Get real about the price-elasticity of demand

Most readers probably recognise this “economics-101” standard price-elasticity curve.

Unfortunately, it only gets anywhere near realistic in the very special case of anonymous commodity markets, so is not much use for assessing practical pricing choices.

Real-world customer behaviours

For real-world markets, where we sell to known customers, we need something that deals with the customers behaviours we want.
to become a customer (start buying from us)
to continue being a customer (not stop buying from us)
to buy more from us (higher purchase rate)

All 3 behaviours respond to price in a highly non-linear manner. Here are illustrative patterns (for any given product/service quality and marketing effort) …

At low prices, the customer win-rate is very high, limited by our marketing reach. The customer purchase rate is very high, limited by customers’ needs (only so much breakfast cereal I can eat, however low the price!). And the customer loss rate is very low – why stop buying a cheap product that’s OK?

As price rises, it approaches levels at which all 3 rates moderate (not necessarily the same threshold for all behaviours) until at high prices the customer win-rate and purchase-rate tned to zero, and customer loss-rates tend to 100%/period (everyone stops buying from us).

Two illustrative price-change scenarios

Here is what happens (blue scenario) to a product’s customers, sales and revenue if its price is steadily increased over 24 months. (In the model itself, the number of customers lost falls back towards zero at high prices, simply because we run out of customers to lose!)

In the green scenario, the price rise is capped at $0.9/unit, so the customer win-rate stops falling, the loss-rate stops rising (but still exceeds the win-rate), and the purchase rate stabilises.

Note that with no price impact on customer gains and losses, the model would be close to the economists’ ideal, though with a more realistic, non-linear curve shape.

Explore the model at sdl.re/priceelasticity

(This model structure, built in the user-friendly Silico online modeling app, can be adapted and built in to your own digital-twin business models).

Long-run price elasticity of demand

Here’s the impact of a simpler step-change in price, from $0.7 to $0.9/unit.

Note that:

  • Sales continue to change at any fixed price except one, because otherwise, customer win-and loss-rates differ (so there is only one fixed point on that economists’ curve).
  • … so short-run price-elasticity depends on when the price change happens.

Towards the end of the period when price is $0.9/unit, the model is capturing the time-path towards long-run price elasticity.

Economists’ discussion of long-run price elasticity seems to focus almost entirely on the time taken to change supply-capacity. At least as important in practice are demand-side impacts, such as changing customer numbers (as in this case), or demand-capacity, as when drivers change to more efficient vehicles when fuel prices change.

Naturally, there is much more to say about the impact of price on demand, not least [a] how it interacts with the multi-faceted customer appeal of the product/service and [b] how interactions with competitors’ prices play out.


See our range of short courses that explain how dynamic business models contribute to a range of management issues and challenges, at sdcourses.com/mini-courses/

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