Imagine a retailer pondering a modest price increase on its popular product. How will this be received? Will this increase traffic and sales or does it conceal the potential to compromise your financial standing? Here, enters price elasticity, retail’s most pivotal influence for success. Price elasticity is a metric that unravels the relationship between price and demand. In economics, price and demand are assumed to have a negative relationship i.e. if price goes up, demand goes down. Price elasticity, a fundamental concept in economics, quantifies this relationship. It measures the response of consumer demand to changes in a product’s price. It lets you grab the reins of your customer’s willingness to pay. and thus tweak the prices of the product accordingly to maximize revenue.
Read our blog on how pricing impacts your Customer Lifetime Value (CLTV)
Now, the demand for a product broadly falls under two types:
(Note: Ed denotes the numerical value of elasticity of demand)
Elastic products (ed >1) – If the elasticity is greater than 1, it means the rate at which the demand falls is faster than the rate at which the price rises. This means the change in the price leads to a greater change in the quantity demanded or supplied by the customer. This insinuates your customer is sensitive to the prices being set in the market.
In this example, the price elasticity of demand (Ed) is 2, indicating that the product has a relatively elastic demand. A price increase of 10% led to a larger percentage decrease in the quantity demanded (-20%), demonstrating that consumers are responsive to price changes in a relatively elastic way for this product. This loss of revenue could have been avoided, provided the seller had known of its product’s elasticity.
Inelastic products (ed <1) – When the price of a product changes, the quantity demanded or supplied only changes slightly or not at all. A change in the price leads to a smaller change in the quantity demanded. The closer the value of ed approaches 0, the greater the resistance towards price change. This portrays that the customer isn’t affected by the prices of the product but lays emphasis on other aspects such as quality, customer service, etc. The demand for necessity products and luxury brands usually have inelastic demand.
However, let’s consider the coffee titan, Starbucks. Starbucks has a unique market position with a loyal customer base. This scarcity of similar options that provide the same experience contributes to what economists term “inelastic demand,” indicating that Starbucks’ coffee experiences low price elasticity. In other words, consumers of Starbucks coffee are not significantly deterred by changes in its price. However, pricing is still very tricky.
But elasticity isn’t a static numerical value. The demand, an Apple iPhone has, at a new release has higher inelasticity than after a month. This means elasticity needs to be recalculated regularly, especially in the realm of retail.
Why is price elasticity complex in retail? Retail: The world of substitutes
If the price of a mobile goes up, consumers won’t hesitate to look for another brand. The price of one mobile affects the quantity sold of another. This is a very prominent type of elasticity in retail known as cross elasticity.
The presence of substitutes in the retail industry renders cross elasticity to be of vital consideration.
Cross elasticity of demand measures the effect of the price of one product on the quantity demanded of its substitute. In other words, the cross elasticity portrays how fast a consumer shifts to a competitive product.
Consider Coca-Cola and Pepsi. If Coca-Cola decides to increase the price of its carbonated soft drinks, some consumers may decide to switch to Pepsi, which is a similar beverage. As a result, the quantity demanded for Coca-Cola may decrease. This is exactly the situation in the retail industry. The presence of substitutes or competition in the market is one of the industry’s biggest challenges.
Read an interesting case analysis on the elasticity of demand in household appliances.
In the above example of Starbucks, not only did they manage to retain their customer base through elasticity but also managed to increase their revenue by pricing in an astute manner. Starbucks only increased the price of their small-sized coffee, which pushed customers to buy the next size. Not only did they manage to increase their price but also increased their revenue by pricing optimally.
The retail industry’s wide product range, seasonal trends, consumer behavior, and dynamic markets require constant monitoring and calculations to find the optimal price. In retail, every price shift can either make or break your success, so understanding and leveraging price elasticity is paramount.
As seen in the Starbucks case above, brands and businesses like yours should master the art of pricing<. It will also help to strengthen the retention of clients and increase revenues. In a world where new substitutes keep popping up daily and in constant market flux, the need for a sophisticated pricing solution becomes evident. Organizations need an automated solution that finds the perfect price for brands to remain competitive in the market.
BRIO, our cutting-edge AI dynamic pricing model, can do that for you. Not only does it dynamically track and adjust to market conditions but it actively calculates price and cross-elasticity of a product to position your brand optimally.
Are you intrigued? Unlock the power of BRIO and navigate the intricate realm of retail pricing with confidence.
To keep up with this dynamic environment, it is imperative to learn how AI pricing engines can help you do that.
Book a free demo of our automated retail solutions or contact our optimization experts at info@sciative.com.
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