How surge pricing works: A guide for SaaS companies

Imagine adjusting your pricing in real-time to match demand, boosting revenue during peak times, and balancing usage effectively. That’s surge pricing at work.

While common in ride-sharing and hospitality, its application in SaaS and digital products offers unique opportunities. By understanding how to implement surge pricing strategically, you can improve revenue, manage demand, and keep customer trust.

Read on to learn:

• The core mechanics of surge pricing and how it differs from broader dynamic pricing
• The pros and cons, including ethical considerations and potential pitfalls
• The pivotal role of AI and real-time data in modern pricing strategies
• Alternatives to surge pricing, like tiered models and usage limits

Let’s kick things off by explaining what surge pricing is.

What is surge pricing?

Surge pricing, also known as price surging, is a dynamic strategy where companies adjust prices in real-time, typically upward, in response to heightened demand and limited supply. Essentially, surge rates kick in when demand outstrips what's readily available.

Events, peak usage times, and sudden spikes in customer activity can trigger these adjustments. It's a form of price flexibility designed to balance market forces.

How surge pricing works

At the core of surge pricing lies sophisticated tech. Algorithms analyze real-time data to detect imbalances between supply and demand. When demand surges, algorithms adjust prices accordingly. Inputs like user activity, inventory levels, and even weather patterns inform these adjustments.

Variable prices emerge from these calculations. Supply and demand elasticity play a key role. In sectors like ride-sharing, surge pricing multipliers are common. Other industries might adopt tiered structures or dynamic markups. The goal is to maximize revenue during peak times, while also tempering excessive demand.

Note: Understanding how to adjust prices dynamically is key. For more on pricing and packaging strategies, please refer to our other blog posts.

Why businesses use surge pricing

Surge pricing serves multiple strategic purposes for businesses. It's a tool to manage market dynamics effectively. Here are some key reasons why companies implement this pricing strategy:

• Maximizing revenue: During peak demand, a business can capture higher revenue per unit, leading to increased overall profitability.
• Incentivizing supply: Higher prices can attract more suppliers or service providers, ensuring adequate coverage during high-demand periods.
• Balancing supply and demand: By adjusting prices, businesses can temper excessive demand and prevent shortages.
• Reflecting real-time market conditions: Surge pricing allows prices to align with current market values, ensuring they remain relevant.
• Managing inventory: For products, it can help manage stock levels and prevent items from selling out too quickly.
• Covering increased operational costs: In some cases, higher prices offset the increased costs associated with providing services during peak times.
• Filtering demand: Surge pricing can filter out less urgent demand, confirming that essential services are available to those who need them most.

Surge pricing vs. dynamic pricing

Understanding the nuances between surge pricing and dynamic pricing is vital. While related, they aren't interchangeable. Dynamic pricing’s meaning encompasses a broad strategy where prices adjust based on market conditions.

It can involve both increases and decreases, responding to various factors. Think of it as a dynamic pricing model that reacts to the market. Surge pricing, conversely, is a subset of dynamic pricing. It refers to price increases during periods of high demand and limited supply.

The bottom line

All surge pricing is dynamic pricing, but not all dynamic pricing is surge pricing. The difference boils down to direction and trigger. Variable prices are a result of dynamic pricing, while price flexibility is a characteristic of both. Dynamic pricing offers a broader range of adjustments, while surge pricing is more targeted.

Examples of surge pricing

Surge pricing appears across various industries, adapting to different market dynamics. Here are some notable examples:

Uber surge pricing

Perhaps the most well-known example, Uber surge pricing, increases fares when demand for rides exceeds the available drivers in an area. Events, rush hour, and bad weather can trigger these increases.

DoorDash and Instacart

Delivery platforms like DoorDash and Instacart apply surge fees or "peak pay" during busy periods. Reduced driver or shopper availability, coupled with high order volumes, leads to these price adjustments.

Airlines

Airlines have long used dynamic pricing, with prices fluctuating based on demand, time of booking, and seasonal factors. Peak travel times result in higher fares.

Hotels

Hotel room rates vary based on seasonality, local events, and day of the week. Prices increase during high-demand periods, like holidays or popular conferences.

Ticketing platforms

Ticketing platforms like Ticketmaster adjust prices for events based on demand, time until the event, and even factors like weather or team performance. High-demand events see significant price increases.

Pros and cons of surge pricing

Like any pricing strategy, surge pricing presents both advantages and disadvantages. Here's a look at the key points:

Pros

• Boosts earnings when things are busy: During peak demand, higher prices increase profitability.
• Gets more help when needed: Elevated prices can draw in more suppliers or service providers.
• Keeps things balanced: Prices adjust to balance supply and demand dynamically.
• Matches what's happening right now: Prices reflect current market values accurately.
• Helps manage what's in stock: For products, it helps manage stock and prevent shortages.

Cons

• Customers might get annoyed: Frequent or extreme price surges can damage brand loyalty.
• Can look like taking advantage: Especially during emergencies, surge pricing can seem exploitative.
• Makes budgeting tough: Customers may find it difficult to budget due to fluctuating prices.
• Risks hurting your reputation: If poorly implemented, it can lead to public backlash.
• Could scare customers away: Very high prices can deter customers, even during peak times.‍
• Demand reduction: Very high prices can deter customers, even during peak times.

Is surge pricing fair to consumers?

When surge pricing applies to non-essential services, like ride-sharing, it's viewed as a market-driven necessity. However, when applied to essential goods or services during emergencies, it can raise ethical concerns. In other words, transparency is key.

If businesses clearly communicate how and when surge pricing applies, it can mitigate negative perceptions. But, without transparency, consumers can feel exploited. Ultimately, the perceived fairness depends on the context and the business's approach.

Note: For SaaS companies looking to implement dynamic pricing strategies, consider exploring related concepts like feature gating and metered usage in our blog.

The role of AI and real-time data

AI and real-time data are pivotal in modern surge pricing strategies. Machine learning algorithms power pricing engines, analyzing vast datasets to predict and respond to demand fluctuations. Inputs such as location, time, and user behavior inform these algorithms.

For example, a pricing engine might increase fares in a specific area during a concert, based on real-time location data and event schedules.

Also, user behavior patterns offer insights into demand elasticity. Historical data combined with current trends allows for precise price adjustments. Real-time inventory levels, competitor pricing, and even weather patterns contribute to the algorithm's decision-making.

The relevance of AI and real-time data in FinOps

In modern FinOps stacks, this data-driven approach is vital. It lets businesses manage costs and boost revenue dynamically. By integrating real-time data into pricing models, companies can make sure their prices remain competitive and profitable.

AI's role extends beyond mere price adjustments; it also helps businesses forecast demand, predict market trends, and refine their pricing strategies over time

When surge pricing backfires

While surge pricing can help optimize revenue, it carries risks. Public perception can quickly turn negative if implemented poorly.

For example, during NYC snowstorms, excessive price hikes led to accusations of price gouging. Emergencies, in particular, exacerbate this issue. Regulatory scrutiny can also arise. In some jurisdictions, laws limit price increases during crises.

Such incidents highlight the importance of ethical considerations. When essential services become unaffordable, public trust erodes. Social media amplifies these concerns, potentially causing lasting damage to a company's reputation.

Mitigating negative perception

To avoid backlash, transparency is a must. Clearly communicate how and when surge pricing applies. Provide real-time notifications and explanations within apps or platforms. Set price caps, especially during emergencies. Consider tiered pricing models that offer more affordable options.

Additionally, use data to predict and manage demand, rather than simply reacting to it. Proactive measures, like incentivizing supply before surges, can lessen the need for drastic price hikes.

Finally, engage with customers. Solicit feedback and address concerns promptly. A customer-centric approach can transform a potentially negative experience into a positive one.

Surge pricing in SaaS and digital products

Surge pricing often applies to physical services, but SaaS and digital products can adopt similar strategies.

Pay-as-you-go models, for instance, naturally reflect real-time usage spikes. When demand for computing resources or API calls increases, costs rise accordingly. It’s a form of dynamic pricing that mirrors surge principles.

Strategic application of surge pricing can occur through feature gating. During high-demand periods, access to premium features might carry a higher cost. Or, limited resources, like bandwidth or processing power, could be allocated at variable rates. Imagine a video streaming platform charging more during peak viewing times.

Likewise, tiered pricing structures can incorporate elements of surge pricing. Higher tiers, offering more resources or bandwidth, can accommodate users with fluctuating needs. This approach allows SaaS firms to monetize demand without alienating users with sudden, unpredictable price hikes.

Note: To further explore dynamic pricing strategies in the SaaS field, consider learning about pricing matrices and usage-based pricing. These models offer other ways to align revenue with real-time usage and users' demand.

Alternatives to surge pricing

While surge pricing addresses demand fluctuations, it's not the only approach. Several alternatives can help businesses manage demand and revenue without the potential drawbacks of real-time price increases. Here are some viable options:

• Tiered pricing: This model involves offering various service levels or feature sets at distinct, fixed price points. For example, a SaaS company might have "Basic," "Pro," and "Enterprise" tiers, each with increasing resources and capabilities.
  
  Customers choose the tier that best suits their needs, providing predictable costs and revenue. This approach allows users with high-demand requirements to opt for higher tiers, effectively self-selecting based on their usage.
• Time-based discounts: Instead of raising prices during peak usage, businesses can offer discounts during off-peak hours. This strategy incentivizes customers to shift their usage to less busy times, smoothing out demand fluctuations.
  
  For example, a cloud computing provider might offer discounted rates for processing jobs run overnight. This method helps manage server load and can attract price-sensitive customers.
• Flat-rate fees with usage limits: This approach combines the predictability of flat-rate fees with the control of usage limits. Customers pay a fixed price for a specific amount of resources or services. If they exceed those limits, they incur additional charges.
  
  This model allows for predictable revenue while also managing resource allocation and preventing overuse. For instance, an API provider might offer a flat rate for a certain number of API calls per month, with overage fees for exceeding that limit.
• Subscription models: Subscription models provide a consistent revenue stream by charging customers a recurring fee for ongoing access to services. This approach allows businesses to forecast revenue and plan capacity more effectively.
  
  Different subscription tiers can cater to varying levels of usage and demand. By offering annual subscriptions, companies can create stability in revenue.
• Dynamic packaging: Instead of altering individual prices, businesses can bundle services or features into different packages, adjusting the package offerings based on demand and user preferences.
  
  For example, a streaming service might offer different packages with varying numbers of concurrent streams or access to premium content. During peak demand, they could emphasize packages with higher resource allowances.

Make your pricing work in real time with Orb

Effectively implementing and managing surge pricing requires agility and precision, but it doesn't have to be a daunting task.

Orb, a done-for-you billing platform, helps SaaS and GenAI companies transform dynamic pricing into a strategic advantage. Here's how Orb can help:

• Pricing agility: Rapidly experiment with and adjust surge pricing strategies. Orb RevGraph and Orb SQL Editor enable real-time price changes and data-driven refinements. Launch new pricing models without engineering bottlenecks, and use historical data to simulate how price changes impact your revenue.
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• Precise billing: Deliver error-free billing and build customer trust with Orb RevGraph. It processes raw event data for accurate, auditable invoices and provides transparent, real-time usage monitoring. Provide compliance and prevent revenue leakage with precise billing calculations.
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• Scalable operations: Scale your surge pricing operations with Orb's API and modular platform. Manage increasing data volumes and complex requirements with built-in revenue analytics and customer usage dashboards. Get enterprise-grade reliability as your business grows.
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• Expert partnership: Confidently navigate dynamic pricing with Orb's expert guidance. Receive dedicated implementation support, industry expertise, and ongoing optimization assistance. Benefit from proven migration pathways and regular business reviews for smooth strategy adoption.
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• Customer insights: Refine your surge pricing strategy with detailed customer usage data. Understand how customers respond to price changes and improve retention with data-driven insights and reports. Use these insights for more accurate reporting and better customer satisfaction.

Ready to transform your surge pricing strategy into a growth driver? Explore our flexible pricing options and find a plan that works for you.