These posts are a collection of notes and summaries from the book “How Brands Grow” by professor Byron Sharp. This work is a must read for any marketer. My personal goal through this series of posts is to get a deeper understanding of the book and its lessons.
You can buy the book here.
Selling T-shirts – A basic example to introduce price elasticity
Let’s imagine that we sell t-shirts for 10€ each, usually we sell 100 t-shirts per day.
One day we decide to promote a 1 € discount on these t-shirts and as a reaction we saw sales increasing to 120 t-shirts per day, a 20% increase.
This 10% discount generated a 20% increase, in economics the ratio between the sales increase and price reduction is called elasticity and in that case is -2.
If the demand for a product changes significantly when the price changes, the higher the elasticity, lower changes in the demand when the price changes, the lower the elasticity.
Some goods like utilities (Gas, Water, Transportation) are quite inelastic, and this is the reason why they can be taxed more by the government, because it will not affect their demand much.
Fast Moving Consumer Goods (FMCG) Price Elasticity
But now let’s return to the elasticity concept under the lens of marketing and price promotions.
What is interesting about elasticities is that several studies found a certain level of stability related to price promotions and factors that can affect it.
In their paper “Understanding the Characteristics of Price Elasticities for Frequently Purchased Packaged Goods” Danaher and Brodie in 2000 studied several brand and category factors that affected brand price elasticities.
The research was based on 26 categories and 110 brands using IRI and Nielsen weekly scanner data.
Based on that research, there are two key aspects that need to be highlighted:
- Average elasticity is around -2.29
- Three factors influenced mainly elasticity:
- competitive intensity in the category
- whether or not the product is storable
- the brand market share
- Overpromotions (high frequency price discounts through the year) reduce the sales uplift over time
Byron Sharp and Ehrenberg also conducted a wide research on price elasticities and they found an average price elasticity of -2.6.
5 factors that affect elasticity
The chapter highlights 5 factors that affect elasticity:
- The “reference price”, people who usually buy product B will buy product A if under promotion is cheaper than product B.
- Price communication. We saw previously how consumers don’t properly remember prices, an effective communication of the price discount through Point of Sales and in-store advertising can increase sales even up to 400% (Woodside & Waddle, 1975). I can guarantee based on my project with Collidascope with some FMCG clients that when a price discount is supported by good media communication the effects are highly amplified.
- Brand’s market share. Brands with smaller market share tend to have bigger gains from price promotion while big brands have smaller price elasticities
- Price Increase. Elasticity is not symmetrical and the studies conducted by Scriven & Ehremberg in 2004 show this behaviour. Price increase generates a bigger effect compared with price discount. One of the studies that support this is the “Prospect Theory” defined by Kahneman and Tversky in 1979. Prospect theory states that people value gains and losses differently, placing more weight on perceived gains versus perceived losses. This was also reported in one book that I read “Thinking fast and slow” from Kahneman and that I strongly suggest.
- Brand’s normal price compared with the competitor’s price. If the price is similar, then the elasticity will be greater.
Price promotion Profitability
Another key aspect of price promotions is their profitability.
Just to give a quick example if we sell a pizza with a contribution margin of 30%.
Immagine a 5€ Margherita.
Then we decide to apply a price cut of 15%, doing so we reduced our margins by 50%.
In the chapter, 3 factors are highlighted by the author as fundamental for short-term profitability of price promotions:
- Margin under normal conditions (no promotion going on)
- Price cut amount
- Brand price elasticity
Based on that it is possible to identify the various “break-even” scenarios.
Basically how much extra volume should be generated to break even from the price reduction.
Short term profitability is also influenced by other two factors:
- Stockpiling effects or consumers anticipated purchases
- Competitors reactions
The author concludes the chapter in a very clear way, the manufacturer should always prefer to advertise the brand instead of conducting deep price cuts.
The manufacturer should always prefer to advertise the brand instead of conducting deep price cuts
I found this chapter very interesting, maybe it is my analytical side that is more comfortable on this topic or simply I was not aware of most of the aspects described by the author on price discounts. Finding a reference to another book that I read was also important, because it indirectly confirmed the validity of the reading.
I can’t wait for the last chapter! Hope you enjoyed this journey.
Woodside, A & Waddle, G 1975, ‘Sales effects of in-store advertising’,
