Besides using above mentioned methodologies to understand price-demand equation, it is important for marketers to understand what factors affect price sensitivity.
i.Factors Affecting Price Sensitivity
According to Tom Nagle, Author of "The Strategy and Tactics of Pricing", there could be nine product related factors that could affect price sensitivity:
a. Substitution Effect: A product having lesser substitutes is likely to be less price sensitive
b. Inventory Effect: A product that can not be stored is likely to be less price sensitive
c. Shared-Cost Effect: A product for which part of the cost is borne by a third party is likely to be less price sensitive
d. Difficulty Comparison Effect: A product which is not easy to compare is likely to be less price sensitive. For example, it is difficult to compare Naturals ice creams with other ice creams and hence buyers of Naturals are likely to be less price sensitive
e. Unique Value Effect: Buyers place high value on unique attributes of the product and are willing to pay higher price. For example, consumers place high value on the shelf life and quality of tetra pack milk and are willing to pay much higher price for that compared to other type of packed milk.
f. Price-Quality Effect: Buyers are less price sensitive to products where consequence of poor quality are very high i.e., products which are assumed to having high quality and hence exclusivity. This phenomenon is often observed in perfumes, high end watches, pens, and cars.
g. The End-Benefit Effect: Products which are likely to be price sensitive are likely to have price sensitive buyers also. For example, loose milk sold on local dairies is very price sensitive and its price fluctuates almost on a daily basis.Buyers of such milk are also likely to be more prices sensitive that say buyers of packed milk whose price is less fluctuating.
h. The Sunk Investment Effect: Products which are used along with assets in which investment has already been made are likely to be less price sensitive.For example, a retailer who has bought a refrigerator to store dairy products is likely to be less price sensitive for purchase of small spare parts of refrigeration unit.
i.Total-Expenditure Effect: Buyers are likely to be less price sensitive for products whose expenditure as a percentage of total income of the buyer is very low.
ii. Preparing Demand Schedule
According to Kotler, each price will lead to a different level of demand and therefore have a different impact on a company's marketing objectives. In the normal case, demand and price are inversely related: the higher the price, the lower the demand. However if price is charged very high, the level of demand falls.
Preparing demand schedule involves estimating demand curve and demand elasticity.
a. Estimating Demand Curve
In most of the products, a change in price would have impact on the demand. The relation between alternative prices and resulting demand is called demand curve.
For some products a cut in prices would result in increase in demand while for some an increase in price may increase demand. Products having snob value may see an increase in demand with increase in price. A premium car maker may sell more units if price is increased as it may add to the image of exclusivity. However,in such cases also a steep increase in price may result in fall in demand.
Establishing a demand curve requires in depth understanding of product and likely response of consumers at different price points. A company can use methodology to draw demand curve. Some of the suggested methods are as follows:
i.Factors Affecting Price Sensitivity
According to Tom Nagle, Author of "The Strategy and Tactics of Pricing", there could be nine product related factors that could affect price sensitivity:
a. Substitution Effect: A product having lesser substitutes is likely to be less price sensitive
b. Inventory Effect: A product that can not be stored is likely to be less price sensitive
c. Shared-Cost Effect: A product for which part of the cost is borne by a third party is likely to be less price sensitive
d. Difficulty Comparison Effect: A product which is not easy to compare is likely to be less price sensitive. For example, it is difficult to compare Naturals ice creams with other ice creams and hence buyers of Naturals are likely to be less price sensitive
e. Unique Value Effect: Buyers place high value on unique attributes of the product and are willing to pay higher price. For example, consumers place high value on the shelf life and quality of tetra pack milk and are willing to pay much higher price for that compared to other type of packed milk.
f. Price-Quality Effect: Buyers are less price sensitive to products where consequence of poor quality are very high i.e., products which are assumed to having high quality and hence exclusivity. This phenomenon is often observed in perfumes, high end watches, pens, and cars.
g. The End-Benefit Effect: Products which are likely to be price sensitive are likely to have price sensitive buyers also. For example, loose milk sold on local dairies is very price sensitive and its price fluctuates almost on a daily basis.Buyers of such milk are also likely to be more prices sensitive that say buyers of packed milk whose price is less fluctuating.
h. The Sunk Investment Effect: Products which are used along with assets in which investment has already been made are likely to be less price sensitive.For example, a retailer who has bought a refrigerator to store dairy products is likely to be less price sensitive for purchase of small spare parts of refrigeration unit.
i.Total-Expenditure Effect: Buyers are likely to be less price sensitive for products whose expenditure as a percentage of total income of the buyer is very low.
ii. Preparing Demand Schedule
According to Kotler, each price will lead to a different level of demand and therefore have a different impact on a company's marketing objectives. In the normal case, demand and price are inversely related: the higher the price, the lower the demand. However if price is charged very high, the level of demand falls.
Preparing demand schedule involves estimating demand curve and demand elasticity.
a. Estimating Demand Curve
In most of the products, a change in price would have impact on the demand. The relation between alternative prices and resulting demand is called demand curve.
For some products a cut in prices would result in increase in demand while for some an increase in price may increase demand. Products having snob value may see an increase in demand with increase in price. A premium car maker may sell more units if price is increased as it may add to the image of exclusivity. However,in such cases also a steep increase in price may result in fall in demand.
Establishing a demand curve requires in depth understanding of product and likely response of consumers at different price points. A company can use methodology to draw demand curve. Some of the suggested methods are as follows:
- Use past data on change in price and resulting change in product shipment and draw a correlation. Effect of other factors like competitors' response, change in other marketing mix elements has to be reduced from price-demand equation.
- Use consumer survey to ask them how many units of product they would buy at alternative price points. Using this approach requires an expert agency which can carefully design the questionnaire, method of administering it, and use of analysis tool to analyze the data.
- Change price in different geographies and measure the product off take in these markets.
b. Demand Elasticity
Demand elasticity is defined as responsiveness of demand for small change in price. In case of a small change in price, there is hardly any change in demand and said to be inelastic demand and if price changes sharply, the demand is said to be elastic. For example, in a particular geography, current price of packed milk is Rs 10 per litre and it is increased to Rs 10.5 per litre and there is hardly any drop in demand, the demand of packed milk in that area would be called inelastic.
The elasticity of demand depends on few factors:
Demand elasticity is defined as responsiveness of demand for small change in price. In case of a small change in price, there is hardly any change in demand and said to be inelastic demand and if price changes sharply, the demand is said to be elastic. For example, in a particular geography, current price of packed milk is Rs 10 per litre and it is increased to Rs 10.5 per litre and there is hardly any drop in demand, the demand of packed milk in that area would be called inelastic.
The elasticity of demand depends on few factors:
- Long run Vs short run: Generally demand is inelastic in short run and elastic in long run. In short run buyers do not notice the change in price and also it is difficult for them to find a good substitute
- Magnitude of price change: Demand is in elastic for small change in price and very elastic for a large change in price
- Direction of price change: For certain products, an increase in price may result in increase in demand. However, a very large increase may again result in decrease in demand.
The higher the demand elasticity of a particular market, the more difficult it is to price a product. In these types of markets any change in pricing would lead to huge flux. The lower the demand elasticity the easier to price a product and make price changes as and when necessary.
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