Behind the elegant window displays and colorful online marketplaces, retailers are fighting a profit war; a war in which profit margins can be as low as 1-2 percent in a market that is rapidly changing. To compete in such a tough environment, retailers need to be armed with the best pricing strategies possible to win. When talking about profit margins, every percent matters, and the right pricing strategy can influence margins drastically. So which strategy is the winning strategy? What pricing method boosts profit margins enough to give competitors a run for their money?
What is elasticity-based pricing?
The strategy that some of the best and biggest market champions have adopted to boost their profit margins is elasticity-based pricing, and their results are undeniable. Elasticity-based pricing refers to the incorporation of price elasticity of demand estimate of a product into its final cost. Price elasticity of demand is the measurement of how pricing changes to an item will affect the demand of the item. Basically, elasticity-based pricing involves changing prices according to how customers will react to those changes in price, which can vary based on numerous factors like competitor prices, time of year, or even the weather on any given day.
Measuring the elasticity of demand for a product in order to apply elasticity-based pricing requires a calculation. The percent change in quantity is divided by the percent change in demand, which typically results in a negative coefficient. This price elasticity of demand coefficient can then be used to conduct an elasticity-based pricing strategy.
How elasticity-based pricing boosts profit margins
Simply put, knowing the price elasticity of demand lets you know just how much consumers as a whole are willing to pay for a product, and at what prices less or more of them would be willing to pay. You can easily tell whether a price change will influence demand too much to actually be profitable, or whether a price cut is not worth doing as the demand will not make up for the money lost. Finding the sweet spot between price and demand allows you to maximize your profit margins, often doubling or tripling them. Going back to the often low profit margins that retailers are attempting to compete with, this is a significant impact.
The human problem
Though it sounds simple in words, applying this calculation to thousands of products fast enough to keep up with the rapidly paced market becomes significantly more complicated. Worse yet, the percent change in demand can be influenced by a myriad of factors, many of which are easy for a person to overlook. Not only can a person easily overlook important factors, but they can also make mistakes. The calculation itself might be simple, but obtaining accurate percentages to work with thousands of times over can leave a lot of room for error.
Aspects that influence demand like what month of the year it is or what prices competitors have for the same/similar products will all affect the quantity demanded, and will also affect how much consumers are willing to pay for a product. Worse yet, thanks to eCommerce and the Internet, these factors are changing in a matter of hours, not days. So if you want to use elasticity-based pricing on a large scale quickly, what are you supposed to do?
Bring in the bots
Simple: take the human out of the equation. Most of the largest and most successful retailers have started to use AI and its ability to perform complex algorithms with an unspeakable amount of consumer data to use an elasticity-based pricing strategy. Have you ever gone on Amazon, left for an hour, and came back only to find that the price of the item you were looking at had changed? It’s because every day, Amazon is changing the prices of millions of products according to these advanced algorithms, applying elasticity-based pricing on the fly, and they stay well ahead of their competition by doing so.
AI can process years of consumer data, find patterns within it that could influence demand, make the calculations for a company’s entire product portfolio, and give the right prices for all of them near-instantly. It does so with a significantly smaller margin of error and gives out the right prices for your products whether you change them every month or every day. This all sounds great, but creating such an advanced system on a large scale all in-house isn’t really feasible for companies that aren’t as large as Amazon.
Luckily for those companies, third party pricing software providers can do all of this for them. Thanks to pricing optimization platforms and other advanced pricing software, you can harness the power of AI to apply elasticity-based pricing and boost your profit margins just like the retail giants do. Leading pricing optimization software is extremely accurate - up to 98% accurate to be exact - and it is a much more affordable and hassle-free option compared to attempting to create an in-house system. Thanks to this advanced pricing software, retailers all over the world can enjoy AI-powered pricing and the boosts in profit margins it brings.
Win the profit war with elasticity-based pricing
Being in the retail industry is a constant battle for better profit margins. With the right weaponry, any retail company can apply elasticity-based pricing, optimize their prices, and increase their revenue as a result. Elasticity-based pricing is the solution retailers are looking for to stay competitive and keep up with the ever-quickening market, and advanced pricing software is the best way to apply it. Equipped with elasticity-based pricing and a powerful pricing platform, the profit war can be easily won, allowing companies to boost profit margins and grow their business.
Author: Vladimir Kuchkanov, Pricing Solution Architect at Competera is a top rated domain expert in business analytics, pricing/ revenue/ sales growth and media management with a successful track record in some of the world's most admired FMCG companies.