Many of us took an Economics course in school. There we learned about price elasticities. In this and another blog, I revisit our college days, reconsider the idea of price elasticity and examine why it matters today more than ever to marketers.
Today marketers are required to use their limited budgets more effectively. That means, for example, that businesses have to be smarter about how to allocate their limited incentive budgets. One way to improve the effectiveness of direct marketing campaign revenues is through the strategic use of price elasticity.
Before we look at how to use elasticities to optimize campaign results, I provide a refresher on the definition of an elasticity.
Definition of Price Elasticity
A price elasticity represents consumers’ “sensitivity to promotions”. The elasticity measures how consumers respond to a change in price, and ultimately helps to determine their sensitivity. Usually the consumers’ response is measured using the response rate to a specific direct response program.
In mathematical terms, a price elasticity is the percent change in a program response rate divided by the change in the price of the service or product being promoted. From a marketing standpoint, price changes are communicated variously as percent discounts, cash rebates, or temporary price reductions.
Marketers often report program lift as the percent change in the response rate relative to some baseline rate. In this context, a price elasticity is simply the program lift rate divided by the percent change in price.
Price Elasticities In Practice
Based on the simple economics of demand, companies usually test price reductions rather than price increases. This leads to a planned loss in per unit revenues, which is paid for through the program incentive budget. In a later article, I will talk about how knowledge of the price elasticities of the customer segments targeted in a direct response program can be used to allocate a company’s incentive budget.
Because knowledge of price elasticities can be used to allocate incentives, it is often helpful to define customer segments on the elasticities. There are several ways to define customer segments based on the price elasticity. These range from simple post-campaign profiling of a mail population to sophisticated latent class regression modeling.