Discount Elasticity — Promotions Response Modelling

Promotions Discount elasticity

Exhibit 35.11   Discount elasticity — an illustration.

Price elasticity (discount elasticity) is a measure of the responsiveness of sales quantity demanded to a (temporary) change in price, and it is determined by the following equation:

$$ \epsilon = \frac{\delta Q}{\delta P} × \frac{P}{Q}, $$

If ε > 1, demand is elastic. Any dip in price due to a price-off promotion is offset by a disproportionately large increase in sales volume. On the other hand, if ε < 1, demand is inelastic, a dip in price will result in a decrease in revenue.

Discount elasticity is essentially the price elasticity due to a temporary price reduction. Since consumers are much more sensitive to a discounted price promotion than a regular price reduction, the discount elasticity is a lot greater than the price elasticity.

Exhibit 35.11 provides an illustration of discount elasticity. The SKUs (items) in this chart, with discount elasticity of less than 1 (such as B, M and P) will experience a decline in revenue (sales value) when promoted. Items such as these with low elasticity tend to possess high brand equity and can command a price premium. Discounting these products will result in the loss of revenue and profit.

Price promotions should be considered in the context of discount elasticities as well as the SKU’s profit margin. Low margin products need to be highly elastic to retain profitability when promoted.

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