Sterling Terrell

[This is part of the series: 7 Tips To Make You Better At Business]

Specifically: The sensitivity of prices matter.

The sensitivity of prices matter because if it is possible to raise the price of a particular item (or all items), for example:  by 10 percent, while the quantity sold of that same item decreases by, for example, only 5 percent – profits are not being maximized.

Economists call the sensitivity of prices the “elasticity” of prices.

Simply put, products that are more sensitive to changes in prices are said to be more “elastic.”

And products that are less sensitive to changes in prices are said to be more “inelastic.”

For example, changes in the price of luxury purses or movie tickets may be more elastic, while the price of gasoline and milk may be more inelastic.

The logic goes that if you don’t have to purchase something – you will be more sensitive to its price.

If the price of movie tickets increases – I might decide to rent more movies instead of going to the theater.  But if the price of milk increases – well, my toddler still needs milk.

I once said that in general:

“If one can increase prices by 10% with quantity sold decreasing by less than 10%, prices will be increased by 10%.”

On this, I was told that I was wrong.

I was.

In reality, I should have been more specific.

I should have said:

“If one can increase prices by 10% with quantity sold decreasing by (a whole percent) less than 10%, prices will be increased by 10%.”

Look at an example.

1000 units sold at $1 per unit = $1,000 in Revenue

If prices increase by 10 percent and quantity sold decreases by 9 percent, the result is:

910 units sold at $1.10 per unit = $1,001 in Revenue

The price increase – and the corresponding decrease in sales – increased revenue!

But what about a price increase of 10 percent and quantity sold decreases of, 9.1 percent?

909 units sold at $1.10 per unit = $999.90 in Revenue

In this case, increasing prices 10 percent with a resulting 9.1 percent decrease in quantity sold – decreased total revenue.

I think about this issue every Sunday morning as I stand in line at my local doughnut shop waiting to order.

The doughnut shop I frequent on Sunday’s has quite a bit of competition.  But as the line flows out the door and I look over their price board, I always think:

“If they increased the price of a glazed doughnut from 65 cents to 75 cents, would a number of donuts they sold actually change by very much?”

The answer is hard to know for sure without trying.

So give it a try.  Play with it.

If you have 100 products, increase the price of 4 or 5 of them by 5 or 10 percent and see how your quantity sold changes as a result.

You may find some items are more or less sensitive than others.  It might be worth it to increase some prices, but it may not be worth it for others.

Remember that the opposite is also true.

In our previous example, what if prices decrease by 10 percent and quantity sold increases by 20 percent, the result is:

1200 units sold at $.90 per unit = $1,080 in Revenue

Let common sense and a little back of the envelope math be your guide.

Remember that in business – prices matter.

And if you are not maximizing revenue, you are not maximizing profit.