Analyzing Pricing and Sensitivity
There are a lot of factors to consider when pricing your product or service. One of the most important is how sensitive your potential customers are to price changes. If they're very price-sensitive, you'll need to be more careful about changing your prices than if they're less sensitive. In this blog post, we'll take a look at what factors influence pricing sensitivity and offer some tips on how to assess it. We'll also explore how you can use pricing sensitivity to your advantage in order to attract more customers. Thanks for reading!
Start with a variance analysis
Read how to perform a variance analysis
This variance analysis led to the following conclusion:
The company in the example has had an increase in costs from its supplier and in order to cover those costs and maintain its margins, chose to increase pricing. The increase in pricing caused the decrease in the volume of customer purchases as a result.
We will use this analysis as our starting point for the sensitivity analysis and find the optimal price point.
Price Elasticity of Demand
To calculate the price elasticity of demand we take the percent change between Q1 and Q2 for both price and quantity.
The price elasticity of demand is the most important factor when it comes to pricing sensitivity. This measure expresses how much demand for a product or service changes as its price fluctuates. Products with high price elasticity are more sensitive to changes, meaning that a slight increase in price can lead to a significant drop in purchases. On the other hand, products with low price elasticity are less sensitive, meaning that a slight increase in price won't have much of an impact on demand.
Calculate Quantity based on Price Elasticity
If we inverse the calculation of the price elasticity formula and multiply it with the change in price, we can get the change in quantity. We can utilize this formula to test different price points, and when laid out in a table, we can compare the quantity for each price point.
Creating a Sensitivity Table
1.Build the P&L formulas to calculate all the way down to Gross Profit using price as the input driver
2.Create a row with many different price points
3.Link the Gross profit of the P&L to the desired data table
4.Highlight the data table
5.Go to the excel ribbon and hit Data>What if analysis>Data Table
6.Link Row input cell to the price input
After laying out the table showing the profit at each price point, we can graph the table to visualize the optimal point to price the product. After the optimal point the trajectory begins to decrease at this point the decrease in quantity is driving revenues lower than the price is increasing it.
Conclusion
Price elasticity of demand is an important concept to understand when setting prices for your products or services. By understanding how price changes impact sales, you can make more informed decisions about pricing and hopefully increase revenue. In order to get a better sense of the price elasticity for your product or service, it’s helpful to perform a sensitivity analysis. This will help you determine which factors have the biggest impact on demand and allow you to adjust your prices accordingly. If you need assistance with performing a sensitivity analysis or determining price elasticity, contact GFT today – we would be happy to help!
