Market Elasticity: The Red Herring of B2B Pricing

Posted by Reed Holden on Apr 7, 2017 9:11:37 AM
Reed Holden

It was a simple conversation with 40 pricing professionals, part of a "current events" topic in pricing session. Towards the end, one of the pricing directors for a line of machines raised her hand and said, "I'm about to have a special price promotion my product line of machines. What do you think?"

Anyone in business just knows that dropping price is going to sell more of just about anything. Right? For those of us lucky enough to have training in economics have that fact drilled into our heads. It's an important fact of business, one that everyone relies on. Unfortunately, here is an example of where it goes wrong.

For my response I asked her if, due to the drop in price, any more factories were going to get built or expanded. She said: "No, but we also have replacement business." I asked her if any machines would be replaced due to a drop in price. She said, "No." My response: "Then why do you want to drop your price?" We got to the heart of the issue with her response: "Because my boss wants me to."

She went ahead and dropped her price to save her job. The discounts she gave didn't yield any additional sales, all they did was cause a dramatic drop in profits.

Here's my point: most of the concepts around market's responsiveness to drops in price are artifacts of consumer markets. Drop the price of potato chips, people buy more. That's the nature of consumer consumption is elastic. Exactly the opposite is often true in B2B where demand is derived from some downstream activity. In this case, the demand was driven by something the pricing director had no immediate control over. Elasticity is not the right measure in derived demand. So the price discount was a Red Herring - a false indication of benefit to the firm. I am surprised at the number of people who still use discounts when price will not impact volume.

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