The last time we talked about price elasticity, it was in the context of the dreaded price war. But it’s been a few months, so now’s as good a time as ever to dive back into the world of price elasticity.
Excited? You should be! Price elasticity—or the price elasticity of demand—is a formula used to determine how a price change will impact the demand for a specific product. Simply put, inelastic products see little change in demand from a change in price, while the opposite is true for elastic products.
But that’s getting ahead of ourselves. First, let’s talk a bit more about what price elasticity is and why it matters in retail.
Price Elasticity of Demand
Price Elasticity of Demand (PED) is determined via a mathematical formula: % Change in Quantity / % Change in Price. It’s like supply and demand, where limited supply results in higher prices. With price elasticity, the measurement is how significant the impact on demand is when a small price change is implemented.
In the real world, price elasticity of demand can be closely tied to brand reputation. For example, Apple has inelastic products because changes in price have little effect on demand: shoppers will still line up outside the store for a new Apple product. Few brands are on Apple’s level, of course, and will instead see shoppers buy from a competitor after a price change.
Therefore, PED is an important metric to measure because it helps predict the behavior of shoppers and identify whether a price change will have a positive or negative effect on your sales.
Sometimes, brands catch on to elastic products when they notice their margins shrinking.
Price Elasticity in Context
Price elasticity relates to many other important metrics and measurements in the retail space. Specifically, price elasticity goes together with pricing intelligence and price monitoring.
When speaking with major brands, we’ve heard that it’s important to measure price elasticity because retailers won’t always say when they’re going to discount an item or alter their pricing approaches. Instead, brands catch on because margins or average unit retail drop.
This makes tracking prices even more important. Elastic products, those that are sensitive to price changes, are vulnerable to the actions of individual resellers. Those are the products that should be closely monitored for price changes, so you don’t find out when you notice shrinking margins. Brands that are on top of their pricing will know the price elasticity of all their products and then monitor those prices across all resellers.
Price Elasticity of Supply
Price elasticity of demand isn’t the only price elasticity metric, though. There is also Price Elasticity of Supply (PES). PES is calculated via a similar formula: % Change in Supply / % Change in Price. It’s like the other side of the same coin with PED.
Price elasticity of supply looks at how sensitive the supply of a product is to a price change. Elastic products see greater changes in supply for any price change, while it’s the opposite for inelastic products. The real-world example here is a product that has an increase in price by 10 percent and a 15 percent increase in supply—it’s elastic, and that price change has contributed to an inventory surplus.
Therefore, PES is also important to measure because it shows how supply will be affected by price and what changes need to occur in the supply chain to accommodate a pending price change.
How to Approach Price Elasticity
The concepts behind price elasticity are well and good, but the real issue is what you should do about it.
As we mentioned, brands that are tracking price elasticity are closely monitoring prices across their reseller network for any fluctuations and adjusting supply and demand accordingly. Beyond that, you should also be measuring consumer behavior as it relates to price. Current behavior is a strong indicator of future behavior. If your shoppers have reacted negatively or positively to a price change in the past, there’s a good chance they’ll do the same in the future.
In addition, you should understand price elasticity but then look past it into the factors that are making your products elastic or inelastic. A big one, like in the Apple example, is brand reputation and brand loyalty. Brands that have strong, even cult-like followings (Apple, Amazon, Tesla, Google) can adjust prices with less of an impact on consumer demand.
So, if you’re worried about changing prices, you may want to:
- Focus on building up some more brand loyalty before implementing any new prices
- Run advertising or marketing campaigns ahead of price changes to increase awareness
- Track competitor prices for fluctuations that could impact your brand (cross-elasticity of demand)
- Align prices with product life cycle (higher prices in early stage, lower prices at later stage)
The bottom line is that price elasticity matters in retail. It is related to many other major metrics, behaviors, and sales drivers, and you should be aware of price elasticity to make educated, effective pricing decisions for your brand.
Want to dig more into pricing intelligence as a whole? Check out this article on pricing intelligence and automated repricing. Happy pricing!