. Knowingly or unknowingly, businesses, if not careful, end up being tagged into one of the categories in their respective business.

Market Segments

• The businesses on this side of the spectrum are priced higher than their competitors and offer very low discounts. E.g. Taj, erstwhile Kingfisher Airlines or Waitrose in the UK!
• Here, the strategy is to sell premium stuff to premium customers.
• Dynamic pricing is not very useful or relevant here; pricing is all about strategy! It is the business model
• The volumes are typically lower as a share of the overall business.
• They are likely to be the cheapest, and pricing is the key lever to bring business.
• Dynamic pricing here could be useful in certain parts of pricing decisions, like liquidation and so on, but again not as effective as the 2nd player.

Overall Questions

• What products should be priced at what margins?
• How frequently should prices change?
• What products should we maximise margins?
• How to balance stock liquidation vs demand planning?
• Completely automated vs Manual Updations?

Depending upon the nature of the business and its positioning within its vertical. Is dynamic pricing of goods an opportunity across multiple decisions?

These are all the broader tradeoffs to be made when designing these systems? The right system is a mix of algorithms with manual/operational guardrails to safeguard against edge cases. Since a completely automated system with no manual inputs is practically unfeasible.

• Humans decide the strategy
• Systems make the tactical optimisations

Pricing is often the most customer-facing and strategic decision. But at the same time, the business needs to make multiple micro decisions to optimise the business. The right system separates strategic and tactical decisions.

This way, the overall business operates with a clear synergy!

Originally published at https://statarb.in on September 4, 2025.