Priced to Flop: Gauging Elasticity
Small businesses may experience greater price elasticity than large businesses because they have fewer resources to increase production speeds and production inputs.
Price elasticity is the measure of change in supply or demand based on a change in price. Price elasticity of demand is based on consumer behavior; whereas, price elasticity of supply is based on producer behavior. An elastic price (think stretchy like a rubber band) means small price changes cause large changes in supply or demand. An inelastic price (think stiff like a glass container) means small price changes cause small or no change in supply or demand. Knowing our business’ price elasticity metrics is the key to scaling your business. Can you measure yours?
Measure Twice, Cut Once
One side of elasticity is measuring the demand side. If we increase prices, will customers stop buying? If we decrease prices, will sales increase enough to justify the per-unit revenue loss? The answer is not simple. Fast food companies bet that consumers were much more loyal to their products than reality has proven. The social media backlash and steep consumption drops have all of them scrambling to regain customer loyalty. Is it too late?
Here are two considerations:
Price fluctuation timeline - Short-term price changes can soften the impact of elastic prices. This can include holiday-related sales or price spikes due to shortages or natural disasters. Long-term or permanent price changes can lead to lasting damage or enduring gains. (Be mindful of the legal ramifications of perceived price gouging or fixing!) -
Competitor market share - Price changes can be pivotal in grabbing market share from competitors, especially if prices for our product or service is elastic. Charging $199 for an annual subscription when a major competitor charges $249 for the same features can draw in tons of customers. Similarly, if we offer combination or package deals for a nominal price increase, we can poach once-loyal customers from competitors.
Supply-Side Dilemmas
The other side of elasticity is measuring the supply side. If we increase production, will we recoup the product costs through more sales? If we decrease production, will it impact revenues too severely? The primary consideration for the supply side of elasticity is reinvestment aversion. If we hesitate to reinvest the added sales revenue or consumer data into the company to grow, maintaining current production levels may be the best choice. Increasing production can lead to a revenue jump that gives us more money to reinvest; conversely, decreasing production may be useful if we are testing new products/services, systems, or markets to gather consumer data.
Final Thoughts
We scale our business through smart pricing and production strategies. Intentionality in managing the impact of price elasticity makes scaling possible. Get to know the limits of customers’ price sensitivity and achieve those goals!
Watch the Wall Street Journal share how fast food value offerings have evolved here: https://youtu.be/Mc5K2zHTezc?si=L6h1_yfWLCfYxEhL.
