Challenges to implementing price elasticity

Do you ever pick up a product that you usually buy in the same store, and put it back on the shelf because you noticed that it was 30 cents more expensive than your last purchase? Or leave a shop without buying anything because the price of the product you were looking for was not what you had in mind?

In the retail sector, price elasticity helps to understand the consumer’s reasoning at the time of purchase, and thus anticipate and quantify their reaction to price movements. The level the consumer’s price acceptability reflects the value that the consumer perceives in the product. Thus, mastering the uncertainty represented by the elasticity of demand offers three benefits to a retailer: identifying how to trigger the act of purchasing, investigating the potential reasons for disaffection with a product, and consequently better steering its profitability.

However, the pricing professionals that we meet admit that when it comes to putting elasticity into practice, the technological challenges implied force them to limit their ambitions. They share disappointments as a consequence of bad experiences i.e. their doubts regarding coefficients’ reliability and difficulties in operational execution. They also regret a lack of understanding of the approach proposed by the technologist, which they consider too opaque. In the end, very few retailers actually implement it today, or when they do, they are forced to limit their ambitions. In our discussions with retailers, we are receiving more and more questions about elasticity. We have collected and analysed these questions in this article, in the hope that it will help other retailers who are looking for fine-tuned and efficient pricing.

Why is elasticity important for retailers?

A retailer wants to be able to secure a certain amount of margin on inelastic or relatively inelastic products by directing consumers to these products. If a retailer wants to change the price, it also needs to know how far to go not to lose the consumer’s confidence and miss a sale. Beyond the impact on product sales in the short term, the impact on overall sales is much more damaging in the long-run. In short, in retail: losing a sale is a problem; losing a customer is a disaster. Another important metric in price management is the sudden shift of a product from the inelastic category to the elastic category. This could, for example, reflect a competitive action to which the consumer is more sensitive. The retailer’s vigilance regarding competing offers may enable them to react quickly and adapt his strategy.

For elastic products, retailers wish to anticipate consumer reactions to price changes, to evaluate up to what price it can change the price to recover margin without eroding sales volumes, and from what price onwards there is a risk of a collapse in sales. It is therefore a risk calculation to decide on the optimal price change.

What are the challenges for teams in charge of pricing?

Be accurate in price change decisions according to:

Traffic objectives: understand how to trigger the act of purchase and anticipate a shift to another product from customers.

lSupply objectives: avoid supply that is unsuited to demand and costly for the retailer (lost sales or storage costs).

Margin objectives: identify products whose value attributes perceived by consumers allow retailers to optimise their margin. E.g., elasticity is a particularly important issue for retailers with their own private labels who wish to promote them within the offer.

Image objectives: following on from the previous point, avoid prices that are too high and do not correspond to the value that the consumer attributes to the product, or too low in relation to the perception of quality that the consumer has of the product. Both cases causing financial losses for the retailer.

What are the challenges for the company’s management?

The reason why major retailers’ management are concerned with controlling elasticity is for their teams to assess the relevance of their strategic choices regarding the offer and the target customer base, taking into account their margin and price image objectives. Ideally they would transform an elastic product into an inelastic product thanks to strategic choices guided by elasticity estimates. Conversely, if some products are highly elastic, this may imply a problem with price positioning or a problem with consumers’ perception of product’s value. Elasticity’s calculation and exploitation is therefore a subject for which the « magic » – AKA opaque – formulas represent too much of a risk: in many cases, the strategy works; but if one does not master its logic and operation, there is a great risk of killing one’s retail strategy.

What obstacles do retailers face in putting elasticity into practice at the operational level?

The frequency of price movements:
To measure consumer reactions, it is imperative to make price changes. Thus, retailers with few price movements think they cannot access reliable coefficients. However, solutions are possible. The first is to accept a price movement that may temporarily impact the price image to test the market and gather insights for future strategic choices. This can be done through a test on a shop or group of shops, during which only the prices charged in these shops get modified, to measure the impact of the price change. The second is to access the formulas proposed by panellists who have studied the impact of price changes by other retailers on an equivalent or similar product. In this way, the retailer can use these elasticity formulas as a basis for its own tests.
Tools that lack flexibility in the face of unforeseen events:
Elasticity is an aid for gaining precision in pricing thanks to price and sales histories, but to remain reliable, it needs to be fed with business information that only a human being has. Teams must have a tool that allows them to qualify estimates and thus control price change decisions. Some retailers have told us of their disappointment following bad experiences with tools that only offer an automated elasticity algorithm as a metric to guide the price, a metric over which they had no control. The latter cannot predict situations such as strikes or covid, for example.

To summarize

Putting price elasticity into practice is finally at the heart of the concerns of all the retailers we meet. So how do you get the right tools when it comes to elasticity? Discover Mercio’s technological answer in the second part of our dossier on price elasticity.

Go further with Mercio:

Mercio’s pricing software removes the technological obstacles associated with the large volumes of data involved in price elasticity, and in particular the cross-elasticity between products in the catalogue. Mercio’s ambition is to offer the precision that is essential for making pricing decisions to meet the challenges of both margin and price image for the retailer. Contact our experts for a demonstration of the Mercio solution