Elasticity vs Value: When Pricing Power Collides with Consumer Expectations
There has been a lot of discussion lately about pricing power, and the need for many brands to raise prices to deal with inflationary pressures on costs, and perhaps some new tariffs. Whenever we do pricing research or talk about pricing there is a lot of discussion about the price elasticity of a brand, and those discussions always take a fairly short-term view. And this reminds me of a story about cookies. Obviously!
Understanding Price Elasticity: How Does Price Affect Demand?
Price elasticity is a fundamental concept in economics that measures the responsiveness of demand to changes in price. It indicates how consumers react when the price of a good or service increases or decreases. From the perspective of a business, it basically means how much permission will my customers give me to raise my prices. Because of inflationary pressures (and now new tariffs) there has been a lot of press lately about brands raising prices. And on the brand side there has been a lot of pressure to be able to either contain costs, or raise prices.
What is Price Elasticity?
Price elasticity is a measure of the percentage change in quantity demanded divided by the percentage change in price. It is typically expressed as a numerical value, with a positive or negative sign. A positive value indicates that demand is elastic, meaning that a small change in price leads to a relatively large change in quantity demanded. Conversely, a negative value indicates that demand is inelastic, meaning that a change in price has a relatively small impact on quantity demanded. If you are reading this blog, you probably already knew that.
Did you say cookies?
So all of this talk about price elasticity makes me think about cookies. In my first job as a market researcher there was a very wise methodologist (Shout out to DJ!) who liked to tell a story about cookies. The story goes something like this. A big time cookie brand needs to maintain margins in the face of rising costs. They commission a smart research company to figure out the best way to do this. And they design a research approach that measures how many chocolate chips you can remove before a consumer notices. They conclude that they can reduce the number of chocolate chips from 24 to 21 without impacting consumer demand. This change results in some cost savings and demand remains consistent. Sounds like a win right?
The problem starts to creep in as the brand goes back for more bites of the Apple. The next year they run research on more potential cost savings, and they end up reducing the chocolate chips from 21 down to 18. Then from 18 down to 16 a few years later. Eventually one day a consumer has a cookie and just isn’t all that impressed with it. This is where the elasticity meets value perceptions.
Elasticity vs Value
So a tricky thing about this discussion, and the thing that shows DJ’s wisdom in the cookie story, is that elasticity is often discussed (and measured) in more of a short term lens. Managers ask if a price increase changes the demand for the current offering. Consumers are measuring value in a competitive context which evolves over time. So as the cookie company is slowly eroding the value of the offering, the competition (candy bar, soft serve) starts looking more attractive.
Implications for Brands
While the short term environment may dictate the need for cost cutting or price increases, you can’t ignore the long term mission to provide more value for your customers. This may require innovation work, or redesigning how some aspects of the product are delivered. But don’t be lulled into thinking the elasticity will always be there without product improvements.