Imagine, the weekend is upon you and you see some delicious looking strawberries at the grocery store. They are plump, ripe, fresh and there is absolutely no bruising. Three kilograms at an unbeatable price. Wouldn’t a nice, fresh strawberry cake, with maybe even some cream, be a great idea for the weekend? No sooner said than done. You buy strawberries, flan cake and cream – even if they are not on your list.
This is a very good example to explain the concept of cross price elasticity. The Gabler Wirtschaftslexikon [Dictionary of Economics] defines it as “A measure of the percentage sales modification of a product given the price change of another product.” In other words, it indicates how the price change of one product (strawberries) can affect the sale of another product (cream and/or flan cake).
In our example, cream and sponge cake are complementary products, that are associated with the strawberries. In the case of complementary goods, the cross price elasticity of demand is negative – in other words, as the price of the strawberries goes down, you sell more cream and flan cake.
In the case of substitution products the exact opposite is true. Substitution goods are “consumer or investment goods that can act as functional substitutes for one another” (Gabler Wirtschaftslexikon). Take butter and margarine, for example, the prime example for substitution relationships. If you lower the price of butter you will sell less margarine. Or, raise the price of butter and sell more margarine. The cross price elasticity of demand is positive.
Dynamic price optimization with complementary products
Intelligent pricing solutions incorporate both effects into price optimization. In the case of the strawberries it is important to check whether or not you have enough cream and sponge cake in stock to cover the predicted sale of the products given a certain price change. Or take asparagus for example. If you are offering reasonably priced asparagus at the grocery store you will often also sell the complementary products hollandaise sauce and ham. Using intelligent pricing helps you avoid running out of stock while maximizing your earnings. For fresh produce such as strawberries, inventory optimization is also of interest when it comes to pricing.
Dynamic price optimization with substitution products
Substitution relationships are created whenever the consumer can choose from similar products that serve the same purpose. Your customers find these alternative products not only your competitors’ product range but also in your own product range. The first step is to identify substitution products in your own product range and then incorporate these products into the dynamic price optimization. One application here is upselling, in which you offer your customers product alternatives of higher value. Or, you use intelligent pricing to promote the sale of a certain product in your range that has a strong margin. The pricing solution sets an attractive price for this product and adapts the prices of the substitution products accordingly.
Dynamic pricing in retail
In our video, Kathleen Proeger uses our strawberry example to show you how intelligent dynamic pricing and the prudsys Realtime Decisioning Engine (prudsys RDE for short) can be implemented in the store to adapt your prices – individually, for a few or for all products – with the click of a button thanks to Electronic Shelf Labels (ESL).