You may have never heard this term, or you may be an expert at it.  Most people under estimate the importance of this subject to their business.  Price elasticity is one of the MAIN reasons that businesses fail or succeed.  When I was growing up I was always told “It is better to make three fast nickels than one slow dime.”  This is what I will get to.

Elasticity is the different demand of a product at different price points.  Let me take a very easy example.  I will use the humble water bottle.  I buy them for less than 10 cents at my local grocery store.  They sell better when cold and it costs about 1 cent per bottle to make it ice cold.  Now we go to sell them, what price do we do it at.  Well many places sell them for $1.  I would make 90 cents each but the demand is low, I may be only able to sell to 5% of the people because most know that is too much.  Now what if I lower the price to 50 cents.  The demand jumps by a lot, I have seen it jump to 25% or more.  Then I offer an option where they can get 3 for $1, and you now get 20% buying 3 and 20% buying 1.   Now let us see how much we make on 100 people.  Option 1, we make $4.50 profit (5*.90).  Option 2 we make $10 profit (25*.4),  Option 3 we make $22 profit (20*.4+20*.7).  Which one would you rather have?  It is a huge difference, and one that most people simply do not notice.  They equate profit per item with over all profit, when in most cases you make MORE profit with lower prices.

You look around all over the place and people just don’t get it.  They sell things for way too much, so they sell very little.  The smaller that a company is the MORE I see this.  Today I went to a local owner operated Asian restaurant, the food was good but we paid almost double what we would have paid for twice the amount of food at Panda Express.  The larger a company the more they understand this, in fact the largest and fastest growing company, Wal-Mart, is built on the concept of Everyday Low Prices.  They do whatever they can to make sure they have the lowest price.

Now many things can effect the elasticity of an item, such as lowering supply or raising demand.  Lets go back to water.  What if you are at a 6 hour long seminar and the ONLY drink is the bottled water, you could price it at $1 and sell a lot of them.  Now what if you had 50 people but only 24 bottles of water, now not everyone can get one and you can charge $2 for each one, people will wait until they really need it or until it is almost out of stock and they will buy.  (They may resent your operation and remember to bring their own water next time they come.)  When something is not elastic it is called inelastic.  In the case of 50 people with only 24 bottles and 6 hours with no drinks you could hold out for $5 a bottle, and at some point people may start to buy.

Elasticity is caused by many things but one of the most common is competition.  If company A sells something for $4 and it is well known this is the price, and you sell the same thing for $4.10 your sales will plummet, but as soon as you go to $3.90 your people will be lining up to buy your item.  Gas companies know this, that is why they watch their competition VERY closely.  But so many companies operate in a vacuum, they have no idea what others are selling the same item for, and they may just be 5% too high, and by dropping their price by 5% they could DOUBLE their profits.  Small restaurants are a very good example.  The local taco stand sells tacos for $3 each, and they are almost always empty, it is rare to even see 2 people in their store.  But down the street taco bell does a similar sized taco, for $1.  Of course the taco stand is better, but is it really 3 times better especially when all you want to do is get full.  Lack of competition also is true, we all have seen the gas station 50 miles from any other selling gas for $1 more than anyone else simply because they know you need to buy.

Another thing that causes changes in elasticity is economic conditions.  When you sell something that is optional, in a time of tight economic conditions your demand will plummet, so you must start lowering prices will do to get your customers back, sometimes you have to lower so much that it no longer makes business sense to stay in business, this is why starbucks just had to close over 600 stores. (It also did not help them that every corner store and McDonald’s started selling quality coffee for 1/3rd the price of starbucks.)

Some things do better when economic conditions are worse, I know many people that are buying more Ramen and Mac and Cheese, it is simply much more affordable if you have $4 gas, less money coming in and you still need to eat.

You also have to think about Complementary Goods.  This is where you must buy A and B together to use them.  Lets think about Peanut Butter and Jelly, and lets assume the only thing you can do with them is make sandwiches.  What happens to the demand of Jelly when the price of Peanut Butter doubles, the demand of both falls, even if jelly lowers the price a bit it will still sell less because the total price of the combo is more.  This is why SUVs sell much less when gas costs $4 a gallon.

So next time you price something look around, see what the market is doing, and don’t be blind to your competition, and for all means don’t over price your product.  One way to test different prices is to have a sale.  (Why do you think large companies have so many things on sale, they often are testing different price points.)

I hope this helps with your business.