For consumer packaged goods (CPG) brands, pricing can feel like a high-wire act. Set pricing too low, and your company could be missing out on margin. Price too high, and demand could snap altogether—and consumers may abandon your brand in the long run. That’s why identifying price elasticity is more important than ever.
Price elasticity tells you how much slack you have in your pricing strategy. Master elasticity and your company will know exactly how to toe the perfect pricing line that maximizes profit. This is how price elasticity works and how CPG brands should—and shouldn’t—determine price elasticity.
What Is Price Elasticity?
Price elasticity describes how much a product’s price influences its demand. If a product’s pricing directly sways its demand, that means its price elasticity is high. A product is inelastic if price changes don’t affect demand. So, at its most elemental level, pricing within an essential product, such as oil, tends to be less elastic than a nonessential product, such as potato chips.
However, determining a clear degree of price elasticity in retail is much more complicated than deciding how essential a product is. Any product’s true price elasticity will shift depending on brand recognition, the availability of competition, messaging, separate product demand, the market, and a laundry list of other variables.
Perfecting Price Elasticity Is Increasingly Important
Financial pressure is weighing down on companies and consumers. Annual inflation in the U.S. climbed above 9 percent in 2022, hitting its highest numbers since the early 1980s.
Heightened inflation means many CPG companies may need to raise prices. Unfortunately, that also means the gap between setting a price a consumer will tolerate and a price that puts them off may be razor-thin.
Even as pressure to raise pricing hits a fever pitch, CPG leaders are struggling to determine their products’ price elasticity, and it’s harder than ever to make confident pricing decisions. One recent Deloitte survey found around half of CPG executives believe they can raise their prices without impacting demand, and the other half say they can’t.
How to Determine Price Elasticity
Traditionally, a leader would use price elasticity analysis to track price and product quantities while removing those variables that may affect demand. However, the traditional approach seems to be leaving CPG leaders in the dark. In fact, one Bain & Company study found that 85 percent of company leaders say they need to start making better pricing decisions.
Even though traditional price elasticity analysis still can serve an important role, there are a few reasons the traditional approach to price elasticity is incomplete:
- Covid changed the rules. The pandemic shifted consumer behaviors and shook up the way buyers evaluate prices. One McKinsey study found that 46 percent of U.S. shoppers tried new brands or retailers during the pandemic. Because traditional price elasticity analysis relies heavily on historical data rather than data from the current market, it may overlook new consumer behaviors that the pandemic triggered. In addition, the new prices you need to charge are beyond any previous prices in the marketplace.
- Cross elasticity is unmanageable. Product prices are more intertwined than ever, and varieties have exploded across the board. In order to measure cross elasticity on multiple products, company leaders need to analyze data on an unprecedented scale. Measuring the impact of competitive response is crucial, which is not possible with in-market scan data.
- There are too many variables to handle. To pin down accurate price elasticity, you have to control for everything from distribution, competitive products, and marketing to communications, market shocks, and more. That means juggling millions of variables—something that’s too strenuous to handle without the help of advanced technology.
- It’s expensive and slow. Traditional price elasticity studies are generally conducted only once per year, takes several months to complete, and can be expensive. In a world where economic influences and demand are shifting rapidly, this approach makes it difficult to react to the pricing environment as it is happening.
A New Approach to Price Elasticity
CPG companies can follow these steps to determine accurate price elasticity in the modern retail world:
- Use virtual shopping analysis to identify cross-price elasticity. Virtual shopping analysis reveals real-time consumer purchasing decisions across product lines. That means you can gather complex, modern data that feeds off current market behaviors.
- Take advantage of machine learning. Machine learning can keep up with the millions of data points and variables that are baked into modern pricing. This technology spots relationships traditional analysis may miss and packages it into reports leaders can use.
- Back up results with traditional price elasticity analysis. This new approach to tracking price elasticity doesn’t require ditching traditional analysis altogether. You can reinforce your findings and uncover concrete trends by conducting traditional price elasticity analysis along with new techniques.
Fitting Price Elasticity into Your Revenue Growth Management Plan
As critical as finding price elasticity is, CPG companies need to plant it within a broader revenue growth management (RGM) strategy to push their products forward. RGM strategies use the company's main marketing levers—everyday pricing, trade promotions, and product assortment—to increase revenue. That means pricing is just one important piece in a bigger RGM puzzle. Here’s what companies need to propel RGM forward:
- Accurate Price Elasticity: Knowing price elasticity allows companies to know exactly how price changes will impact their product demand. Not only does that position a company to maximize profit, but it also pads the company from market shocks.
- Realistic Market Trends: To grow revenue consistently, it’s important to account for all of those variables that impact the product. Examples include promotions, marketing, and distribution.
- Quick and Effective Results: With markets and consumer preferences shifting so quickly, it’s no longer good enough to drill into your product fundamentals periodically. Instead, revenue growth requires constant updates and regularly digging into data.
Learn to Streamline Data and Enhance Your Company
Identifying price elasticity and carving out more revenue depends on your company’s ability to quickly collect, understand, and digest data. Watch the “Price Elasticity Analytics Reimagined” webinar hosted by our sister company, Blacksmith Applications, to learn more.
Ready to talk to an expert that can help you understand your price elasticity needs or start your virtual shopping experience? TABS Analytics and Decision Insight help CPG companies explore their full potential. Schedule a demo today!