However, that price may be different from the final price, due to discounts and other discounts that the product may have. It is common for companies to consider lowering prices through promotions of many kinds, including direct discounts. At the end of the day, the price paid by the customer is what comes into the company and is where the profit is made from.
One concept about price that economists like to measure is called price elasticity. When the price of a product changes, there is a natural shift for consumers to buy less when the price goes up or buy more when the price goes down. The price elasticity index measures the percentage change when one of these two factors occurs. A study featured in McKinsey Quarterly indicates that a small increase in price, say 1%, results in an 8% increase in profits. Increasing the price of products can have a positive effect on profitability. Despite what has been said, the opposite could happen. If consumers react negatively to that increase, then it can cause a drop in revenue, which negatively affects profitability.
Price sensitivity is a relevant issue that every company should know with a certain level of detail. Much of the theory indicates that price elasticity is always negative: when prices go up, demand goes down. This issue makes companies very uncomfortable in an environment where prices must generally be changed upwards due to different factors such as inflation or differentiation. It is of great interest to know in advance the effect that a price change could have on demand. A slightly negative price elasticity, say -0.1%, is very different than a very negative one, say -3%. A price elasticity of -0.1% would cause a small loss of customers (perhaps up to 5%) while a price elasticity of 3% could cause a very large loss (perhaps at least 30%).
Although prices will regularly be increased, the objective will always be to maintain or increase the profitability of the company. Price elasticity plays a relevant factor, since it will give us an idea of the consumers that are lost when prices increase. When the price elasticity is small, there is a good chance that the decrease in demand will be offset in profitability by the increase in price. That is, a 1% price increase will cause demand to decrease, but customers who stick around buying at the new price could increase the company’s profitability.
An always critical issue in all cases is how to lose as little demand as possible. There are several considerations for this, including:
- Highlight the value of the product for the consumer. Highlight all the benefits that the product has.
- Maintain or increase advertising in traditional media (eg TV, press) and non-traditional media (eg digital social networks). Beyond increasing spending, make it easier for the consumer to see.
- Increase brand exposure for the segment of interest. Related to the above, but in other areas such as shelf positions, store advertising, sponsorships, among others.
Maintaining the brand without price increases only erodes profitability. Increasing prices can have negative consequences, but doing it with creativity and knowledge can have a very positive effect, knowing how different customers react. Making the customer willing to pay more for a product results in one of the most profitable marketing decisions.
By: Dr. Jorge A. Wise, Professor of Marketing and International Business at CETYS University, member of the CETYS Graduate School of Business