How to Use Price Elasticity in E-commerce to Improve Profit Margins

E-commerce is one of the most competitive landscapes for retailers. Internet-savvy consumers can easily locate the best prices with a quick Google search. Amazon and other online giants offer prices that are difficult to beat. And today’s consumers are rarely willing to pay full-price for anything.

In a world where consumers will only agree to the best deals, how can e-commerce retailers improve their profits?

The Importance of Your Pricing Strategy</strong

One of the most challenging things e-commerce professionals face is pinpointing the right price point for their offering. Your pricing strategy directly impacts your revenues and bottom line. The way you price items might instantly turn away or attract certain shoppers. And while you don’t want to lose customers because your prices are too high, you also can’t lower prices to the extent that your profit margins will shrink.

With this in mind, it’s critical for e-commerce retailers to understand price elasticity.

What is price elasticity?

Price elasticity, which is also known as “price elasticity of demand,” has to do with the extent to which the demand for a product will be affected by a change in its price. A small change in the price of a product that is highly elastic will result in a large change in the quantity demanded. On the other side of the spectrum, for a product that is highly inelastic, the quantity demanded will not change when the price changes.

The goal for e-commerce marketers is to move their products from being elastic to being inelastic. In this scenario, their products will be differentiated from competing items and valuable to consumers such that a fluctuation in price won’t change the consumer’s willingness to buy it.

As you may have guessed, price elasticity is affected by a number of things. This includes the type of product you’re selling, the health of the economy, your target audience’s income, and what your competition is doing. Consider, too, that some products will naturally be more or less elastic depending on the extent to which they’re perceived as essential or merely nice to have.

Here are some examples to help you understand the concept of price elasticity of demand. Let’s first look at a non-essential, nice-to-have item like bananas. Should the price of bananas increase dramatically, the demand would likely drop significantly because people can instantly substitute bananas with something else. Bananas are a nice-to-have, not an essential. Alternatively, a tank of gasoline, for most people, is an essential, not a nice-to-have. So while a price increase on a tank of gas might aggravate consumers, they will still pay for it. Therefore, gasoline is considered inelastic.

Calculating Price Elasticity

Price elasticity of demand can be calculated with the following equation:

Price Elasticity of Demand = (% Change in Quantity Demanded)/(% Change in Price)

Let’s calculate the price elasticity of a pair of jeans for which the price is changed from $100 to $120. Assume this 20% price increase resulted in a drop of the quantity sold, from 1,000 units to 900 units. The percentage decrease in demand is -10%. To calculate the price elasticity, then, our equation would look like this:

– .10
——- = – .5
.20

When you’re talking about price elasticity, the negative in the resulting figure is traditionally ignored. So in this example, the price elasticity is .5. What matters more than whether the result is positive or negative is how close it is to zero. The closer the price elasticity is to zero, the more inelastic the product is.

How Price Elasticity Can Help Improve Profits

Why does price elasticity matter? And how can e-commerce retailers use it to improve profit margins?

The most straightforward answer to the value of understanding the elasticity of demand is that this understanding allows you to more accurately predict how price changes will affect your revenues before they happen. This is much more powerful than understanding how those changes impacted you after the fact. By understanding the price elasticity of your offering, you can get an idea of the extent to which a price increase or decrease—based on your target audience’s reaction to it and how it will impact quantity sold—can help you improve your profit margins.

Because consumers these days are so sensitive to price changes and will usually spend the time needed to hunt for the best deal, most products are elastic. But, as we mentioned earlier, your goal should be to make your product as inelastic as possible. Even if your product is a luxury—something that is easily eliminated if a budget is tight—you can move it toward being inelastic through impeccable product design and development, excellent service and powerful marketing.

If there is a lot of competition offering the same type of products as you, it’s essential to find ways to make your offering stand out that your customers will appreciate. This might be in the service and support you offer. Or, it might be in added features or qualities that differentiate your products from competition. Focus on features that your customers will find essential and that your competitors aren’t offering.

The key to using price elasticity in determining your prices and growing your profit margins is to understand your consumers and why they behave in the ways they do. Consumer behavior is impacted by a variety of factors and changes daily, but by making small price changes and measuring your consumers’ reactions in order to understand your product’s elasticity, you can gain the insights that will help you sell more without dropping your prices.

To read more about the relation between behavioral economics and marketing,
and demonstrate how creative marketing organizations can leverage the fundamentals of behavioral economics
download our eBook: Behavioral Economics as a Key Marketing Driver. Contact us, today.

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