What Influences Price Elasticity and Price Perception the Most?
We are ready now to unveil some popular myths on price elasticity, and we’ll show you that the perception of your prices by customers is flexible, and it’s possible to calculate it.
Let’s start with the definition: the price elasticity of a service or product is the change of percentage of demand with respect to the price change.
Generally speaking, the consumers buy fewer products if the price increases, so usually elasticity is negative. But for convenience, it is often expressed as a positive number.
Elastic demand situation is the one where elasticity is greater than 1. In this case, the demand dramatically depends on the price in the short term. For example, consumers buy the packaged frozen vegetables which are the cheapest on the short terms. In the long term, they won’t buy enormous amounts of frozen vegetables even at low prices.
The demand is inelastic if elasticity is less than one. Here in the short term, the demand depends very little on price. For example, in the short term consumers buy the same amount of gasoline, no matter what the price is. They need it to get home or to work. Though, the long-term changes in behavior may occur.
Is positive price elasticity possible?
Positive price elasticity is difficult to imagine. It means that the higher the price, the higher the demand, and vice versa: if the price increases, demand increases as well. That still may be possible for luxury products.
How to calculate price elasticity
Suppose you’re a pizzaiolo. When the price of pizza is $4, the demand is 60 slices of pizza per day. When the price is $2, the demand is 80 slices per day.
We need to use this formula:
- QD2 - QD1
2 = 20
3 = 2
7 * -3
2 = -3
Taking into account this data, PE is
It means that the demand for pizza is inelastic because the PE is between 0 and -1.
What influences the price elasticity
The researchers at the Ehrenberg-Bass institute for marketing science managed to find the key factors which influence the price elasticities and the ones which are of lesser importance (some of this findings are available in this article).
Ready to hear the straight up truth?
Those are the consistent patterns across brands, products, and countries they’ve discovered in their experiments concerning the price elasticity. Those patterns often contradict the popular myths.
- If the cost is the same or higher than the cost of a market leader in the category, the elasticity gets higher as well. The point is not that the price as such matters, but the relative price availability, i.e. in respect to the category leader and to the round point (for example, $10).
That’s why to keep the demand 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 to the leader.
- It is believed that the bigger is the brand, the smaller elasticity. Though, it’s 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. In this case, the consumers are buying a product which is less expensive or better promoted.
- Nobody likes significant increase in price, that’s why there is a rule of single-digit price increase (no more than at 9,9%). If the price increases by 10%, consumers get nervous and buy significantly less.
- 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 there. However, in general the price elasticity is lower for the economy segment, and for the luxury goods, each having its loyal customer base.
- 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”.
- As for the consumer, elasticities are bigger for the less recent buyers, as they know less about the brand quality and they choose what is cheaper or has a discount. Also 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.
Looking at price elasticity for consumers willing to buy products at particular shop, we see their price awareness: the overall perception of a retailer as a cheap one, a middle priced one or a luxurious one. 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 and optimal comparing to their competitors.
Price perception depends on brand positioning in the advertisement, also on the prices of traffic drivers, bestsellers, and KVI-positions.
It’s a never-ending battle here.
Let’s take into account the experience of a European discount retailer who sells apparel. Because of stiff competition, he decreased prices for the whole board, though customers didn’t perceive changes and the sales volume didn’t go up. Consumers incorrectly perceived his prices as higher than those of his competitor. Buyers were confused by this broad range of prices, also they were more sensitive to prices of particular categories, such as children’s T-shirts.
How to improve the price perception
In the case described earlier the solution was in defining roles for categories and pricing according to them. It helped the company to achieve the price image it desired and to increase revenues.
What is the other way for improving the price image of a store?
- Remarketing. In the case of setting up a campaign for the customers who were already visiting the website, retailer has 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 catch up the customer who left a cart or a webpage and to send him a based on advantages message: “Don’t miss the possibility to buy this product, which is available only at our shop” or “The most advantageous proposals, only for you!”
- To care about the customer. In what sense? To make recommendations for him proposing a cheaper supplier at the best price on the market. It increases CTR in 2.5 times!
- To open a section of discounted products, e.g., on the goods from storefront. If it’s impossible to make a further discount on particular product, to give bonus points for buying it. To recommend buying extra goods.
- Not to advertise the KVI in top channels, if their prices aren’t the most optimal on the market. It may seriously harm the price positioning image.
- As for the price aggregators, it’s essential to set the optimal prices if one is promoting goods on them, because otherwise he will only promote the image of an expensive store. The retailer has to communicate to his consumer only the most advantageous proposals in all advertising channels.
By setting up fine-tuned marketing campaigns, the retailer may systematically increase the proportion of people who return to him.
How to get to know the price perception not asking the shoppers?
Usually retailers are interviewing customers in order to understand how they see their brand in relation to their competitors. In Competera we developed another way to calculate it.
First, we need to see, what competitors affect the sales volume for every category in every store in question.
From this table, we may see that the store C is the most influenced by competitors. It means, that his customers don’t necessarily see its prices as “optimal” and often compare them to the competitors. The sales volume depends on competitor’s prices for the largest amount of goods here. It mean this store has a high cross-elasticity. We may calculate this taking into account the competitive data and the sales history.
Now, let’s see the ranking of this shops.
Store A has the highest added value, because its customer trust it and they think the prices are low there. Store B depends on its competitors and has less optimal prices from the point of view of the buyers, although in fact the prices there are just as low as in Store A. Store C has unreasonably high prices for the main categories comparing to the competitors and has low added value. We added another type, Store D, which is a luxurious brand having its loyal customers, nonetheless the high prices. As a retailer you probably want to stay in the green quadrants.
Price elasticity is the ratio between change in demand and change in price. The higher the elasticity, the more the price influences demand. It depends on such factors as the medium market price, the size of brand, the type of consumer, etc.
Price perception is how a buyer sees retailer and whether he thinks that his prices are optimal or not. This is one of the most important notions in the eCommerce now, as how consumers perceive prices is as important as the prices themselves.