Pricing your product or service involves careful consideration of numerous factors, with one of the most pivotal being the sensitivity of potential customers to price adjustments. If your customer base is highly price-sensitive, you must exercise caution when altering your pricing structure, compared to a scenario where they exhibit lower sensitivity. In this blog post, we will delve into the factors influencing pricing sensitivity and provide valuable tips on how to gauge it effectively. Additionally, we will explore how you can leverage pricing sensitivity to your advantage, ultimately attracting more customers.
Initiate with 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.
At the core of pricing sensitivity lies the concept of price elasticity of demand. This metric quantifies the extent to which demand for a product or service fluctuates in response to price variations. Products with high price elasticity are profoundly sensitive to price changes, even minor increases can result in significant demand reductions. Conversely, products with low price elasticity exhibit reduced sensitivity, with slight price adjustments having minimal impacts 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
Construct Profit and Loss (P&L) formulas that encompass calculations down to Gross Profit, with price as the input driver.
Generate a row featuring multiple price points.
Establish a link between the Gross Profit in the P&L and the desired data table.
Highlight the data table.
Access the Excel ribbon, navigate to Data > What if analysis > Data Table.
Connect the Row input cell to the price input.
Once the table showcasing profits at each price point is complete, visualize the data with a graph. This graphical representation will aid in identifying the optimal pricing point. Beyond this point, the trajectory starts to descend. Here, the reduction in quantity begins to outweigh the increase in revenue brought about by price increments.
Conclusion
Comprehending price elasticity of demand is pivotal when determining the pricing strategy for your products or services. By grasping how changes in price influence sales, you can make more informed decisions regarding pricing, potentially boosting your revenue. To gain a deeper understanding of price elasticity and perform a robust sensitivity analysis tailored to your product or service, do not hesitate to reach out to GFT. We are here to provide expert assistance in performing sensitivity analyses and evaluating price elasticity, ensuring your pricing strategies align with your business objectives. Contact us today, and we will be delighted to assist you!