HIGH DEFINITION ELASTICITY: How price elasticity of demand changes over time.

Date: August 5, 2020

Consumer packaged goods (CPG) and Retail companies are on the continuous search for new opportunities for growth. Among them, two of the most important opportunities are pricing and trade promotion strategies, which try to find the optimal prices for every promotional cycle. Anyone who has worked with this knows that this is not an easy task. In an environment of unprecedented uncertainty with rapidly changing situations, price elasticity is the main indicator to correctly choose the price that optimizes the volume, sales, or margin, and many decision-making processes in CPG and Retail companies strongly depend on it.

However, this key indicator has been calculated in the same way for more than two centuries, providing an average of the price sensitivity of a product for long periods of time. As a result, this low definition price elasticity is not answering the following vital questions: What is the best moment to promote a product? Which is the optimum duration for a promotional action? Which is the best product to be promoted next week?

With the aim of unraveling daily changes in price elasticity of demand Wise Athena, in collaboration with CUNEF University from Madrid, has recently developed a new innovative computational method based on dynamic linear models, Kalmar filter in combination with a new approach firstly presented in this research paper

It has been proven that only using this high definition elasticity method, can daily changes in elasticity be observed. Furthermore, the method has been tested and compared and it has been shown that the new method explores solutions that provide small errors and achieves singular and more consistent results with the observed input data.

As can be seen in the attached image, price elasticity of demand fluctuations over time is really important for correctly modeling the demand of a product.

Based on our research CPG and Retail companies are wasting money on areas of ineffective trade promotion spent. Daily deviations in price elasticity of demand are essential and they can be unraveled only using the new high definition elasticity.

These fluctuations open the possibility for more effective everyday and promotional pricing strategies that could exploit these small changes in price sensitivity.

In Conclusion

An accurate estimation of future demand is crucial for the survival of any business. An overestimation of the demand can increase the associated costs like storage and inventory management. An underestimation, on the other hand, can mean loss of sales opportunities and existing customers.

The widely used Dynamic Linear Models are extremely sensitive to input variances. In this regard, the new approach of MinPE can deliver the most accurate input variances. It is a valuable metric to evaluate product sensitivity against these changes making it a perfect strategy in pricing and trade promotions for businesses all over the world.

So, go ahead and download the research paper here to experience and implement its benefits firsthand.

You can find the full version of the research paper in the following link.

Written By Vicente S.
Sr. Data Scientist at Wise Athena. Generating strategies and profitable decisions based on data and predictions.

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