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Understanding Promotional Price Elasticity

How to leverage promotional price elasticity to improve your promo effectiveness

Promotional pricing is a complex, multi-faceted science that can be difficult to measure in full. As such, at Revionics we are often asked by retailers how to best leverage promotional price elasticity of demand. To offer some of our insight, this short read will address how consumers perceive promotional pricing and how Revionics can quantify their response to various pricing actions via promo elasticity.

Price Elasticity of Demand

To level-set, let us make sure everyone is on the same page about the price elasticity of demand and what you can do with it.

  • Price elasticity is used to measure the relationship between price and demand and how changes to price will affect the demand.
  • Products with an elasticity greater than 1 are elastic, and products with an elasticity less than 1 are inelastic.
  • For elastic products, you can reduce prices to drive more sales volume.
  • With inelastic products, you can increase your prices to drive higher margins with limited impact on units sold.

Price Perception and the Buyer’s Purchasing Decision

Now that you have a basic understanding of price elasticity, let us add one more layer of complexity and describe how consumers perceive promotional pricing. First, we define what promotions are and why retailers promote. From a business lens, promotions are an investment in a product or brand using price discounts to convince prospects to buy and, ultimately, increase brand awareness or units sold for that product.

From a scientific perspective, price elasticity and promotional price elasticity of demand both measure impact of demand from price changes. However, promo elasticity tends to generate more demand at a lower price point due to customers being exposed to additional promotional content such as banners, end caps, and coupons.

As an illustrative example, consider this analogy. My resting heart rate hovers around 60 beats per minute (bpm). However, when exposed to physical activity, my heart rate may elevate to 90 bpm. In this scenario, my exposure to running, jumping and squats increase my heart rate, similar to how products placed on promotion may increase the quantity sold. The most critical, and yet difficult, part is decomposing the demand signal into all the influencing factors and making business decisions based on each factor in isolation.

Unfortunately, all promotions aren’t created equal. Some are good and some are bad. To better understand how consumers perceive promotions, we first need to understand the elements that go into making a purchasing decision.

However, not all customer considerations at the point of purchase are within a retailer's control. Consumers are constantly influenced by hundreds of factors both in and out of the retail landscape that affect their purchasing behavior. Yet, we know that three of the most important factors influencing shoppers are time, budget, and now more than ever, safety.

When I make a purchasing decision, it is often rooted in a deficit or a problem of sorts where the product fulfills a need. Based on the urgency (aka time), I search "google" to compare prices online and at local retailers (aka budget), and, if applicable, if my brand of choice is available. Given the pandemic, I weigh my urgency, budget, and safety against a store visit. If a visit is out of the question and I must wait, I typically would pay a premium for the retailer who can deliver the fastest. And as studies have shown, the global pandemic has forced consumers to be more channel, retailer, and brand agnostic.

So, my shopper journey took on the below steps:

  • Identified a deficit, problem, or need
  • A quick search on price and proximity
  • Assess time, budget, and safety constraints
  • I either drive to pick it or click it to ship it

In the above scenario, I've already decided to buy, so would there be value in investing in me via a promotion? It depends. Assuming brand loyalty isn't an issue, I may have sought out the low-end brand only to purchase the high-end brand because the promotion made me feel good knowing I have a better quality product. Adversely, the promoted price just happened to be my lucky day. It didn't sway me in either direction, but it may influence me to prioritize one retailer over another on a future shop. For the retailer, a short-term investment of price may have the potential to drive long-term benefits.

Understanding Promotional Elasticity with Data-science

Before we go any further, I have to admit. I have some good news and some bad news. Now, for the bad news. So far, we haven't truly exposed you to how complex the task of accurately modeling price elasticity is, let alone promotional price elasticity. You have to understand that elasticity can vary by market, store format, brand, pack size, season, and, more importantly, sales types such as regular, promotional, and markdown price. Absent a sophisticated pricing solution that leverages AI to adapt and simulate consumer behavior based on various pricing strategies, you are in a boat at sea without paddles, gas, and a compass informing you how to make equitable business decisions using promotional price elasticity.

However, the good news is that here at Revionics we can model and decompose the exposure to promotional vehicles, tactics, and offers in a way that factors for the multitude of variable inputs impacting promotional results. If you've ever heard the saying, "hindsight is 20/20", then you will understand the motivating factors our team of brilliant data scientists and retail experts used to craft a solution called Promo Effectiveness. With the insights from Promo Effectiveness, retailers can:

  • Identify the most effective way to promote based on historical performance
  • Determine promotional lift by categories and vehicle
  • Identify categories that drive most uplift, basket effects, or substitution
  • Identify the most effective discount depth for a category
  • Ensure future promotions are within the effective range
  • Identify best times to promote
  • And the list goes on…

Here at Revionics, we help retailers do this every day. Most recently, a major APAC convenience store used Promo Effectiveness to identify $20M in nonprofitable promotions and craft a promotion plan to capture $6.1M in profit over the next 18 months. They leverage our science to effectively calculate millions of elasticity values and dynamically adapt them as demand shifts from one consumer to the next, day in and day out.

Not to belabor the topic, but aren't you curious to know how much money you are leaving on the table due to ineffective promo spend? Which products should you promote to drive sales in other categories, or which products, when promoted, steal from other categories and skew your ability to assess how profitable your promotion campaigns are? Well, leave the details and heavy lifting to our science and give us a call for a complimentary pricing checkup with our experts.