Elasticity of Price and Price Perception

What influences price elasticity and price perception the most?

Many myths revolve around price elasticity. We’re here to show you that the perception of your prices by your customers is flexible, and how it’s possible to calculate it.

Nick Tikhomirov


Price Elasticity Explained

Price elasticity seeks to answer a few very important questions that you as a retailer need to know about your customers and how they perceive your prices. With price elasticity, you can understand if people will buy more of your product if prices drop, and if so, how much more they will buy. Inversely, it can tell you how much less likely they are to buy your products if your prices are raised. By calculating a product’s elasticity of demand, you can measure the responsiveness of customer demand, i.e. their willingness to buy your product after you make any price changes.This change in demand with respect to price change is represented by a percentage.



Generally speaking, increasing prices leads to a decrease in customers purchasing your products. This means that the price elasticity is usually a negative value. However, for simplicity’s sake, price elasticity models express these values as positive numbers when they are calculated.

The simplest calculation for the price elasticity of demand (PED, or PE) is done by dividing the change in quantity demanded by the change in price.

PE = Change in Quantity Demanded Change in Price

However, you first need to find the change in quantity demanded, as well as the change in price. This makes the original equation shown look a bit more complex, but all the values are easily understandable with some context.

Arc Elasticity
of Demand
= Q1 - Q0
Q1 + Q0
2

P1-P0
P1+P0
2

The original quantity of demand is Q0, with the new demand quantity being Q1. The same follows for product price and their change: the original price is P0, and the new price is P1.

Let’s say we are calculating the PE for a pizzeria in London. When they set the price of a slice of pizza at £4, the demand is 60 pizza slices per day. If a slice of pizza is sold at £2, the demand is 80 slices per day.

Putting this information into our PE equation looks like this:

80-60
80+60
     2     
2-4
2+4
2
= 20
 70 
-2
3
= 2
7
*  -3 
 2 
=  -3 
 7 

Our resulting price elasticity coefficient is about -0.43, which as stated before we will represent as a positive number: 0.43. Because our resulting value is between 0 and 1, we now know that our product in this case is inelastic. Had the value been greater than 1, this would mean the product is elastic.

6 most influential factors in price elasticity

Researchers at the Ehrenberg-Bass institute for marketing science managed to find the key factors which influence price elasticity, and also the factors which are of lesser importance. You can read more about their findings in this article).

Their research found patterns across brands, products, and countries, and some of their findings contradicted popular beliefs about price elasticity. Let’s go through the six main influential factors they found one-by-one:

  1. If the cost is the same or higher than the cost of a market leader in a category, the elasticity gets higher as well. The point is not that the price itself matters so much, but the relative price availability, i.e. in respect to the category leader and to the round point (for example, $10). This means if you want to keep the demand of your product optimal, you have to take into account the brand strength of your rival. If you’re a follower in price, calculate the optimal price index relative to the leader.
  2. It is commonly believed that the bigger the brand, the smaller elasticity their products will have.This is not always the case, because it also depends on the “commodification” of the brand (the assignment of market value). Here, the brand value is “diluted” because the quality of commodities such as washing powder is less or more the same for every brand. For products like this, the consumers will buy a product which is less expensive or better promoted.
  3. Nobody likes significant increase in price, that’s why there is a rule of single-digit price increase (no more than 9,9%). If the price increases by 10%, consumers get nervous and buy significantly less.
  4. The mass market has the highest price elasticity. In this segment, the price elasticity increases, if the price is 5% higher or lower than the medium price. However, in general the price elasticity is lower for the economy segment as well as for luxury goods, as they have a loyal customer base.
  5. A highlighted discount works 1.5 times better than the discount or another promo which wasn’t highlighted (for example, with different color). The reduced price needs to be “red-labeled”.
  6. Price elasticity is higher for the less recent buyers, as they know less about the brand quality and they choose what is cheaper or has a discount. On a similar note, price elasticity increases for those who are more price conscious, though they have the “threshold line” the lowest price at which they are buying goods.

Price Perception

How customers perceive the prices in a store is just as valuable as the prices themselves. Retailers want to assure customers the prices they have are the fairest compared to their competitors.

Price perception depends on brand positioning, advertisement, as well as the prices of traffic drivers, bestsellers, and KVI-positions.

Obtaining the right price perception for your products and company is a never-ending battle, and can be very difficult to do.

Let’s take into account the experience of a few UK retailers such as Tesco and Sainsbury’s a few years ago. Because of stiff competition, they decreased nearly all of their prices across the board. Customers didn’t perceive these changes the way they had hoped, and their sales volume didn’t go up nearly enough to make up for the decrease in prices. Though buyers were sensitive to some of discounts in particular categories like cosmetics, in general their price perception did not change. The result was a brutal price war between some of the largest retailers in the UK, and resulted in millions of pounds in lost revenue.

How to improve the price perception

In the case described earlier, the situation was made less severe by defining categories and brand images better, and avoiding copying competitor price changes.Though this did help the retailers avoid further profit loss, the issue of price perception in their respective markets still remains.

But how can retailers like these improve the price perception of their stores?

  • Remarketing. As a retailer, you need to show the best proposal possible regarding cost, promo or availability. It’s not worth advertising the items which are not in stock.
  • Trigger emails. It’s a great idea to send emails to customers or potential customers based on the concept of FOMO (fear of missing out): “Don’t miss the possibility to buy this product, which is available only at our shop” or “The most advantageous proposals, only for you!”
  • Care about the customer. What do we mean by this, exactly? Make recommendations for them, proposing a cheaper supplier at the best price on the market. It increases CTR 2.5 times according to our findings!


  • Create a section of discounted products. If it’s impossible to lower the price on particular product any further, give bonus rewards or advantages to the customer for buying it. A good example is giving a discount for a complementary product.
  • Don’t advertise your KVIs if their prices aren’t the most optimal on the market. It may seriously harm your price perception, and damage your brand image as well.
  • Setting optimal prices for products using price aggregators is essential, because otherwise your store will be perceived as expensive. As a retailer, you have to communicate to the consumer only your most advantageous proposals across all advertising channels.
  • Set up fine-tuned marketing campaigns. This way, you can systematically increase the proportion of people who return to your store.

How can you know your price perception without asking customers directly?

Usually retailers are interviewing customers in order to understand how they see their brand in relation to their competitors. At Competera we developed another way for you to calculate this.

First, we need to see what competitors affect the sales volume for every category in every store in question.

 
Store A
Store B
Store C
Product category 1
A Sales volume doesn't depend on competitors' prices
AB
AC
Product category 2
AB Sales volume depend on prices in the Store B
B
ABC
Product category 3
A
AB
AC

From this table, we can see that store C is the most influenced by its competitors. This means their customers don’t necessarily see their prices as “optimal” and often compare them to competitors. The sales volume depends on competitor’s prices for the largest amount of goods here, meaning store C has a high cross-elasticity. We may calculate this taking into account competitive data and their sales history.
Now, let’s see how these shops are ranked.


Store A has the highest added value, because its customer base has a high level of trust with them, and they think the prices are low. Store B depends on its competitors and has less optimal prices from the point of view of the buyers even though the prices in store B are just as low as in Store A. Store C has unreasonably high prices for their main categories when compared to their competitors, and has low added value.

We added another type, Store D, which is a luxurious brand having a loyal customer base, but nonetheless has high prices. As a retailer you want your business to be in the green quadrants of this graph.

Conclusion

Price elasticity is the ratio between change in demand and change in price. The higher the elasticity, the more the price influences demand. Price elasticity depends on factors such as the medium market price, brand size, type of consumer, etc.

Price perception is how a buyer sees a retailer and how optimal they view the prices offered. This is one of the most important notions in eCommerce at the moment; how consumers perceive prices is as important as the prices themselves.