Price elasticity in retail: definition and example
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Do you know what a 5% drop would actually amount to?
Schedule a meetingDiscover AI-Powered Sales ForecastingPrice elasticity of demand measures the sensitivity of demand for a product to a change in its price. It is calculated as follows: % change in quantity sold ÷ % change in price . A product is said to be elastic when a small change in price leads to a large change in volume.
The Essentials in 6 Questions
A coefficient that relates a change in price to a change in volume.
Pricing teams, category managers, and promotions managers.
Before any price increase, price decrease, or promotion.
By reference, category, channel, and geographic region.
Predict the impact of a price on volume, revenue, and margin.
Based onsales history, by isolating the price effect from other variables.
Why Price Elasticity Guides Pricing Decisions
Because, before changing a price, she explains how that change will affect your sales volume and your margin.
- Optimize pricing decisions: anticipate the impact of a price increase or decrease on revenue and margin (see the calculation and examples of price elasticity).
- Managing Promotions: Highly price-elastic products generate higher sales volumes during promotions, which can offset the decline in unit margin. This is the foundation of effective promotion management.
- Tailor the strategy by category: certain departments (fresh produce, apparel) have very different price elasticities, which call for distinct pricing approaches.
Example of a Price Elasticity Calculation
The price of a pair of jeans drops from €50 to €45, and weekly sales increase from 100 to 130 units: its price elasticity is -3.
Price: The jeans go from €50 to €45.
in terms of volume: 100 to 130 units sold per week.
Elasticity (30% ÷ -10%): a highly elastic product.
Conversely, a staple good (such as milk or bread) has an elasticity close to 0.
This result has a name: the elasticity coefficient, a key input for any pricing simulation prior to a decision.
How do you measure price elasticity?
The formula is simple; the challenge is to isolate the effect of price from everything else.
Collect the history
Sales, prices, promotions, and inventory, by product code and by channel.
Counteract Other Effects
Seasonality, weather, competitors' promotions, stockouts: anything but price.
Calculate the coefficient
Elasticity = % change in quantity ÷ % change in price.
Try it out before you decide
Test several pricing scenarios and compare their impact on the margin.
At the catalog level, this calculation is performed through modeling. This is the role of our AI-powered sales forecasting, whose elasticity estimates are then used in the simulations run by our price optimization software.
3 Mistakes to Avoid When Dealing with Price Elasticity
Incorrectly measured elasticity leads to pricing decisions that are worse than what intuition would suggest.
- Confusing elasticity with correlation: A decline in sales is not always due to price. Elasticity isolates the effect of price by controlling for other variables.
- Use a single elasticity value for all channels: it can vary significantly between in-store and online, or by geographic region.
- Neglecting cross-elasticity: Lowering the price of one product can negatively impact sales of a related product (seecross-elasticity and cannibalization).
Frequently Asked Questions
Short answers to the most frequently asked questions about price elasticity.
What is price elasticity?
Price elasticity measures how much a product's sales change when its price changes. It is calculated by dividing the percentage change in quantity sold by the percentage change in price. An elasticity of -2 means that a 1% price increase will decrease sales by approximately 2%. In retail, it is used to anticipate the effect of a price increase, decrease, or promotion on sales volume, revenue, and profit margin. For the full definition and other examples, see price elasticity of demand .
How do you calculate price elasticity?
To calculate price elasticity, we divide the percentage change in quantity sold by the percentage change in price. For example, a packet of coffee increases in price from €4.00 to €4.40, a 10% increase, and its weekly sales decrease from 1,000 to 850 units, a 15% decrease. The elasticity is -15 ÷ 10 = -1.5: the product is elastic. This simple calculation assumes that nothing else has changed during the period, such as promotions, weather, or competitor pricing. To isolate the effect of price, we use historical regressions: see the method for calculating price elasticity .
How do you interpret price elasticity?
Price elasticity is interpreted according to its absolute value: less than 1, demand is relatively insensitive to price; greater than 1, it is elastic. For a product with low elasticity, such as a basic necessity or a brand with strong customer loyalty, a price increase raises revenue because volumes decrease only slightly. For an elastic product, one with strong competition or easy to replace, a price decrease can, on the contrary, generate enough additional sales to compensate for the lost margin. Positive elasticity is rare and often indicates a measurement bias, for example, a promotion that was not taken into account.
What factors influence price elasticity?
Price elasticity depends primarily on the availability of substitute products: the easier it is for a customer to switch products or retailers, the more responsive they are to price. It also varies according to brand awareness, purchase frequency, the product's share of the budget, and its essential nature. The same product does not have the same elasticity everywhere: it changes from one store to another depending on local competition, and from one season to another. Finally, a product's sales also react to the prices of similar products: this is known as cross-price elasticity .
How to use price elasticity to set retail prices?
Price elasticity is used to classify products according to their price sensitivity and to adapt each product's strategy. Products with low elasticity can withstand a moderate price increase to rebuild margins. Highly elastic products, which are frequently compared, are those where a price reduction improves both price image and sales volume. Elasticity is also used to calibrate the depth of a promotion, to avoid a discount that costs more than it generates. The complete approach is detailed in the 6-step method for leveraging price elasticity .
How do pricing software tools take price elasticity into account?
Pricing software estimates the elasticity of each product based on historical sales data, prices, and promotions, while controlling for other factors such as seasonality and stockouts. It then uses this data to simulate the impact of various prices on volume and margin, and recommends the price that best serves the target objective. When a product's historical data is insufficient, it relies on comparable products in the same category. At Booper, these estimates feed into an engine that combines predictive models with business rules defined by the retailer.
Key Takeaways
- Price elasticity = % change in volume ÷ % change in price.
- It is measured by reference and by channel, isolating the price effect from other variables.
- It is used to simulate price increases, decreases, and promotions before implementing them.
Would you like to know the elasticity of your products?
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