Last week, Marka and the tribe discussed how understanding price elasticity can help businesses like FEI arrive at an intelligent pricing strategy. This week, they discuss inelasticity of demand and its applications to pricing. Remember, fire = print.
Marka stood in front of the FEI tribe holding a Slinky. “As we discussed last week, elasticity is how responsive demand is to a change in price. This Slinky will help us understand the concept of inelastic demand. Say its length represents a product’s price and its width represents a product’s demand. Now let’s raise the price of our product that’s experiencing inelastic demand,” she said, extending the Slinky as far as it would go.
“The width doesn’t change,” Zoot observed.
“Yes, exactly,” Marka said. “If a company determines its product is experiencing inelastic demand, it can raise the product’s price with a relatively limited effect on demand.”
“How can companies create inelastic demand for their products?” Numo asked.
“One way is to simply own a monopoly on a market or product category,” Marka replied. “In this case, consumers don’t feel they have much of a choice and will be forced to pay much higher prices.”
“Another is to develop highly-differentiated brands and products,” she continued. “Grape Computers, for example, commands almost twice the price of competing models because consumers perceive its brand and products as unique, with benefits not offered by competing, lower-priced models.”
“No product is 100 percent inelastic,” Numo pointed out. “This only exists in Economics textbooks. Grape knows it would move more units at a lower price, but the company determined its profitability would be maximized at a high price point—just not crazy high.”
“Is demand for our new matches elastic or inelastic?” Zoot asked.
“Relatively inelastic...for now,” Marka said. “There’s currently no competition for our matches, which in theory means demand should be relatively inelastic. There are substitute products out there, however, such as Flintstone’s flints. If we price our matches too high, consumers may stick with the flints even though they’re less convenient. But the current lack of competition for our new product may allow us to charge two or three times what we could in a more crowded market.”
“I’m learning so much about price,” Zoot said. “What’s next on the agenda?”
“We’re going to determine how different kinds of internal costs will help determine how our product’s prices are set,” Marka replied.
“I can hardly wait,” Numo said, practically salivating at the thought of more numbers.Today’s FIRE! Point
Elasticity is defined as how responsive product demand is to a change in its price. Products with little competition or those that are highly differentiated are less sensitive to changes in price, or inelastic. Even if a company owns a monopoly in a product category, however, there are often substitute products available that will increase the elasticity of the monopolized product.FIRE! in ActionConsumers will pay more for differentiated products
Despite discount options and $300 price tags, True Religion and Rock & Republic remain two of the most popular jean brands. True Religion’s sales have grown from $2 million to $110 million in the last five years, while Rock & Republic saw a 270 percent revenue increase
in 2006.Next week: The FEI tribe determines how internal costs factor into a company’s pricing strategy.