Drivers of Price Elasticity: Market Share

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From the course by University of Virginia

Cost and Economics in Pricing Strategy

188 ratings

University of Virginia

Cost and Economics in Pricing Strategy

188 ratings

Course 1 of 4 in the Specialization Pricing Strategy Optimization

How much should you charge for your products and services? Traditionally, businesses have answered this question based on the cost to produce or provide their goods and services. This course shows you the economic factors behind pricing based on cost and the pros and cons of a cost-based pricing approach. Led by Darden faculty and Boston Consulting Group global pricing experts, the course provides the practical and research-based models and methods you need to set prices that maximize your profits. By the end of this course, you’ll be able to: --Apply knowledge of basic economics to make better pricing decisions --Recognize opportunities for price discrimination—selling the same product at different prices to different buyers—and recommend strategies to maximize sales and profits --Calculate three types of price elasticities to determine the impact of price on demand --Analyze and apply different pricing models -Cost-plus pricing -Marginal cost-plus pricing -Peak-load pricing -Index-based pricing --Evaluate the impact of channel intermediaries and customer lifetime value on pricing

From the lesson

Common Pricing Metrics: Elasticities

This week we'll dive deep into the world of demand modeling. We'll start with a brief overview of regressions--what they are, why they're useful and how to calculate them using Excel. Then you'll get a chance to use regressions as you learn about three types of elasticities--relationships between demand and price or other factors--and the drivers of these elasticities. We'll finish with a price optimization based on demand models--a truly useful method for pricing based on economic factors. By the end of this week, you'll be able to impress your colleagues and friends with your knowledge of mathematical models and how to use them to inform your pricing strategy!

Price Elasticities8:33

Cross-Price Elasticity6:53

Income Elasticity4:32

Drivers of Price Elasticity3:16

Drivers of Price Elasticity: Market Share4:22

Drivers of Price Elasticity: Competitors' Prices4:48

Calculus: Taking a Derivative3:58

Price Optimization Considering Demand8:12

Price Optimization Example4:00

Meet the Instructors

Jean Manuel Izaret
Senior Partner and Managing Director, Leader of BCG’s Global Pricing Practice
Thomas Kohler
Associate Director, Pricing
Marketing, Sales & Pricing Practice
Ronald T. Wilcox
NewMarket Corporation Professor of Business Administration & Senior Associate Dean for Degree Programs
Marketing

Step two is how big you are in the marketplace.

This will also drive your elasticity.

And what matters here is the magnitude of your size.

Know whether you're 1% or 2% or 3% higher.

Let's think through one detailed example to illustrate how that works.

Imagine for one moment that you have two competitors in the marketplace.

One with 80% share, and one with 20% share.

Small player, large player.

What happens when the smallest player lowers the price by 5%?

Some customers surely will move from the large player to the smaller player.

They are the people who switch.

Lets imagine 5% of customers will switch.

So 5% of customers switching for a 5% price delta.

You could be thinking the elasticity is the ratio

of the percentage of volume moving, versus the percentage of the price moving.

That will be 5% divided by 5%.

That will be 1.

Well actually, what matters is not the volume of the market that we'll move,

but as a proportion of each of the players.

And let's do the math here.

If you look at the 5% of the customers compared to the 80%,

that's 6% of the volume of the larger players that is moving away.

Now, the same 5% should be compared to the smaller player.

And 5 out of 20, this is 25%.

So now we need to compare that to the 5% difference in price points.

So you have to do the ratio of a 6% change in volume for 5% change in price points.

That's the ratio for the larger player, and

that gives you a elasticity of 1.2.

For the smaller player, it's 25% of the volume moving for 5% price change.

And that's an elasticity of 5.

What that means here is, in the same market, for

very comparable products, the elasticity for

the two different competitors is going to be completely different.

This is amazing.

This is quite surprising.

Many people forget that fact.

But you need to keep it in mind.

Are you a really small player in the market, or are you the established player?

The takeaways from this are quite simple, and

they explain some of the behaviors we see in the marketplace.

The larger players are the one that have lower elasticity.

Therefore they tend to price higher.

And they established what we call the reference wise points or

the pricing umbrella.

We call it the pricing umbrella because

as you could see from the numbers we calculated, the incentives for

most of the small player is usually to price slightly lower.

Sometimes a lot lower than the larger players to gain share.

Of course, that 's the beauty of the market balance.

Which is if the smaller players keep gaining market share,

the elasticity is going to go up, and you will get to a more balanced market, right?

So that is the balance between large players and small players.

But you have other circumstances where that same effect happens.

For instance, in different channels.

Imagine you sell through retail channel and you decide to start an online store.

This online store at the beginning will have a really low

volume because you're just starting it.

What you will find is that the online store will have a much higher elasticity

than the retail store.

Which is why for most of the markets, that's one of the explanation that

explains why the price points online tend to be lower than the price points offline.

If we can fast forward 20 years and

imagine the online channel is going to be as big as the retail channel,

you will then have a balance of prices in both places.

That's the equilibrium of the markets.

So, that's the explanation about why elasticity depends on

who you are in the marketplace.

You need to remember that.

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