Cross-Price Elasticity: The Impact of the Price of One Product on Another
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Do your promotions help boost sales across the entire department?
Schedule a meetingDiscover AI-Powered Sales ForecastingCross-price elasticity measures the sensitivity of the demand for product A to a change in the price of product B. If it is positive, the products are substitutes (two brands of soda); if it is negative, they are complements (a printer and a ink cartridge); if it is close to zero, they are independent. It helps avoid pricing decisions that cancel each other out at the category level.
The Essentials in 6 Questions
The effect of one product's price on the sales of another.
Pricing, promotion, and category managers.
Before any promotion or price reduction in a category.
Between substitutes and between complementary items within the same product line.
Think in terms of categories, not on a product-by-product basis.
Percentage change in sales of A ÷ percentage change in the price of B.
Why Cross-Elasticity Changes How a Promotion Is Perceived
Because a promotion that boosts sales of one product can take sales away from neighboring products and lower the department's profit margin.
- Avoiding cannibalization: Lowering a price can undermine sales of a substitute product, which can be anticipated by calculating cross-price elasticity.
- Optimize promotions: Promoting a product whose complementary items have a high margin creates a positive ripple effect.
- Managing the product mix: developing a pricing policy at the category level, not just by SKU.
Real-world example: a beer promotion that erodes profit margins
A promoted beer sees a 35% increase in sales, but the department's revenue grows by only 3%, while its margin decreases by 8%.
The price drops from €1.99 to €1.69 (-15%). Sales of two competing brands in the aisle fall by 12% and 18%: cross-elasticity is positive, and the products are substitutes. At the category level, the promotion erodes the total margin.
How do you measure and use cross-elasticity?
By observing the effect of price changes for a product on the sales of its competitors, and then simulating this effect at the category level.
| Value | Relationship | Example |
|---|---|---|
| Positive | Substitutes: When the price of one goes up, sales of the other go up. | Two beer brands. |
| Negative | Additional information: As the price of one rises, sales of the other fall. | Pasta and sauce. |
| Close to 0 | Standalone products. | Laundry detergent and chocolate. |
The calculation takes into account historical sales data, price changes, promotions, and seasonality. Our AI-powered sales forecast estimates these relationships between products; our promotion management system incorporates them to simulate the net effect of a promotion on the entire department. See alsothe halo effect.
3 Mistakes to Avoid with Cross-Elasticity
Think on a product-by-product basis; don't overlook private-label brands or neglect supplements.
- Thinking on a product-by-product basis: Optimizing each SKU individually can destroy value at the category level.
- Ignore non-branded substitutes: a store brand can cannibalize a national brand, and vice versa.
- Underestimating complementary products: A price drop on pasta also boosts sauce sales.
Frequently Asked Questions
Short answers to the most frequently asked questions about cross-elasticity.
What is cross-elasticity?
Cross-price elasticity measures the sensitivity of the demand for product A to a change in the price of product B. It reflects the economic relationships between products: substitutes, complements, or independent products. It is an essential concept for managing a product assortment in a consistent manner.
How should positive or negative cross-elasticity be interpreted?
If the value is positive, the products are substitutes: when the price of one rises, demand for the other increases. If the value is negative, they are complements. If the value is close to zero, they have little interaction.
Why is cross-elasticity important in pricing?
It anticipates the indirect effects of a price change on other products in order to optimize profitability across the entire category rather than for a single product.
How do retailers use it?
To adjust prices, create promotions, limit cannibalization, design bundles, and maintain consistent product lines.
Key Takeaways
- Cross-price elasticity measures the effect of the price of one product on the sales of another.
- Positive: substitutes; negative: complements.
- It requires that a promotion be evaluated based on the margin for the entire category.
Would you like to predict the effect of a price change on similar products?
Booper measures the cross-elasticity between your products to avoid unpleasant surprises.
Let's talk about your category promotions →Discover AI-Powered Sales ForecastingYou might also be interested in these articles
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