Imagine a scenario with me for a second. If you were to print out every article on the internet about marketing promotions, and every article on price elasticity, how much ink do you think you’d need for each of the topics? I think you’d probably need a swimming pool’s worth for promotions, and a Mount Franklin bottle worth for pricing.
A quick google reveals there are 2.48 billion results for marketing promotion, and 58.3 million results for price elasticity.
It seems like we’re living in a marketing world obsessed with marketing promotion. It’s strange. Because while nailing a good campaign might get you on a yacht on the French Riviera, understanding price elasticity could well get you one of those billionaire superyachts for the Pacific Ocean. Especially now, when a well thought out pricing strategy could be the perfect counter to rising inflation costs.
If the job of marketing is to either sell more products at the same price or sell the same amount of products at a higher price, then shouldn’t marketers and their agencies have a good understanding of price elasticity? That is, exactly how much your product’s price can change without it impacting sales.
A Price Elasticity Refresher
Simply put, price elasticity is how much demand shrinks when you stretch your product’s price. The more elastic your brand, the less goods you’ll sell when you up the price.
You can understand your price elasticity using this formula:
[% Change in Quantity Demanded] / [% Change in Price]
For example, imagine a shoe company raised the price of its flagship product by 10% from $150 to $165. In response, its sales drop from 1,000 to 800, a 20% decrease. Applying our formula, we get an elasticity of 2.
Jill Avery, a senior lecturer with Harvard Business School, explains that it’s less about the elasticity number and more about the zone the product or service falls into. Products and services can be:
- Perfectly elastic: Small changes in price lead to very large changes in quantity sold.
- Relatively elastic: Small changes in price cause large changes in quantity sold (usually, price elasticity is greater than 1). Our shoes above are relatively elastic. Other relatively elastic categories are products like customer electronics, where buyers are sensitive to price changes and can switch brands.
- Unit elastic: Any change in price is matched by an equal change in quantity of sales (elasticity is equal to 1).
- Relatively inelastic: Large changes in price cause small changes in demand (elasticity is less than 1). This could be strong brands which have built a lot of brand equity, like Apple, the exception to our consumer electronics example earlier. This could also be staples like power and pantry staples (salt, pepper) where demand stays fairly constant.
- Perfectly inelastic: Where quantity demanded does not change when the price does. This is usually only seen in monopolies where one company charges whatever it wants.
Now you know the theory, let’s take a look at two ways price elasticity can help you be a better marketer.
A practical way to measure effectiveness
Once you have your price elasticity, you can use it to measure your marketing’s performance. If your marketing efforts work, then your elasticity will decrease. That’s because you’re either selling more product, selling the same amount of product at a higher price, or both.
So how do you determine your shifting price sensitivity in response to marketing? Here’s how some of the best have done it:
- If you control your Point of Sale environment, you can create tests where you increase price on items and measure response on sales. This is even easier if you have an eCommerce presence, where updating pricing is almost automatic.
- Once you have that, you can set up different test cells with different mixes of marketing activity to determine impacts on pricing.
A gateway to several pricing strategies
Decreasing price sensitivity over time will impress your CFO and your CEO, but that’s just the beginning. Canny marketers should be thinking about using price elasticity to model how pricing shifts will impact demand. This can be achieved easily enough with a spreadsheet in Excel or Google Sheets. It’s beyond the scope of this article to explain how. Seek out support from your analytics team, or consult this textbook for more details.
Once you understand how pricing shifts impact your product’s demand, you can plan out various pricing strategies, choosing the one that will benefit your bottom line the most. Here are some pricing strategy examples:
- Volume maximising, or penetration. Brands who use this set a low price to attract a large number of customers and gain market share. Amazon, Walmart, McDonald’s, and ALDI all use this pricing strategy, focusing on keeping costs low to grow scale.
- Profit maximising. This is used by luxury brands like Chanel, Louis Vuitton, and Gucci, who maintain large margins with high prices and annual increases. Chanel in particular have doubled the price of their handbags in the past decade. Apple, the masters of pricing, also pursue this strategy.
- Bundling. This is where brands offer multiple products and services for a lower price than individual products combined. Perhaps the best example of this is Microsoft, who offer Teams, Microsoft Authenticator, PowerBI, Sharepoint, and others as part of an Office subscription to fend off other tech companies.
- Loss leading. This is where brands sell a product or service at a low price or even a loss to attract customers with the hope they’ll sell more profitable products to customers later. Gillette is the pioneer of this, selling razors at cost to lock people in to the more profitable razorblades over time. Nespresso and 7Eleven also use variations on this strategy with machines and coffee at cost to get people in the door.
- Freemium. Similar to loss leading, where brands give away products and services to make money on upgraded services or features.
Regular communication of price elasticity with agencies can also help sharpen strategies, tactics, and creative work. Rather than keeping pricing data hidden in the fear that agencies “won’t get it”, savvy marketers should be talking about pricing and demand impacts to make sure that agencies are focusing on the same thing as they are – and delivering work that builds brand equity and the bottom line.
Pricing isn’t the sexiest of topics. But spending time to understand price elasticity allows marketers to really measure the impact of marketing, and in turn, communicate it to the rest of the business. It also means you can implement new pricing strategies to maximise profit. In the volatile economic circumstances of the next couple of years, it will be the marketers that nail pricing that will succeed.
