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A Prof es s ional P r i c i n g S o c i e ty P u b l i c a ti o n
Price Elasticity - Sensitivity:
An Opportunity for Price Improvement
There is ongoing debate as to the effectiveness of price sensitivity and elasticity analysis in forecasting the change in
unit quantity with respect to a pricing
action. In this article, the author uses
a case history analysis to analyze how
price elasticity and sensitivity can be
integrated into a price setting process,
with the outcome providing significant
price improvement opportunities at
an SKU or customer level. Dick Sobel is Managing Director of the Pricing Analytic Group, a member of the
Professional Pricing Society and Director of Analytics at PricePoint Partners.
He can be reached at richard.sobel@
pricing-analytic.com.
T
here is ongoing debate as to
the effectiveness of price sensitivity and elasticity analysis in
forecasting the change in unit
quantity with respect to a pricing action.
Keeping in mind the influences of markets, segmentation, competitive environment and product specific special situations, price sensitivity and elasticity
analysis can be an effective tool in price
optimization, forecasting and price setting.
Price sensitivity analysis can help determine the amount of value created by a
product or service by providing an indiDecember 2013
cation of your customer’s willingness to
pay (WTP). It can also become a competitive advantage, when WTP is better
understood.
Buyers are less price sensitive when the
product they are buying is unique or of
high quality, prestige or exclusiveness
or when substitute products are hard to
find or cannot easily be compared. The
converse is true for customers with high
price sensitivity.
Faithful customers tend to be less price
sensitive, where price sensitive buyers are
subject to customer churn. Sometimes
the loss of unit volume due to a price
increase is caused by the price sensitive
customer looking for alternatives while
the
2 loyal customers remain.
the outcome providing significant price
improvement opportunities at an SKU
or customer level.
Case History
This case study will evaluate price sensitivity- elasticity with a large distributor
having over 10,000 SKU’s and 1500 customers serving a large North American
customer base.
The company uses a cost plus approach
to pricing as multiple vendors implement price increases on a periodic basis
throughout the product portfolio. Prices
are raised to compensate for vendor cost
increases, however there is minimal visibility as to the effect of these price increases on subsequent unit volume and
margin.
There are times when methods for deter- The served markets are very competimining WTP such as Van Westendorp,
tive with different distributors selling the
conjoint analysis, qualitative & quantisame products within the same territories
tative
and to the same customers. The compaCasesurveys,
History:next best alternative and
won/loss data are not readily obtainable. ny wishes to maximize their price inHowever if a company’s comparative
creases without jeopardizing overall unit
We will evaluate price sensitivity- elasticity with a large distributor having over 10,000 SKU's and
transactional
data is available, price senvolume and or gross margin.
1500 customers serving a large North American customer base.
sitivity and elasticity can be calculated
and
to price
1 shows
four
(4) scenarios
Thecontribute
company uses
a costimprovement.
plus approach to pricingFigure
as multiple
vendors
implement
price for
increases on
a periodic
the product
portfolio.
Prices
to compensate
Combined
with
any ofbasis
the throughout
above WTP
price
actions
andare
theraised
corresponding
affor vendoritcost
there
visibility
as tomargin
the effect
of theseChanges
price
methods,
is aincreases,
powerfulhowever
addition
to is minimal
fect
on gross
dollars.
in
increases
on arsenal.
subsequent unit volume and margin.unit volume that occur without a price
your
pricing
action
are not included
thisproducts
discusThe served markets are very competitive with different
distributors
selling the in
same
Through
case territories
history we
look
at customers.
sion.
within theasame
andwill
to the
same
how price elasticity and sensitivity can
company into
wishes
to maximize
price increases
without jeopardizing
overall unit
beThe
integrated
a price
settingtheir
process,
Forecasting
price realization
andvolume
profitand or gross margin.
Figure 1
Price Change Scenarios
Impact on Gross Margin Dollars
Increased price with increased unit volume
Maximum Increase in Gross Margin Dollars
Increased price with decreased unit volume
Gross Margin dollars may increase or
decrease depending on unit volume
Decreased price with increased unit volume
Gross Margin dollars may increase or
decrease depending on unit volume
Decreased price with decreased unit volume
Maximum Decrease in Gross Margin Dollars
Table 1
5
The
PRICING ADVISOR
3535 Roswell
Road,
Suite 59
Chart 1 (below) plots the required unit volume to maintain
constant
gross
Marietta,
GA
30062
margin when either increasing or decreasing price.
770-509-9933
w w w.pri ci ngsociet y. com
A Prof es s ional P r i c i n g S o c i e ty P u b l i c a ti o n
Figure 2: Plots the required unit volume to maintain constant gross margin when either increasing or decreasing price.
ability is dependent on understanding price sensitivity and whether your price
actions meet your strategy and profit goals. The
change in gross margin dollars is affected by the current %GM of the SKU. The
higher the gross margin of
a product the less sensitive
is the unit volume change
needed to maintain constant margin dollars.
10,000
9656
35
9,000
8057
8,000
% Change in Price
25
6862
7,000
Units
30
20
5975
6,000
15
5262
4675
5,000
4185
4,000
10
3771
3415
5
3,000
0
2,000
-5
Units
Percent change in price
Product Gross Margin @85%
In Figure 2 (above), a 5%
1,000
-10
reduction in price requires
0
-15
a 17% increase in unit volume to maintain constant
gross margin dollars. Howrebates and volume-mix when comparFigure 3’s contribution margin bridge
Chart 1
ever a 5% increase in price can maining year on year data. In this example,
showing the result of a 6.4% year on
tain constant gross margin dollars with
a 6.4% price increase was implemented
year price increase. In this example, price
a 13% reduction of unit volume. These
on a product with a low price sensitivity- realization ($15,748) exceeded the negaChart
1, a 5%
reduction in price requires a 17% increase
unitofvolume
to maintain
constant
relationships are factored intoInthe
overall
elasticity.
tive in
effect
a material
cost increase
of
in
price
can
maintain
constant
gross
margin
gross
margin
dollars.
However
a
5%
increase
price sensitivity discussion and provide
($5216) and the impact of a negative
4 pricing opportunities
a user with
above
The impact
of unit
volume
change
rela-relationships
rebate ofare
($78),
and a unit
volume-mix
dollars
with a 13%
reduction
of unit
volume.
These
factored
into the
overall
and beyond covering cost increases,
as
tive
to a price and
action
is the basis
forwith
pricepricing
reduction
of ($568).
price sensitivity
discussion
provides
a user
opportunities
above and beyond
we will see
sensitivity
and
elasticity
optimization.
In gross
Let'slater.
look at a case history
contribution
bridge
Chart
(below)
that illustrates
covering
cost margin
increases
asinwe
will 2see
later.
this case
an material
aggressive
price
increase
was A similar chart or data analysis can be
margin dollar changes due to price realization,
direct
cost,
rebates
and volume-mix
Let’s look
at acomparing
case history
warranted
the overall
SKU price
performed
across the entire user prodwhen
yearcontribution
on year data. In this
example,as
a 6.4%
price increase
was senimplemented
on
margin bridge
in with
Figure
3 that
sitivity-elasticity was very low. (Elasticity uct portfolio. Each SKU will fall into
a product
a low
price illussensitivity-elasticity.
trates gross margin dollar changes due
of -1 to +1 is viewed as inelastic)
one of the categories shown in Figure 1.
impact ofdirect
unit volume
change
andonly exception would be SKU’s with
to price The
realization,
material
cost,relative to a price action is the basis for price sensitivityThe
elasticity optimization. In this case an aggressive price increase was warranted as the overall
no price change during the
Figure 3 SKU price sensitivity-elasticity was very low. (Elasticity of -1 to +1 is viewed as inelastic)
comparative time frame.
The Pricing Analytic Group
SKU
Gross Margin Dollars
$105,000
$15,749
$100,000
$5,216
$90,000
$85,000
$80,000
$75,000
$92,744
$78
$95,000
$82,857
Year on Year Gross Margin Bridge
$568
Prior Year Units:
Current Year Units:
Prior Year Sales:
Current Year Sales:
Elasticity = (.11)
$70,000
%GM From 33.7% to 35.7%
$65,000
$60,000
$55,000
$50,000
Gross Margin $
Volume/Mix
Chart 2
Material
Rebate
Price
Gross Margin $
6
6862
6815
$246K
$260K
Anwww.pricing-analytic.com
opportunity for
Price Improvement
Figure 4 on the next page
is a cross section of price
sensitivity data for a select
number of SKUs. The same
analysis is suitable to customers as well. It looks at
both the percent change in
quantity for a 1% change in
price and the overall elasticity.
Elasticities between -1 to +1
are generally considered inelastic. Figure 4 combined
with a contribution margin
analysis as shown in Figure
3 provided the user with
the required visibility to
make effective pricing deciDecember 2013
customer basis.
The
PRICING ADVISOR
3535 Roswell Road, Suite 59
Marietta, GA 30062
770-509-9933
w w w.pri ci ngsociet y. com
A Prof es s ional P r i c i n g S o c i e ty P u b l i c a ti o n
Figure 4: Price Sensitivity Bands - SKUs - Customers
Price Sensitivity Bands – SKUs - Customers
(1)
2012
SKU
Description
Units
10635 JUNIOR MINTS
501
10636 SUGAR BABIES
134
10640 CHUCKLES ASST
268
10644 NESTLE CRUNCH BAR
1005
10647
NESTLE 100 GRAND
BAR by price
445
SKU's
- Customers
are sorted
10757 WET ONES ANTIBACTERIAL
2013
bands
depending
on the
10772
MCORMK RSTD
GARchanges
BRD SEA of1320
10784 with
BIG MAMA
SAUSAGE
quantity
respect
to changes in 4047
10800 BABY RUTH
1504
price.
13460 HERSHEY CH CHP KIS DGH
30
13462 HERSHEY REESES PB DGH
38
10689 RICH'S PIZZA DOUGH 7IN
1397
17579 WRIGLY 5 RAIN
5801
20350 AL ICE SMOOTH LEMONADE
83
18360 HOT N RD CHEESBRGR
1346
(2)
1% price
change = Percent
x % of
change
qty
in price
$ Sales
% GM
$6,958
$1,884
$4,020
$20,741
$9,196
$4,277
$20,971
$37,520
$20,685
$1,452
$1,864
$65,272
$54,164
$4,273
$28,871
7.1%
8.2%
6.7%
7.7%
7.9%
19.2%
13.0%
16.4%
7.7%
13.9%
15.1%
12.3%
7.2%
28.9%
14.5%
(3)
Yr to Yr
Change
in
Quantity
(4)
(5)
Percent
change in
quantity Elasticity
SKU - Customers
0.4%
1.4%
1.3%
0.4%
2.7%
1.1%
9.2%
0.3%
2.8%
3.9%
6.1%
3.8%
1.7%
1.6%
0.6
6.0%
5.0%
7.8%
4.6%
3.4%
3.2%
3.3%
8.9%
4.0%
-6.3%
-3.7%
-5.2%
-0.7%
-5.6%
-3.1%
-11
-10
-30
-18
-44
69
307
109
151
6
7
227
-76
-8
-27
-2.1%
-6.9%
-10.1%
-1.8%
-9.0%
3.5%
30.3%
2.8%
11.2%
25.0%
22.6%
19.4%
-1.3%
-8.8%
-2.0%
-0.37
-1.48
-1.41
-0.40
-2.85
1.11
8.09
0.32
2.69
3.40
5.41
3.34
-1.73
-1.59
-0.64
A
B
C
D
• Column (1) calculates the impact in the change of quantity as a result of a 1% change in price for an SKU or customer.
• Column (2) is the actual SKU or customer price realization percent
on a year to year comparative sale.
• Column (3) is the actual unit volume change for the SKU or customer.
• Column (4) is the annual percent change in unit volume per 1% of
price realization.
• Column (5) are the elasticity values.
Increased Price - Increased Volume
Increased Price – Decreased Volume
Decreased Price – Increased Volume
Decreased Price – Decreased Volume
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So how can we use price
sensitivity data to help
Figure 4 examines the effect of a change
improve price setting and
In Figure 4 we keep all of the changes
in quantity for a given change in price
price improvement?
Column (1) calculates the impact in the change of quantity as a result of a 1% change in price for an SKU
and sorts the results into four (4) pricing in price as a positive number. The corReferring to Figure 4, products in row
or customer.
responding elasticity calculation can be
bands:
“A” (Increased price with decreasing unit
Column (2) is the actual SKU or customer price
realization
percent
on a on
year
comparative
sale. factors less than
negative
or positive
depending
theto yearvolume)
with elasticity
Column
(3)
is
the
actual
unit
volume
change
for
the
SKU
or
customer.
• Increased price with increased unit
direction of quantity change.
one display low quantity change with
Column
(4) is the annual percent change in unit volume per 1% of price realization increased prices. Gross margins actuvolume
Column
(5) are
the elasticity values
§ Best
Outcome
The comparative time frame, that is
ally increase as the price realization more
§ Product Skimming Strategy
whether the data comparison is monthly, than offsets for the loss of unit volume.
quarterly or yearly plays an important
This outcome works well if you are tryIncreased
Price with
decreased unit
role in evaluating what price actions to www.pricing-analytic.com
ing to prune a product or where loss of
The•Pricing
Analytic
Group
volume
take and the magnitude of the actions.
unit volume for a non strategic product
§ Outcome works if overall gross mar- Monthly data may be too frequent and
is acceptable.
gin dollars increase
annual data too long.
§ Product Pruning Strategy
As elasticity factors increase the loss of
However, a timeframe helps establish an unit volume may result in lower gross
• Decreased Price with increased
SKU profile for price sensitivity. Quarmargin dollars and so more caution is
unit volume
terly works well as there is a time delay
required in how much if any future price
§ Outcome works if overall gross mar- between when a price change is impleincreases are merited.
gin dollars increase
mented and the time it takes to flow
§ Penetration Strategy
through your customer’s purchases and
Row “B” is the best case scenario where
be reflected in your transactional data.
unit quantity is increasing with increased
• Decreased Price with decreased
price and supports a price skimming
sions on a product or customer basis.
December 2013
unit volume
§ Worst
Outcome
Chart
3
7
The
PRICING ADVISOR
A Prof es s ional P r i c i n g S o c i e ty P u b l i c a ti o n
strategy. Here high positive elasticity is
exhibited robust increases in quantity
good as it demonstrates that the willing- and gross margin. When implementing
ness to pay for these products are high.
a penetration pricing strategy that is a
Again, the marketing manager evaluates the significance of these changes
The use of price sensitivitywithin their market and
competitive environments
elasticity analysis for forecasting
when setting future prices.
and implementing a price change
These SKU’s enjoy high
margin improvement opis an important tool in the price
portunities.
optimization tool box.
In row “C” (decreasing
price with increasing volume) SKU quantity outcomes need to be positive with a net improvement in gross margin dollars. The
higher the SKU initial gross margin, the
better the outcome will be when lowering prices. All of the examples shown
8
desire to increase market share, row “C”
outcomes are desirable.
Row “D” SKU’s perform the worst,
where lowering the price resulted in low-
3535 Roswell Road, Suite 59
Marietta, GA 30062
770-509-9933
w w w.pri ci ngsociet y. com
er unit quantity Product managers need
to understand what external issues if any
are affecting the pricing actions taken.
Summary
The use of price sensitivity-elasticity
analysis for forecasting and implementing a price change is an important tool
in the price optimization tool box. Combined with contribution margin analysis
and an understanding of your customers,
markets and competitors it can support
proactive price setting and positive price
realization.
The distributor in this case history is
achieving 1-2% price realization where
price sensitivity-elasticity is included in
their price improvement process.
December 2013