For those types of products or services, the demand curve would be considered to be abnormal. This is important data when determining pricing method and techniques.įor example, a customer expects to pay a high price for a Lamborghini or for a yacht (it's part of the prestige) and demand in those product categories is not affect by price but by brand identity. As you might expect, the higher the price, the lower the demand unless you are selling luxury or prestige products or services. Using a spreadsheet analysis, you can develop demand curves that show you at what price point demand will start falling. The relationship between rising price and falling demand is the price elasticity of demand. Define the product or service in the test, set various levels of price for that product (going up in specific increments), and ask at what level of price does your customer consider the price to be 'fair' at what level of price would your customer consider an alternative and, finally, at what level of price would your customer would stop buying. If possible, try to test pricing through surveys, or focus groups, or by talking to your customers. ![]() The Relationship Between Price Elasticity and Pricing Strategy What is the demand elasticity of your product in your market? Understand that price elasticity of demand is closely tied to the amount, direction (up or down), and frequency of price change. If Price Elasticity of Demand is greater than 1, then demand is elastic and it is more than proportionately affected by a change in price. This means that the increase in price would result in the same decrease percentage in demand. If Price Elasticity of Demand = 1, then demand is unit elastic. This means that the demand change will be proportionately smaller than the price change. If Price Elasticity of Demand = between 0 and 1, then demand is inelastic. This means that demand is not affected by price changes (the demand curve in this instance is vertical). If Price Elasticity of Demand = 0, then demand is perfectly inelastic. Note: While the result is a negative, economists typically don't show it that way in the formula. The percentage change in demand divided by the percentage change in price.įor example, the demand for hotel rooms decreased by 10% when hotel room taxes increased by 8%: 10% divided by 8% = 1.25 (demand is elastic in this example it is affected by an increase in price). The demand elasticity formula calculates the impact of a change in price for a given product on demand: The market is less sensitive to price when the product is a necessity, as compared to a discretionary item. ![]() The market is less sensitive, and relatively inelastic, when the cost of switching from one product to another involves significant cost (penalties for moving to another supplier - such as breaking a lease). The market is less sensitive when products have quite different qualities and are therefore hard to compare to each other price increases in this scenario often do not affect demand. The market is more sensitive when the product or service is easily substituted for a more economically priced alternative price increases in this scenario would affect demand negatively. The market is less sensitive when the product is unique or differentiated and has high value price increases in this scenario do not affect demand. This is particularly important when you are introducing new products or services to the market and, when you are changing price (that is, increasing or decreasing price). Part of your strategy in building price must be to consider price sensitivity. ![]() Have you segmented your market (by demographic, psychographic, geographic, and other factors)?Īnd then, most importantly, do your customers value the differentiation? Price Sensitivity Setting prices is also affected by how unique or differentiated your product is in other words, is it a commodity item or a specialty or niche item? To set a price for your product or service you need to know your market and your competition, know what the demand, and understand the price elasticity of demand for your product or service. Understanding how to set prices is a key element to your pricing strategy. Note: It is hard to write about this subject without sounding like an economics professor but I've tried to make this subject as clear as possible as it is important to your business. Many business owners do not treat pricing as a strategy but it is.Īnd it is important to recognize that price needs to be a part of your marketing mix program. Pricing your product or service is a key element in the success of your business.
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