Did you know that Nike almost went out of business in 2001?
Well… almost. But they survived. This debacle resulted from a flawed understanding of demand and supply. However, they were able to turn this situation around before it got too bad (although they lost about 100 million in sales).
Even though they overcame this challenge through their determination, grit, and advanced technology, the underlying principle revolves around understanding the principle of Price Elasticity of Demand and Supply.
What is Price Elasticity?
It sounds very simple, yet, the application is enormous!
Price elasticity is simply a measure of how the change in price affects the change in quantity demanded or supplied. This is an interesting aspect of price sensitivity and it comes in handy when trying to implement certain changes in a business economy.
For example, if a retailer is considering increasing the price of certain books on sale, estimating the new price without prior information of the market will be difficult. The best bet will be to physically check their store prices or ask business owners around, and there are a million ways by which this can fail. The environment might differ or other retailers might change price too frequently or not display prices online. However, with pricing intelligence tools which provide real-time pricing data by retrieving it directly from websites, the prediction will be based on accurate information and will come off perfect.
The Importance of Price Elasticity
You must’ve heard that price elasticity is one of the most important concepts in business economics. This is not an exaggeration. In fact, that’s a very humble ovation. This seemingly simple concept has immense applications on your business and the outlook of things.
For one, it is a strong indicator of how consumers will react to price changes in your industry. Using the price elasticity metric, you can safely and accurately estimate the loss or profit you stand to incur or gain by slightly modifying the price. You can also get insight into the sensitivity of consumers and volatility of the market.
In an already crowded market, establishing a new business might prove tasking, especially with the plethora of data and variables to work with. It gets more difficult if you plan to tackle it manually. However, there are easier ways to addressing the problem. We shall discuss more about sophisticated tools which make the job of calculating the price elasticity of demand and supply more accurately.
Difference Between Price Elasticity of Demand and Price Elasticity of Supply
As earlier stated, price elasticity studies the relationship between price and quantity. Price elasticity of demand deals with the relationship between price and the quantity demanded while price elasticity of supply is the change in the quantity supplied divided by the change in price.
The table shows that when demand is elastic (> 1) – a rise in price will subsequently lead to a rise in total revenue and vice versa. Similarly, when demand is inelastic (< 1) – both price and total revenue will move in the same direction, that is, a rise in price will lead to a rise in total revenue and vice versa. However, when the demand is unit elastic (= 1) – a rise or fall in price will not have any impact on total revenue, here, quantity demanded changes proportionately.
While price elasticity of demand helps a retailer know the range of possible selling prices and the impact on the propensity of customers to request for the same product, the price elasticity of supply shows how producers are able to either flexibly change production or be rigid with the price. These values can be expressed as a percentage and there are curves to display the actual representation of this relationship.
Relationship Between Price Elasticity and Total Revenue
If you are concerned about generating appreciable revenue, your aim should be to make your product as inelastic as possible. How can you do this?
Traditionally, it takes weeks of gathering intelligence manually, days of crunching numbers, and more weeks of actually interpreting the results you get. Considering the volatility and flexibility of the market, this method might eventually provide you with useful-outdated information.
However, with sophisticated monitoring tools like SpotLite which execute price and promotion tracking the entire process is not only automated saving time and hours of manual work, but it also offers pin-point accuracy.
Effect of Price Elasticity on Retail Performance
Have you ever felt like you’re selling your products at a ridiculously cheap price? Maybe you’re convinced that you can only sell your products when you reduce the price of your products. Perhaps, you feel the exorbitant price of your goods is the cause of your dwindling sales. Unfortunately, you don’t want to lower the price arbitrarily. It’s a vicious cycle!
What if you had access to the ‘promotions’ being offered by your competitors? Even better, you have in-depth knowledge of the price which consumers will gladly pay for a particular product. You need not go through endless manual processes to get information as vital as this.
With online price intelligence automation, you get detailed reports on a wide range of information on the market and you can use it to your advantage. You can easily tweak the price of the products based on your pricing strategy and objectives, whether it’s to increase margin, volume or sales.
How Price Elasticity Increases Profit Margins
Price Elasticity is an important tool in engendering business discrimination. To put things in perspective, business discrimination is a phenomenon whereby a supplier decides to change the pricing structure of the same product for different markets. For instance, a watch which is sold for 50 US dollars, is then peddled for 170 US dollars on a different market.
Also, for businesses with competition within the locality, it might be difficult to discover that your competitor is selling the same shoes you sell for 50 US dollars, at 170 US dollars. However, converting the pain to purpose is even more beneficial. Instantly, you can increase the price of your goods, knowing fully well that the customers will continue to buy. This is one way in which retailers increase the profit margins of their products. An absolute deal, considering that you got the information for a fraction of the profit you made.
How to Calculate Price Elasticity
Price elasticity is measured by computing the absolute value of the ratio of the percentage change in quantity demanded/supplied to the percentage change in price. For instance, if you choose to increase the price of your product from $50 to $60, this is an increase of about 20%. All things being equal, you should expect fewer sales as a result of this increase.
Let’s assume you are only able to supply 35 units of your product instead of 50 pieces, the percentage change becomes -30%. The price elasticity then is calculated to be -0.3 divided by 0.2, giving 1.5 (absolute value).
As you observed, the negative sign was ignored. We are only concerned about how far this value is from 0. If you calculate your price elasticity to be greater than 1, this means it is elastic, otherwise, it is termed inelastic. If, however, this value is 1, it is called unitary.
This calculation is not only possible with values from your company. For example, a new company just testing the waters barely has any self-generated data to rely on. Does this mean that the business will suffer due to ignorance? No! You can get insight into how a particular industry is faring with the aid of pricing intelligence and promotion tracking tools.
To Sum Up… Understanding Price Elasticity IS A MUST.
The next time you hear about a new business making waves in an extremely crowded market where the chance of success is minuscule, just know that Batman and Robin are in town. Retailers with a perfect understanding of price elasticity of demand and supply will inevitably disrupt the industry.
However, it doesn’t end there. The process of collecting data, going through pertinent records and monitoring competitor’s performance is extremely stressful. A dedicated team of 100 professionals will manage to fare averagely. The advent of technology, though, tilts the playing field in your favour. Online price and promotion tracking platforms like SpotLite provide unbridled & accurate information on this matter. You can get started here.