Episode #0026 - What is price elasticity?

In this episode of Pricing College - we go back to University for Economics 101. If you increase prices - how much will volume fall? Is that something we should know or care about? Is there anything we can do to influence elasticity - or is it a given? Why does the Tax man care about elasticity - or in-elasticity?   Today we're going to talk about a very popular concept in pricing called price elasticity. Now price elasticity has an important role in pricing because it's a measurement, which tracks consumer demand or responses in relation to a price. So, if a certain price is high, what happens next? Does demand go up? or down? Does volume go up? Or down? I think we need to be clear that in this podcast, it's a variable method of spreading information so we're not intending to give you mathematical formulas or look at it in that concept, but we're just going to give an introduction that any marketer any salesperson and certainly any pricer that should know. It's an interesting concept because a lot of pricing managers use it, especially in say more consumer-focused B2C industries like airlines, cruise ships, the tourism leisure industry, and even cinemas, things like that, especially ones which have a capacity restraint of some sort, goes with dynamic pricing quite well. However, in B2B, a lot of pricing managers don't use price elasticity, maybe they should say they don't need to because there's very little difference, however it's a good measure to always track volume and demand according to price changes, whatever industry and sector you work in the market. I previously have worked in a B2B environment, and we will put through annual price rises and I'll be honest the very concept of price elasticity was never even discussed. The company would have had an overview that a certain number of customers would leave business price increases, but they wouldn't have had a calculation, they wouldn't have had a forecast, and it was all very mathematics and almost as if the cost of the price elasticity did not exist.  In B2B, it's an assumption that it tends to be a cost-plus price-setting sort of regime, most customers are sort of on the same price, with different rebate structures. So, why do we need to monitor the elasticity? We need to monitor the elasticity because your customers are different and what that shows when somebody says that to me is that you haven't segmented your customer base, you don't report on price response or neither do you understand it. I think in this topic we'll give an example or two. In this instance, it's very much commonly used in economics and academia or our government who likes to tax things and maximise their tax income, they certainly know about elasticity and inelastic products and services. If you ever think about where the government puts taxes on or what consumer products have been taxed, it's always something that if you increase the price, the demand will stay relatively stable. Think of cigarettes, think of petrol for your car, think of alcohol, those sorts of things tend to be very inelastic, obviously up to a point that some countries have lifted minimum pricing for alcohol. But if you're going to make a car journey, if the price of petrol goes up a couple of cents it’s probably not going to make a huge difference to how much you consume. So it comes down to when a customer needs a product or service, then they're likely to be more or less sensitive to price, and think about other things rather than just the price point. They're thinking about the value the product has to them, whether it solves a specific issue, like everybody needs to put petrol in the car for the car to move so they can go from A to B, so to a certain point, this is why it's inelastic. But I suppose in terms of B2B, you've got to start thinking about those drivers as well in terms of when I put my price up, what happens when I put my price down? Does it change? That's it and obviously, every instance is very different. The reason the government can do it is that they’re part of flood increase across the entire economy for petrol or alcohol or whatever it is. When you're an individual business the elasticity will likely be much more prominent because people could swap out for other providers, they can swap for another similar but slightly different product. So you need to consider the exact instance of your business, know that value drivers as to why people buy from you, and then you should be able to overtime as you builds up a history of knowledge of your customer base, you should be able to have a reasonable estimate as to the elasticity of prices that you will make.  Also remember I suppose this is a tip, yes the price is important and it does drive demand, but it's not the only thing. I think sometimes in pricing we get fixated on the power of price to drive demand when sometimes it's more than that and we've got to refocus that back to the customer, what is driving the behaviour? Yes, it's price. What else is it? Why are they buying from us? And then when we read our pricing elasticity is measured with that frame in perspective in mind, then we can start working out. What drivers we talked about before about loss aversion? and what the drivers are price elasticity? The number one driver of price elasticity is that loss aversion concept I do recommend going back to that podcast. So it's not just price that drives demand in other things too. I sometimes see price elasticity, not as a standalone thing but it's almost a result of your business. We talked about pricing power, when a company has an off-brand reputation, trust relationships with customers, those sorts of things they have pricing power and the pricing power goes hand in hand with price elasticity. If you have pricing power, it means fundamentally you can increase prices, and hopefully not see a large drop off in volume so they go hand in hand. The pricing power and pricing elasticity, I think, are the different ways of looking at the same thing. If you have a great business if you work hard with your customers and your sales team marketing, everything's working well, I would be suspicious that you could see your price elasticity become more favourable to you.  I agree I see price elasticity as an important measure to monitor the market and to monitor different segments. It becomes more useful when you've got your segmentation worked out, and then you can start looking at different customer groups and their response to price by a group. And then after that, it's one of the measures so there are multiple things you can do to interpret price elasticity because on its own it's just a basic measure, so we want to get to, why it's happening? we can see it's happening with the price elasticity, so why is that happening? because from there we can start to reset prices according to value. I think if you look at the example we gave of where you have a better relationship with your customers or your product is much better. If you take a real extreme example of that where there is no competition, you look at monopolies or, companies with huge market power oligopolies etc governess jealousy to control those because those companies can increase prices for electricity or water or whatever it is, railway travel, and there's nothing the customer can do they still have to buy. So, in those instances, it does lead to price gouging, which again we covered in a previous episode. When pricing power is unfettered or uncontrolled, you will have certain problems in the market, and that is something that a lot of government agencies seek to control as well. So it's a topic that covers business but also economics and a lot of government interference.