What if Apple decides to release a budget iPhone?
What if Netflix offers exclusive Marvel content?
Sounds too good to be true?
In marketing, the most crucial part is assessing how consumers react to changes in a product. Any decision that leads to a modification in your product can influence whether consumers choose to buy it or not. Setting the right price is a challenging task in business, mainly because it greatly impacts your company's overall financial performance.
A crucial component of pricing is comprehending what economists refer to as price elasticity. It stands out as one of the most basic and vital economic concepts that any business owner or sales professional should grasp. Being aware of the price elasticity of your offerings is central to effectively predicting outcomes, devising a solid pricing strategy, and establishing a dynamic and successful company.
What Does Pricing Elasticity Imply?
Price elasticity measures how changes in the price of a product affect the quantity demanded and supplied. There are three categories of price elasticity:
- Price elastic: This occurs when price changes have a substantial impact on the demand or supply of a service or product.
- Price inelastic: In this case, demand and supply respond oppositely to changes in price, meaning they move in the opposite direction.
- Price unit elastic: This situation arises when a price change is proportionally aligned with the changes in demand and supply, moving at the same rate.
If a service or product experiences significant shifts in quantity demanded with even slight price adjustments, it is considered highly price elastic. Conversely, if a notable change in price results in only a minimal shift in the quantity demanded, the service or product is deemed inelastic.
How Can Price Elasticity Be Calculated?
To determine a product's price elasticity, you divide % quantity change by %price change. Let's check the formula for the price elasticity of demand:
Price Elasticity of Demand (E) = (% Change in Quantity Demanded) * (% Change in Price)
For example, if a product experiences a 15% increase in quantity demanded due to a 10% reduction in price, the price elasticity of demand would be calculated as 15% / 10% = 1.5.
Ideally, in Software as a Service (SaaS), you'd prefer your product to be inelastic. An inelastic product demonstrates a demand that can withstand changes in pricing. On the other hand, a highly elastic product's demand may not sustain itself and could eventually lose momentum. The equation provides insights into your product's characteristics:
- E=1: Your product is unit elastic, and price changes correspond equally to changes in demand or supply.
- E>1: Your product is elastic, meaning changes in price lead to a greater than-proportional shift in demand or supply.
- E<1: Your product is inelastic, indicating that changes in price result in a smaller shift in the demand or supply for your product.
In simpler terms, demand is considered elastic if the elasticity value is above 1 and inelastic if the value is below 1.
How Does Price Elasticity Benefit Businesses?
By employing the elasticity formula, businesses can identify and differentiate between elastic and inelastic products. Subsequently, they can establish more effective pricing strategies for each product or category to sustain revenue and profitability.
For elastic products, companies have the option to lower prices, thereby boosting sales volume. The reduction in prices not only stimulates increased sales but also enhances the market's perception of your brand's pricing.
On the other hand, for inelastic products, businesses can opt to raise prices to achieve higher profit margins with minimal impact on the number of units sold. This approach allows companies to capitalize on the relatively stable demand for these products.
What Are the Benefits of Plastic Elasticity Modeling?
Price elasticity serves as a tool for pinpointing the price at which maximum profitability is achieved. In this delicate balance, increased margins and prices are counterbalanced by a decrease in sales and demand. This optimal price point can be assessed against current pricing to evaluate whether products are under or overpriced. It's crucial to note that these projected points should be appropriately weighed with other metrics for effective decision-making.
Pricing strategies and calculated maximum profit points offer valuable directional guidance for product teams. When integrated with data analytics that encompasses competitor statistics, this information becomes instrumental in aligning prices with the current market, recognizing shifts in the market, and optimizing products at a location or segment level.
Understanding the responsiveness of customers to price changes allows companies to set prices that better match what their customers are willing to pay. This alignment can lead to increased profitability and heightened sales. Therefore, leveraging price elasticity data is crucial for steering your pricing strategy.
With insights derived from price elasticity, businesses can:
- Identify products crucial to customers, contributing significantly to building your brand's price image.
- Determine which products are regularly compared by customers.
- Determine how much profit and revenue you will make at different price points for a quantity of items, your entire assortment, or a single item.
- Develop a demand function and illustrate a demand curve.
- Devise an optimized, demand-driven, and automated pricing strategy.
Use Strategic Pricing for Business Growth
In the end, it's crucial for your business to remain meaningful to consumers and stand out from competitors. Once you establish that, you have the flexibility to fine-tune prices—either downward or upward—to more accurately reflect the value you offer to your customers. Your existing price elasticity serves as a key data point in guiding these future decisions.
