Inelastic Price Metric

Estimating Price-Volume

When the price for a product is inelastic, a percentage change in price results in a smaller percentage change in volume sold. For example, the medical instrumentation product above has a current selling price of $50,000. At this price the company is able to sell 1000 units per year. Their cost per unit is roughly $20,000, a 60 percent profit margin. What would happen if they changed the price, up or down?

The marketing and sales team estimated that at a price of $55,000 (a 10% price increase) they would lose 250 units sold per year. This would lower the units sold but increase sales from $50 million to $53.63 million. More importantly, this price move would increase gross profits from $30 million to $34.13 million as shown above.

Inelastic Price Metric

An important marketing metric to uncover from price-volume is the elasticity of this product. As presented in the table above, a 10 percent price increase is estimated to reduce volume sold by 2.5 percent. As shown below, price elasticity is the percentage change in volume per one percent change in price and in this example yields a price elasticity metric of –.25.

When the price elastic metric is smaller than -1.0 the price is inelastic. At the company’s current price point this means for every one percent change in price the product will experience a .25% change in volume. This could be different for a price decrease, or different for large changes in price.

What’s the Right Price Move?

When we have an inelastic price, the price move is easy. Up! A price increase, while lowering the unit volume sold, will result in higher sales and gross profit as shown in the table above. In the graphic below we provide a simple set of guidelines when a product has an Inelastic Price. Lowering price when the price is inelastic would be disastrous. A price decrease would lower sales, lower margins and lower profits. A price increase when the price is inelastic should result in higher sales, higher margins and higher gross profits.

Boundary Condition Elasticity

Because the marketing and sales team estimate of price-volume change was subjective, it is useful to understand the bandwidth for error that they can operate within and still be making the right price move. The Boundary Condition in this case is the price elasticity needed to maintain current gross profits with the recommend price change. In the table above, the Hold Profits column estimates the price elasticity boundary condition. At this level of price elasticity, the gross profits would be maintained. At any level of higher price elasticity, the gross profits would decrease. Given the difference between the estimated price elasticity of -.25 and boundary condition elasticity of -1.43, there appears to be sufficient room for error in the teams’ estimate.

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