ECON First believes that business success centers around the businesses knowing the economic and demographic characteristics of their primary market area. While business experience, insights and intuition are important, they are substantially advanced by hard data.
A major question that all businesses struggle with at one time or another is when and how to change prices. To advise businesses on price changes ECON First uses a combination of basic economic theory, market data, and insights from the business owner.
Economic theory on pricing centers around the concept of “price elasticity”…or simply the sensitivity of sales to a change in price. A change in the price of a good or service can result in either a small or a large change in sales.
What makes this so important to businesses is the direct relationship between price sensitivity and revenues. If a 10% increase in price produces just a 5% decrease in quantity demanded, then the result is a rise in revenue. Alternatively, if a 10% increase in price causes a 15% drop in quantity demanded, the result is a fall in revenue.
Experience and applied research has identified four major determinants of the price sensitivity of a good or services.
The Nature of Demand: There are certain goods and services that consumers would consider to be necessities, the extreme being a heart bypass. Other goods and services are clearly luxuries, such as yachts and rare diamonds.
Competition and Substitutes: Obviously, the more acceptable alternatives for a good or services that are available to consumers, the more price sensitive is the demand for any one particular good or service. It is important to keep in mind that consumers include travel and search time in their calculation of prices.
The Share of the Consumer’s Budget: Very inexpensive items tend to be price insensitive while consumers are very price sensitive to large ticket goods or services.
Time: For most goods and services the passage of time results in more substitutes and therefore greater price sensitivity for a particular good or service. Brand loyalty and the switching costs can help to reduce price sensitivity in the presence of new substitutes.
Applying these determinants provides immediate insights into the price sensitivity of demand for various goods and services.
Demand for business airline travel, for example, tends to be price insensitive while demand for vacation airline travel is more price sensitive. Due to the over whelming competition, demand for any particular fast food restaurants is very price sensitive.
Consumers will spend more time and resources and be far more sensitive to price differentials for large ticket items such as owner occupied housing, especially compared to purchasing a new tooth brush. Young people are far more sensitive to a hike in cigarette taxes than are adult smokers.
THEORY IN PRACTICE
To advise clients on price change strategies, ECON First gathers data from the primary market area on the major determinants of price sensitivity, and supplements the data with insights from the experience of the business owner.
Due to the availability of substitutes, especially over time, the demand for most goods and services is price sensitive. This means that to increase revenue from a particular good or service the business must lower the price so the increase in volume will produce an increase in revenue.
Decreasing prices is a painful decision for most businesses, especially in the face of already declining revenue. And businesses are concerned about customers’ perceptions of the good or service from their particular business when prices are slashed.
ECON First recommends a variety of strategies for lowering prices and avoiding the image of “cut rate” goods or services.
The most straight forward strategy is to fix the price schedule for a determined period of time and let inflation reduce the “real” price of goods or services.
Another common strategy is to engage in a time limited price discount campaign. The hope here is that once the customer experiences the particular business’s goods or services that a portion of the new discount clients will be retained as full price customers.
Price segmentation can separate potential customers based upon their ability to pay (e.g., senior discounts).
Business owners have insights that will recommend one or another strategies.
ECON First specializes in providing the hard data that allows business owners to make more informed decisions regarding start-ups. expansion, marketing channels, and pricing strategies. The type and frequency of marketing campaign used by regional businesses should take into account the continual turnover of households through relocation.
Let ECON First help you to construct a revenue maximizing pricing strategy.
Dr. John E. Stapleford