Price elasticity of demand (PED) demonstrates the variation in consumer price demand. Businesses can inevitably gain insight into customer behavior and pricing strategies using CPG, supply chain, and data analytics.
This article delves into the need for PED, its related factors, and how data analytics will benefit through better pricing decisions.
What is the Price Elasticity of Demand(PED)?
Price elasticity serves as a compass for businesses in a complex market. It is an invisible tool that tells us what will happen to consumers when prices change. This leads to demand curves and, eventually, revenue.
According to McKinsey, a 1 per cent price rise would generate an 8 per cent increase in operating profits if volumes remained stable.
Understanding price elasticity allows companies to foresee how customers act under different pricing axes. CPG Analytics helps analyze these trends. The following queries can be solved by calculating price elasticity:
- Will they choose to leave the more expensive one and buy the cheaper one? Or will they be ready to pay more for getting the best product and, thus, stay?
- What will be the impact of price reductions on sales and revenue?
The price Elasticity of Demand can be calculated using the formula below:
Example Scenario
Imagine a tech firm that makes a popular smartwatch. The demand for these smartwatches is elastic, meaning buyers react to price shifts. If the company raises the price of its smartwatches even a little, it might cause a significant drop in sales.
This happens because customers could choose cheaper options or wait to buy until the price falls.
As a result, the company risks losing more money from fewer sales than it would gain from charging more per watch. Knowing this, the company’s leaders should focus on selling more watches or cutting production costs to increase profits instead of considering raising prices. For example, they could add new features to make their product stand out, start focused ad campaigns, or look for ways to improve their supply chain.
Factors Influencing Price Elasticity
Nature of Good
The elasticity of demand depends on various things, such as the nature of goods that can be necessities, comfort, or luxury goods. It’s worth mentioning here that the classification of goods based on this distinction is subjective. In other words, a single good for one individual can be a necessity, a comfort item for another, and an overdone good for others.
Necessity goods (e.g., vegetables, medicines) are inelastic in demand, as people need them even if their prices change.
Comfort goods (e.g., fans and refrigerators) have elastic demand, as people can postpone their consumption if the prices increase.
Luxury goods (e.g., cars, diamonds) are inelastic in demand, as people are less affected by price changes.
A possible example is when a person from a developed country sees a smartphone as a comfort good, and one from a developing country sees it as a luxury good.
Availability of Substitutes
The increased number of substitutes augments the [price] elasticity of demand. Small price rises can induce consumers to switch to other products. Supply chain analytics can track these substitutions effectively.
Example: When the price of Coca-Cola goes up, the most common action is that consumers may shift from Coca-Cola to other soft drink brands or even those of different brands.
Price Level
Demand elasticity depends on the value of the product concerned. A product with a higher price is generally more elastic because price changes have a bigger impact on the customer’s buying ability.
Example: A 10% price hike on a ₹50,000 laptop might be material for a consumer, whereas a 10% hike on a ₹50 packet of chips is not that much.
Income Levels
Income levels shape the elasticity of demand. The rich do not have a price response reaction, so they do not care about price fluctuations, and poor people are vulnerable to price sensitivity.
Example: A 10% price increase on a luxury car will not be enough to make a high-income person buy one, but a 10% price increase in a basic necessity like rice will hurt a low-income household.
Period
If gasoline prices rise suddenly, consumers may refrain from changing their behaviour. However, they can switch to more efficient vehicles or other transport modes after a long time.
- Analysis of online reviews and Social influence: Positive online reviews and social media endorsements persuade consumers to appreciate price fluctuations, thereby being a strong factor in risk management.Personal morals and preferences: Personal values and preferences like ecological awareness and health awareness of consumers can affect the elasticity of demand. A person committed to sustainability might be a more sensitive buyer when it comes to the prices of eco-friendly products.
- Contextual factors: Nevertheless, other local factors, like cold weather conditions, might influence consumers’ choices about what to wear. For example, the demand for winter clothing might be more elastic in colder climates than in warmer regions.
Price Analysis by TransOrg
Client Objective :
Our client, a multinational food, snacks, and beverages corporation with an annual revenue of over 1 billion dollars and with presence in nearly 150 countries and territories, spends billions of dollars annually in its global marketing and advertising.
- Client wanted to analyze its own brands vs. competitors’ price positioning across the top countries in the Middle East region to identify growth opportunities that can help maximize or optimize their shampoo portfolio while retaining volume share.
TransOrg’s Role:
TransOrg Analytics successfully developed a price positioning model for one of the leading FMCG brand , in the Middle East region to identify the appropriate competition universe for the client’s brands, gaps in product positioning vis-à-vis its competitors and price bands where client could establish its leadership.
Key Deliverables:
TransOrg’s analytics produced the following:
- Identified top 3 brands competing with client based on price and/or pack variants and brand positioning
- Introduce larger pack sizes as client present in 200 & 400 ML variants whereas competitors in 600+ ML pack sizes as well
- Nominal price increase without volume share loss in 400 ML size
Conclusion
The practical application of price elasticity concepts usually becomes the turning point in a company’s poverty or wealth. Thus, this article concentrated on turning theoretical discussion into a real-life example. For example, in the supermarket business, real-time data analysis will predict the consumption of products like biscuits. TransOrg Analytics revamped inventory control and sales projection systems with data analytics solutions.
