We were reviewing the results of some analyses with a client recently, and the client observed they had raised the price of one of their biggest selling products and volume had decreased. Our client concluded the demand for their products was very price elastic. Certainly the classic calculation (the percentage change in quantity sold divided by the percentage change in price) would provide an answer that demand was elastic. However, the demand for a product can change for many non-price reasons and it is important to know the differences before adjusting your prices or pricing strategy. To understand those differences we want to look at the source of the demand, the behavior of customers across a range of products, the fit of the products with changing customer needs, and our service levels.
Our client in this case operates in a B2B environment. That means the demand for our client’s products is derived from the demand of their customers’ products. If the end-market demand has turned down, our client’s customers will not need as much product, regardless of whether the price has increased or decreased. If our clients lowered prices, their customers would appreciate it, but those customers would probably not buy any more than they did. What would they do with the extra products since they are not selling any more of their own?
We tend to view elasticity of demand as a product function and price sensitivity as a customer attribute. Nevertheless, those two measures overlap, and we urge our clients to look at multiple perspectives. For example, if our analysis indicates demand for something is elastic, we should expect to see similar results for similar products or products that address similar applications. By the same token, if the math indicates that certain customers are price sensitive, is that price-sensitive behavior of those customers consistent across the full range of products? Often when we dig deeper and look for corroboration, we find products that should have similar demand elasticity results do not, and we find customers that appear to be very price sensitive on some products are very insensitive on other products. When we see inconsistent results, we urge caution before drawing conclusions about demand elasticity or price sensitivity.
Markets change as the needs for features, functions, and benefits within customers change. If your products or services do not address those changing market needs, demand for your products will decline. Misinterpreting lower demand for your products as being price elasticity rather than a poor alignment between your products and customer needs, will result in a continued downward spiral of sales and margins. Lowering your prices will lower your sales and margins, but will not improve demand. And if you delay adjusting your products and services to the new needs of the market, demand will continue to fall.
Lastly, make sure your service has not deteriorated. Customer satisfaction surveys consistently indicate that service is at least as important as price, often more so. If your service KPIs are deteriorating, expect demand for your products to deteriorate also. Your customers are working very hard to satisfy their own customers, and if you are causing them headaches, they will look for a supplier that makes their lives easier.
Price elasticity of demand and price sensitivity are basic economic concepts. Measuring them can be relatively straight forward, however in B2B markets there can also be a lot of noise. If demand for your products is truly elastic or your customers are really price sensitive, there will be times when lowering prices is the correct course of action. However if the results you are seeing in those measures are really being driven by other factors, lowering prices will just lower your sales and margin. Do your homework. Validate your KPIs from multiple perspectives before making any moves. If you are really unsure, stand pat or test small price changes to gain corroboration. Don’t bet your business on false indicators.