The Marketing Book 5th Edition

Pricing 351

transaction size, timing of the purchase and
distribution channel (to name but a few). (Good
discussions of price customization can be found
in Simon, 1992; Nagle and Holden, 1995; and
Dolan and Simon, 1996.) However, irrespective
of whether price customization or a ‘one price
policy’ is to be pursued by the firm (e.g. see
Hochet al., 1994), the decision maker requires
knowledge regarding how customers are likely
to respond to prices of different magnitudes;
this is the issue of price sensitivity and is
discussed in the next section.

Understanding price sensitivity

The conventional analysis of price sensitivity
stems from economic theory and its analysis of
price elasticity(). This shows the percentage
change in quantity demanded (i.e. sales vol-
ume) as a result of a percentage change in
price:

= percentage change in sales volume

÷ percentage change in price.

Thus, a price elasticity of –2.0 implies that
a 10 per cent increasein price would result in a
volumedecreaseof 20 per cent (–2.0×10 per
cent). If = 0, then demand is said to be perfectly
inelastic, as sales volume is completely unre-
sponsive to price changes. If =–, demand is
said to be perfectly elastic, as sales volume goes

up from zero to infinity as a result of a price

change (a very rare case). If  = –1, then

demand is said to have unitary elasticity, i.e. a

given percentage change in price is accom-

panied by exactly the same percentage change

in sales volume. If –1 < < 0, then demand is

said to be inelastic, as the proportionate change

in sales volume is smaller than the change in

price. Finally, if –<< –1, then demand is

said to be elastic, as the proportionate change in

sales volume is greater than the change in price.

Table 13.2 shows the implications of different

elasticity values in terms of their effects on sales

revenue.

While the concept of price elasticity is very

useful for thinking about the likely effects of

price changes on sales volume, a great deal of

caution is necessary when applying it. For

example, in the light of Table 13.2, one may be

tempted to rush into recommendations of the

sort: ‘if a price elasticity of less than 1 is found,

a price increase can be immediately recom-

mended, since this means that the percentage of

decrease in sales volume is smaller than the

percentage of increase in price’ (Dolan and

Simon, 1996, p. 30). However, this assumes that

(a) the firm is willing to sacrifice somesales

volume, and (b) the revenue gains are going to

be translated into profitgains. Neither of these

assumptions may be warranted because ‘the

goal may be to maintain a presence in the

market, take customers from competitors, or

use the product to help sell other products in

the line, even at a revenue loss... [or] costs

Table 13.2 Impact of price elasticity on sales revenue

Demand is Price increase Price decrease

Perfectly inelastic Revenue increases Revenue decreases

Perfectly elastic Revenue decreases Revenue increases

Unitary elasticity Revenue does not change Revenue does not change

Inelastic Revenue increases Revenue decreases

Elastic Revenue decreases Revenue increases