One of the most critical components to pricing is what economists refer to as price elasticity. Given the bottom-line impact pricing can have on overall profitability, it’s a critical concept for all marketers to understand.
Price elasticity is the measure of the market’s response to price changes. Elasticity helps us understand how much a change in price will affect market behaviors. If we make a small change in price, will the change have a dramatic impact or a minor impact on the demand for the product?
Elasticity is important to pricing decisions because it helps determine whether raising or lowering prices will enable us to achieve our pricing objectives. Will a discount drive increased sales? Will a price increase cause us to lose many buyers or just a few? We have to answer these questions in order to select the most effective pricing strategy.
Common sense says that the cheaper your product or service is, the more people will buy it. Likewise, the more expensive it is, fewer will buy it. But it’s not that simple. Elasticity is affected by other factors such as brand, type of product, economic factors, competition, etc.
The calculation for price elasticity is the percentage change in quantity demanded, divided by the percentage change in price. When the absolute value of the price elasticity is greater than one, the price is elastic and people are very sensitive to change in price. Likewise, when the absolute value of the price elasticity is less than one, the price is inelastic and people are insensitive to change in price.
Typically, there are five zones to price elasticity:
- Perfectly Elastic—a small change in price results in a very large change in demand. Products are viewed as expendable and there is no brand loyalty.
- Relatively Elastic—small changes in price cause significant changes in demand. Consumers might have a definite preference, but they can also easily find other comparable products.
- Unit Elastic—changes in price are matched by changes in demand.
- Relatively Inelastic—large changes in price cause relatively small changes in demand. Consumers are not willing or are unable to find a substitute product.
- Perfectly Inelastic – demand is not impacted by changes in price. These tend to be products that people need and have relatively limited or no options.
Knowing where your product or service falls within this price elasticity spectrum can help determine your pricing strategy. Direct mail provides the perfect channel for price elasticity testing in a controlled measurable environment.
At Creative Solutions, we provide a full spectrum of services from offer development and list procurement to creative execution and data analytics. We can help you cut through the clutter and noise in the market and generate incremental revenue. Call 302.543.8533 or email us today to explore how we can help you.