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What is Price Elasticity of Demand?

It's the sensitivity of demand to changes in prices. When prices go down, demand goes up, and vice versa.

Now, let's look at the reasons for Price Elasticity of Demand.

The primary factor is the necessity of the product or its cost. A change in price doesn't always result in the same proportionate change in demand. For example, a small change in the price of a washing machine may significantly affect its demand, while a large change in the price of sugar may not affect its demand much. Elasticity of demand varies for different goods based on your product and your customers.

Nature of the product:

  • Necessities like food grains, vegetables, and medicines are inelastic.

  • Comfort items like fans and refrigerators can be postponed, so they are elastic.

  • More comfort items like air conditioners and washing machines are even more elastic.

  • High-end luxury products like luxury cars and high-end watches are highly elastic.

Availability of substitutes:

  • Demand for a product with many substitutes is more elastic. Even a small price increase can make consumers switch to alternatives. For example, if the price of Coke goes up, people may buy Pepsi

Income level:

  • Demand elasticity is generally lower for higher-income groups compared to lower-income groups. Demand for lower-income groups is highly elastic.

Price level:

  • Costly goods have high demand elasticity because their demand is very sensitive to price changes. For example, if the price of laptops increases, sales decrease.

Postponement of consumption:

  • Goods like washing machines, where demand is not urgent, have highly elastic demand. If the price goes up, people may postpone their purchase.

Number of users:

  • If a product has multiple users, its demand is elastic. For instance, if the price of electricity drops, demand goes up.

Share of total expenditure:

  • The portion of a consumer's income spent on a particular product influences the elasticity of demand. Low-value items are more elastic (e.g., salt and needles), while high-value items are more inelastic (e.g., computers and dishwashers).

Time period:

  • Demand is generally inelastic in the short term, depending on whether the time period is a month, a year, or a day.

Habit:

  • Products that have become habits are less elastic because they are considered necessities. For example, tea.

To understand your product category's necessity, the segment you serve, and pricing potential, analyze your product, your target customers, and their purchasing power. For example, if you serve a tier II automotive company, consider the affordability of your end customers.

Until now, pricing and margins have had enough leeway. Going forward, organizations aiming to stay in business must reevaluate their financials. If your operations aren't streamlined, you may not achieve the same margins, even if you manage to maintain your top line.

Lower-priced segments attract more demand, but increased competition in these crowded markets leads to reduced market share and lower margins. Cartel agreements may not work as well because alternatives become widely available.

The simple formula for the selling price is: Raw material cost + Production cost + Profit. Now, selling prices are determined by the market, and you don't have much control over raw material costs. That leaves you with two aspects to manage: operational costs and profits. Profit is the goal of your business, so you end up optimizing production costs. This is the key to success for the next decade for a successful organization.

Reducing waste, minimizing buffers, and improving production efficiency are crucial to winning in this scenario. You can't afford to waste resources, given the tight margins. A skilled and trained workforce is essential for efficient production, and you may not find the right skills with temporary labor or frequent employee turnover. In the future, you may find labor, but trained labor for your type of production may be scarce. So, retain your workforce. Suppliers must be taken care of to ensure a timely supply of the right products.

Efficient production's most critical aspect is scientific production planning. No resource, whether it's materials, capacity, or labor, can be wasted. Therefore, planning must be done with the utmost care to ensure the right product reaches the right place at the right time. "Hit and miss" strategies are no longer an option. A systematic production plan that optimizes resources is the key to success. Meeting customer demands on time without accumulating excess inventory is crucial for satisfying customers and staying profitable.

The next step is executing the production plan with minimal deviations to maintain profitability. Don't think of this as a short break; it's bringing about many irreversible changes. Many organizations that refused to adapt have become history. Be positive and change for a better tomorrow. If you change, you can survive.

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