How price elastic is your brand
A weekend advertisement in a newspaper, where a retailer showcases offers and deals on its products has the potential to draw in crowd and increase the store’s sale. The advertisement costs a significant amount. Add to that the cost of planning that campaign, and of course, the discount value offered on the products. The discount value is known as markdown, which is the difference between maximum retailing price (MRP in India) and the discounted final price that customers have to pay for that product. If there were no offers, no advertisement on the day, there would still be some sale to look forward to. By offering the discount and advertising the same, the store is hoping that it gets some additional sale. It has taken a decision, and like all decisions, it has an opportunity cost associated with it. In order to get the extra sale, some investments have gone into it. The store can now only hope the extra sale will justify the investment.
There are many factors that influence a store’s sale. The products and their offer prices are important factors. An advertisement in any medium will have limited space, and would not be able to feature more than a finite number of products. A digital catalog of offers can probably have fifty products to showcase, a newspaper print advertisement can have twenty product offers or there about, while a TV advertisement will have not more than two or three products to choose from. Two or three products is too less a number to appeal to a large number of customers. A retailer will at least hope to showcase twenty offers, which will appeal to more customer cohorts. Hence, print medium turns out to be a preferred choice for retail advertisements. Out of four thousand products available in the store, there can be so many combination of those twenty products to choose from. Selecting the proper combination makes all the difference. Customers will not be attracted, if the selected products do not appeal to them.
So, what will appeal to customers? There is a way to guide that process. One of the cornerstones of pricing strategy, microeconomics, and a great marketing/product foundation is the theory of price elasticity of demand, also known more simply as price elasticity. Price elasticity is an economic measurement of how quantity demanded of a good will be affected by changes in its price. In other words, it’s a way to figure out the responsiveness of consumers to fluctuations in price. If the quantity sold of a product exhibits a large change in response to changes in its price, it is termed “elastic,” that is, quantity stretched far from its prior point. If the quantity sold has a small change in response to its price, it is termed “inelastic”, or quantity did not stretch much from its prior point. The correlation between price and units sold is what determines price elasticity.
Since quantity demanded usually decreases with price, the price elasticity coefficient is almost always negative. Statistically, we are talking about a negative coefficient of correlation between multiple data points of price and the number of units sold at that price. Any product that has a correlation between -0.6 and -1 (a correlation can fall anywhere in the range -1 to +1), can be called as price elastic. It is an important measure in data science and helps in optimizing pricing and promotion in a retail store.
Price Elasticity examples
Price and demand typically head in the opposite direction, but the demand curve varies greatly based on product (and, in particular, on how necessary the product is). A product which has proven to be extremely price elastic is the famous instant snacking noodle, Maggi. Price and sale in it’s case have a negative correlation, which means with each drop in prices for its larger pack, more units are sold. This is however, not true for a smaller pack of Maggi. There are not much variation in smaller pack prices anyways. The correlation charts for Maggi large packs and small packs shown below proves the point. If you plot the individual data points of price and units sold, you get a cluster of data points, as seen in the below charts. A linear trend line of these data points, can tell us about the elasticity of the product. A horizontal or vertical trend line would mean the product is inelastic. But a slanting line would indicate that price and units sold are proportional to each other (inversely proportional in such cases).
Bournvita, a health drink for children, is another example of a price elastic product. It has a correlation close to -0.7. Whenever there is an offer on this product, large uplift in sale units is seen.
There are however, other popular products that are not as price elastic. Amul butter is one of them. Even if the prices vary in this product, we do not see much variation in sale. This could be due to the fact that butter is a low shelf life product. A customer will not necessarily increase her daily consumption of butter, just because there is a price offer available. If there was a way to store the extra units, she might have bought more till the offer is on. But for a low shelf life product, if not properly stored, buying more units will go waste. Parle-G is an extremely popular biscuit variety that also does not show much price elasticity. Among other brands in it’s category, Parle-G occupies the lower end of the price ladder. Dropping prices further, does not help attract more customers. We see this pattern hold true for the lower priced or smaller pack products across categories. Both Amul butter and Parle-G have another thing in common. Both are products that can be clubbed as ‘necessities’. This is opposite to a ‘luxury’ product. Necessities products turn out to be inelastic more often than not.
Factors affecting Elasticity
There are several factors that affect how elastic (or inelastic) the price elasticity of demand is, such as the availability of substitutes, the time frame (if it has a seasonal demand), the market share, whether a product is a luxury or necessity, and how narrowly the market is defined. A product that has higher brand stickiness (more customers preferring to buy that brand each time they shop from the category) is usually more price elastic. Case in point, Nivea and Vaseline products in body lotion category. These brands have higher stickiness. Any price drop in these brands usually sees higher off-take. Carbonated soft drinks is more consumed in summer months. This category becomes price elastic in summer season. There is not much of a point in dropping their prices in winter season. Some of the factors of elasticity are listed below.
Shelf Life
We normally see higher price elasticity in home and personal care categories. These products have longer shelf life. So, even if a customer buys more than what is required for current consumption, the extra units can be stored for future use. This is difficult in case of staples or packaged food categories. With lower shelf life, there are higher chances of the product going waste if not consumed within a limited time period. Hence, there are fewer customers who buy more units in food products. So, packaged food or staples products are comparatively less price elastic. Offering discounts in large packs or multiple packs of a higher shelf life product can appeal to more customers.
Luxury Brands
For personal care categories, there is always a latent need to upgrade. Whenever the premium products are offered at a discount, there is higher off-take. We see this in case of soap, body lotions and skin care categories. Whenever there are lower prices on offer for more premium brands, there are higher off-take. A higher priced product with richer content, turns out to be price elastic. More customers may avoid it due to it’s higher price, but are aware of it’s richer value proposition. So, whenever there is a drop in it’s price, customers take to buying it. This is relevant for packaged food categories as well. In tomato ketchup, Heinz is a comparatively premium brand. It is also more elastic than all other ketchup brands.
Value Add
Take the example of a category like, deos or shampoos. You would not see much difference in the product content among different brands. So, brands have little choice but to price their products at similar levels. What we are left with is many brands are available within a very narrow price range. Whenever there is a price drop in any of the brands, customers readily shift to that brand. With little product differentiation, price becomes the key differentiator. This makes the category extremely price elastic. It is a fact that without a value added product, brands cannot price their products at a higher level than their competitors. In such cases, they tend to offer discounts on larger packs and make them price elastic.
Regional Brands
Talking about value add, brands that are popular in a particular geography have been able to build their brand value for their product differentiating factor. Most of them are found in food categories, where their unique taste or flavour makes it difficult to find substitutes to them. Without a substitute, price elasticity reduces drastically. Rice, as a category is dominated by regional brands with their very own texture and taste. You would not see much price competition among rice brands for the same reason. Among packaged food categories, namkeen category has a lot of local brands with unique flavours preferred by the local populace. This category also is inelastic. Advertising local brands has its own merit in terms of showcasing variety of range. A local rice variety or a local namkeen brand can well attract customers with the unique taste they offer, but not necessarily through price offers. Offers and deals in local brands will mostly lead to unnecessary markdowns.
Private Labels
Private labels promoted by respective retailers, normally see larger price variations in the hope to capture market share from top brands. But they seldom see any significant price elasticity. What is important for a private label is to be available at a lower price point in that category, compared to the more popular brands. But beyond that, price variations do not help private labels any further. This is consistent with the pattern that we see, lower priced brands are inelastic. A retailer normally will not gain much by advertising a private label product.
Season
In case of seasonal products, like carbonated soft drinks (sold more in summers), body lotions and tea (sold more in winter) they show higher elasticity in their respective seasons. Unless there is a need to liquidate inventory, it makes little sense to drop their prices in off-season. Interestingly, deodorants is one category that is an exception. It is primarily a summer category and shows a uniform rate of sale in the summer months. But in winter, brands compete to offer significantly larger price drops. This has impacted it’s winter sale to almost equal it’s summer levels.
Pack Size
In most of the cases, larger packs have more price variations through offers and deals, and have higher price elasticity due to this. Offers in smaller packs do not make much sense for a brand. If a price drop is not accompanied by higher sale, the investment in markdown does not help. Making a customer shift from a smaller pack to a larger pack does lead to higher sale because of increase in value per unit. So, variations in prices is more relevant for larger packs. In this way customers are incentivised to buy larger packs.
Markets
In India, markets that have higher penetration of modern trade see more price elasticity. The southern and western markets in India, like Bangalore, Hyderabad, Chennai, Mumbai and Pune have more than 30% penetration in modern trade. With more competition, there are more choices for customers. Any price drop by a retailer sees more traction. The northern and eastern markets in the country have much lesser competition among modern trade and see lesser elasticity. This brings us to another important point, where differential pricing for the same product across different markets makes a lot of sense. It helps save significant markdowns. A retailer with a pan-India presence, can afford to charge higher prices in inelastic markets and earn more profit. The extra profit can be used to pass on to customers as price offers in more elastic markets.
Formats
Hypermarkets are more price elastic than neighborhood stores. Customers normally visit hypermarkets once a month with their full shopping list. There is a lesser chance that she will come back to shop before the next month. So, it makes sense for the hypermarket store to up sell and make her buy more with offers and deals. The customer also does not mind buying few extra products, offered at good deals. A neighborhood store do not need to offer as much deals. A customer shops in a neighborhood format more out of convenience, when there are fewer products to be bought (more top-up purchases). This makes a neighborhood store inelastic. This is the reason a neighborhood store need not advertise as much.
How frequently/ how long the price changes last
Most products become more elastic in the long run. If prices increase in any product for long, customers might find substitutes or learn to live without it. If we see frequent price drops on any product, customers would eventually form a habit to wait for those price drops to happen, rather than buy the product at its regular price. If price drop extends for a long period, it might be difficult to sell that product at it’s original price. In all these cases, there is every possibility that frequent price changes, long price variations, etc. makes a product more elastic.
Customer Cohorts
All the patterns and insights that we have seen on elasticity thus far form out of individual data points. The lowest level of such data points is one customer buying one product at a particular price point. Not every customer reacts to price variations in the same manner. If there is a price drop in a health drink, one customer might buy multiple packs to take advantage of the price drop, while another might not change her shopping behavior. In such a case, the product is elastic for the first customer but inelastic for the second person. The holy grail for a retailer is to plan customer wise price variations to maximize sale. A selection of products and their prices could be different for different customers (or customer cohorts). That is where data science comes in full form.
The science of price elasticity helps in a significant manner to advertise the right product at the right prices, and at the right time in case of seasonal products. Offering unnecessary markdowns only drains profit margin. So, the next time you see a retailer advertising product offers, know that price elasticity has played it’s part in choosing the products for that advertisement.
