If you’re in the consumer packaged goods (CPG) industry, you’re likely familiar with the concept of price elasticity of demand.
This refers to the degree to which changes in the price of a product affect its demand in the market.
Understanding price elasticity of demand is crucial for setting pricing strategies that maximize profits, as well as maintaining market share and staying competitive in the market.
In this blog post of the CPG Jargon series, we’ll explore the concept of price elasticity of demand in the context of the CPG industry, as well as the implications it has for pricing decisions.
What is Price Elasticity of Demand?
Price elasticity of demand is a critical concept for businesses, particularly those in the consumer packaged goods (CPG) industry.
It is a measure of how much the quantity of a product demanded changes when the product’s price changes. The concept is based on the principle that when the price of a product goes up, the demand for that product generally goes down.
However, the extent to which demand changes in response to a price change varies depending on a number of factors.
If demand changes significantly in response to a price change, the product is said to be “price elastic.”
If demand changes only slightly in response to a price change, the product is said to be “price inelastic.“
How is Price Elasticity of Demand Calculated?
Price elasticity of demand is calculated by dividing the percentage change in the quantity demanded of a product by the percentage change in the price of that product.
The resulting number is a measure of how sensitive the quantity of the product demanded is to changes in its price.
The Formula for calculating price elasticity of demand is:
Price Elasticity of Demand = (% Change in Quantity Demanded) / (% Change in Price)
For example, let’s say a company increases the price of a product by 10%, and as a result, the quantity demanded decreases by 20%. The price elasticity of demand for that product would be:
Price Elasticity of Demand = (-20% / 10%) = -2.0
A negative result indicates that the product is price elastic. In this case, a 10% increase in price led to a 20% decrease in quantity demanded, indicating that the product is relatively sensitive to changes in price.
How to track brands performance to Calculate Price Elasticity?
In order to evaluate the performance of their brand in specific regions, brand managers must create dashboards and analyze multiple data sets.
This process involves working with various teams, including analysts and the insights team, who utilize data visualization and analytics tools to provide insights, which can take up to 2-3 months.
Unfortunately, this delay can negatively impact the brand’s market position, potentially leading to consumers switching to other products.
Fortunately, tools like Explorazor are available to help brand managers obtain real-time, actionable insights from their data by simply asking questions in a user-friendly format.
With Explorazor, brand managers can perform root cause analysis, drill down into opportunities, and identify potential red flags, enabling them to make swift and informed decisions.
Factors Affecting Price Elasticity of Demand
In the CPG industry, there are many factors that can affect the price elasticity of demand for a given product.
For example, the availability of substitutes is a key factor. If there are many other similar products available in the market, consumers are more likely to switch to a competitor’s product if the price of the original product increases.
This means that the product is likely to be price elastic.
Conversely, if there are few or no substitutes for a product, consumers are less likely to switch to an alternative if the price of their preferred product increases.
This means that the product is likely to be price inelastic.
Another factor that can affect price elasticity of demand is income levels.
Products that are considered necessities, such as food and shelter, tend to be price inelastic because consumers are willing to pay whatever price is necessary to obtain them.
However, products that are considered luxury items, such as high-end electronics or designer clothing, tend to be more price elastic because consumers are less willing to pay high prices for non-essential items.
Brand loyalty can also affect price elasticity of demand. If consumers are highly loyal to a particular brand, they may be willing to pay higher prices for that brand’s products, even if there are cheaper alternatives available.
This means that the product is likely to be price inelastic.
Conversely, if consumers are not loyal to a particular brand, they are more likely to switch to a cheaper alternative if the price of their preferred brand’s product increases.
This means that the product is likely to be price elastic.
What happens if I change the price of my products often?
For CPG enterprises, understanding price elasticity of demand is crucial for setting pricing strategies that maximize profits.
Products that are price inelastic can generally be priced higher, while products that are price elastic may need to be priced lower to maintain sales volume. By knowing the price elasticity of demand for their products, companies can make informed decisions about how to price their products to maximize revenue.
However, companies should also be aware that price changes can have unintended consequences.
For example, if a company raises the price of a product too high, it may cause consumers to switch to a competitor’s product, resulting in a loss of market share.
Similarly, if a company lowers the price of a product too much, it may result in lower profits even if sales volume increases.
Therefore, it’s important for companies to carefully consider the potential consequences of price changes before implementing them.
In conclusion, price elasticity of demand is a critical concept for CPG businesses that want to optimize their pricing strategies and stay competitive in the market.
By understanding the factors that affect price elasticity of demand and the implications it has for pricing decisions, companies can make informed decisions that maximize revenue and maintain market share.
To see how Explorazor can help you unlock valuable insights from your data, request a demo today.
