Jeff Bezos, chief executive of online retailer Amazon.com Inc. (www.amazon.com), learned the hard way that his customers think they have the right to pay the same amount for something as everybody else.

Last fall, Bezos conducted a pricing test by offering some customers discounts on 68 selected DVD titles, while charging everyone else the normal price. The program was conducted discreetly, without any notification to customers, but discussions in DVD chat rooms revealed the price differences. The chat quickly turned to outrage.

Many of Amazon’s customers seemed convinced that Amazon was deliberately treating customers differently based on how loyal, or price-sensitive, they seemed to be. "I find this extremely sneaky and unethical," one member of DVDtalk.com wrote. "If you walk into a store, you aren’t charged more based on how many times you pick up the DVD to look at the cover, are you?" Another message labeled the company a "shyster."

Bill Curry, an Amazon spokesman, said the company wasn’t setting prices based on customers’ past purchases or demographic information. "We’ve never done that, and we never will," he said. Instead, he said, the company was testing prices randomly to "determine the shape of the price curve."

Still, faced with angry customers, Amazon quickly refunded the difference to anybody charged the higher price, sending nearly 7,000 customers an average of about $3.

A similar outcry happened when customers discovered Amazon was randomly offering the Diamond Rio MP3 music player for $50 less than the usual $234 price. Again, the company backed down.

Even though dynamic pricing—a practice by which different customers are charged various prices for the same product, based on what the retailer thinks they will pay at that moment—is widely considered the future of merchandising, early experience shows that the practice currently has serious drawbacks.

There is a huge opportunity, as Amazon saw firsthand, to engender bad faith among customers. The potential for legal trouble looms, especially concerning privacy. In some cases, dynamic pricing may not even prove to be cost-effective.

 
As the Amazon incident shows, many people simply aren’t ready psychologically to pay their own price. Some, in fact, think companies have a responsibility to offer uniform prices. While the Internet makes it easier for companies to change prices on the fly, it also makes it almost impossible to hide those changes from customers.

Dynamic pricing "touches a nerve in the public," said Vernon Keenan, an Internet commerce consultant based in San Francisco, who has written extensively on the practice. "People have this centuries-old perception they shouldn’t be charged more for something because of who they are. Whether you are Bill Gates or homeless you should pay the same amount for a cup of coffee."

While it is true that dynamic pricing has long existed in many industries, such as airlines, that doesn’t mean customers like it, or that they will willingly let other industries adopt the practice. Keenan says consumer resistance to customized pricing dates back to the peasant revolts of the Middle Ages, when royalty routinely raised prices based on any number of factors, including whim.

He says that even setting prices based solely on supply and demand—as many companies do—has its limitations. Keenan says that "dynamic pricing creates tension between customers and sellers," because customers eventually will demand that controls be applied, perhaps by the government.

People also will try to find ways to game the system. When customers inquire online about purchasing airline tickets, they have been conditioned to expect changing prices even if they are checking on the same day for the same trip on the same airline. Customers are being taught to keep hunting until they find the price they want.

The issue of privacy, always thorny, causes particular problems for those attempting dynamic pricing. At the heart of the pricing strategy is the collection of customer data, often without the customer’s consent. Yet DoubleClick Inc. (www.doubleclick.com), the online advertising network, and similar companies have learned the hard way that consumers aren’t ready to have their shopping and surfing habits recorded. Early last year, DoubleClick was forced to change its data-collection practices.

Marc Rotenberg, executive director of public-interest group Electronic Privacy Information Center (www.epic.org), says the move to dynamic pricing will push companies to learn enough about customers to know their "bottom line" price, even if that means violating their privacy. "It’s like a card game where the merchant is trying to figure out what card the other player is holding," Rotenberg says. The Federal Trade Commission "is going to have to look closely" at dynamic pricing, he adds.

Even if customer attitudes and legal concerns disappeared as issues, practitioners of dynamic pricing have learned that it simply doesn’t work very well for certain products. Airline tickets and hotel rooms, for instance, have shown themselves to be great candidates for dynamic pricing, because they are reasonably expensive items whose value disappears completely once the plane takes off or check-in time passes. Products such as gasoline don’t lend themselves nearly so well to the pricing strategy. They don’t cost enough to be worth the overhead occasioned by dynamic pricing, and their value doesn’t disappear so suddenly or completely.

Not that people haven’t already tried small-ticket items. WebHouse Club attempted to sell both gasoline and groceries with the technology and the "name your price" business model pioneered by Priceline.com (www.priceline.com), which sells airline tickets online. WebHouse had impressive backers, including Priceline’s founder Jay Walker, Paul Allen’s Vulcan Ventures Inc. (www.paulallen.com) venture-capital firm, investment bank Wit SoundView Group Inc.’s Arista Fund (www.witsoundview.com), and investment bank Goldman Sachs Group Inc. (www.goldmansachs.com). But customers decided that they had to go to too much effort. For a small savings, they not only had to go to the WebHouse site to name their price and then wait to see if someone accepted it, but they also had to go to a participating gasoline station or grocery store to collect. WebHouse also faced huge logistical challenges in working with grocery stores. There wasn’t enough cooperation because the stores don’t have the same incentive that airlines have to offer rock-bottom prices as a deadline looms.

Priceline itself, while reasonably successful, has found its dynamic pricing model doesn’t give it access to a consistent inventory of airline tickets; the airlines give Priceline only those tickets they can’t sell at higher prices. The same holds true for a Priceline venture that sells mortgages online.

Perhaps more significantly, Priceline is learning that many consumers value convenience over low price. "There has to be balance between savings and convenience," said Robert LaBatt, principal analyst of the e-business services group at information-technology research company Gartner Group Inc. (www3.gartner.com). "With Priceline, you have to jump through hoops of fire to get moderate savings. And you have no control—they take your money before they even sell you a ticket."

Companies that have forged ahead with dynamic pricing, despite the obstacles, have found that their success or failure may depend on how well they explain the rules of engagement to customers ahead of time. LaBatt says, "Implicit pricing, where you’re not telling people why the price is set where it is, makes consumers upset and alienated." By contrast, if the customer feels he has some control and understands exactly how prices will be set, things may go more smoothly.

That observation has led many companies to consider online auctions. While offering highly dynamic prices, auctions leave customers happy, because they participate openly in pricing decisions and can step out of the bidding anytime.

Scott McNealy, CEO of Sun Microsystems Inc. (www.sun.com), says online auctions eventually will be used to sell nearly every kind of product, including groceries, on a sort of universal spot market. He envisions products being sold in online auctions in much the same way as securities are traded in the stock market, with prices rising and falling continually depending on demand. "The Internet is the world’s biggest trading floor," McNealy says.

McNealy anticipates what he calls an "auction economy," where, instead of trying to forecast what customers will purchase in the future, companies manufacture their products on a daily basis and then auction them online. As a result, businesses will avoid building more products than they can sell.

Advocates of dynamic pricing eagerly assert that an auction economy would benefit both the consumer and the business. The point isn’t simply to raise prices to the highest level consumers will stand for, but to serve the customer better by tailoring the sale directly to him. In many cases, that will mean lowering prices, not raising them, advocates say.

They note that dynamic pricing already is accepted in business-to-business e-commerce, where industries have established exchanges to negotiate and barter for products and services that previously would have been covered by long-term contracts. Advocates say such exchanges will make industries more efficient by increasing competition.

Proponents also say consumers will be able to band together in buyers clubs to bargain for deeper discounts than they would receive individually.

That claim appears to be almost entirely theoretical at this point; no online buyers club has been a big success. Still, as people struggle to figure out the right method for applying flexible pricing, technology continues to develop and make the job easier. There is, for example, a new class of software such as E-Commerce Pricing Solution by Optivo Corp. (www.optivo.com). The software studies a customer’s behavior and purchasing patterns to determine just how price-sensitive he may be. The software can automatically set the price at that level. Zilliant Inc. (www.zilliant.com) offers Intelligent Pricing Solution, which not only analyzes interactions with customers, but also looks at Web sites of competitors. The software then recommends the "right" price for specific customers.

None of the dynamic-pricing developments should come as a surprise, according to Stuart Feldman, director of International Business Machine Corp.’s Institute for Advanced Commerce (www.ibm.com). Feldman says consumers have little reason to take uniform pricing for granted, or to be offended at paying a different price than their neighbors. Flexible pricing, he says, is not only the future, but it also has been around for decades without consumers paying much attention to it. As anyone living in Manhattan or Silicon Valley knows, where a customer lives can influence what he pays for almost every item—residents of wealthy Atherton, Calif., for instance, talk about the "Atherton premium" that gets tacked on to everything from gardening services to home construction.

Feldman says that modifying the price of a product for an individual or group isn’t any different than sending some customers, but not others, discount offers. Department stores, for example, often invite "preferred customers" to sales that are closed to the general public.

Erik Brynjolfsson, director of the Center for eBusiness@MIT (www.mit.edu) says: "I think customers aren’t used to [dynamic pricing]. If it’s mishandled, it’s a public-relations nightmare. But, in the long term, we’re going to see customers look forward to it, as they do now to coupons and frequent-flier miles."

Still, he and Feldman say that, until the practice becomes ubiquitous and accepted, retailers will need to adopt more invisible ways of changing prices dynamically. Retailers also will have to pick their targets carefully.

One popular scheme speculates that soda machines could vary the price according to the weather, charging a higher price for a Coke on a sweltering day. Such a scheme, according to Feldman, would be doomed to fail. "There’s always a certain degree of unhappiness people have about being gouged," he says. If anyone ever makes such an attempt at dynamic pricing, he says, "there will be one very dead Coke machine."

Flynn is a free-lance writer based in San Rafael, Calif., and a frequent contributor to the New York Times technology coverage. She can be reached at ljflynn@aol.com.