RA Quick Insights: Break-Even Price Elasticities - a Simple, but Powerful Sanity Check

Have you ever offered a deep Price Discount in December in hopes of accelerating 4Q and YE target achievement, only to drive Unit Sales but suffer huge Gross Profit losses?

You proposed a -40% Price Investment in one of your anchor products, along with an accompanying sales blitz and marketing materials.

The -40% YE promotion is not unheard of, and you've seen End-of-Quarter and End-of-Year Discounts north of -50% occasionally - primarily to meet Competitive price points.

After all, your Gross Profit % is still at a healthy ~ 20% after the deep discount (down from a GP% of 50%).

You meet with your finance and pricing counterparts, who begrudgingly support the December price promotion.

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Break-Even Price Elasticity (B/E P/E) is a simple but often underutilized concept outside the Consumer Products industry. There are two versions of B/E P/E that the Pricing and Commercial teams anchor to:

1. Revenue Break-Even Price Elasticity: what would the product's Price Elasticity have to be to remain Revenue-neutral with my Price Investment? (in other words, generate the same Revenue $ at the new Price compared to the old Price).

2. Gross Profit Break-Even Elasticity: what would Price Elasticity have to be to remain Gross Profit neutral? I.e., generate the same Gross Profit $ at the new Price as we did at the old Price.

It's a powerful concept because it serves as a quick sanity check of our Pricing Decisions. It can quickly tell us whether our proposed Price Investment is reasonable or if it's wildly aggressive and has a substantial adverse impact on our Operating Profit.

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Take a look at our fictional, -40% Price Investment example below:

• To break even on Revenue $, our Price Elasticity would have to be -1.7 or higher (i.e. “more elastic”). If our historical Price Elasticities have ranged from -4 to -0.5 in our industry, this number seems reasonable, and we can feel comfortable making this price investment.

• To break even on Gross Profit $, our Price Elasticity would have to be -10 or higher. In contrast to our Revenue-neutral P/E number, this one seems highly improbable, especially if our max Elasticity has been -4.

Stated differently, to make the same Gross Profit $ during our December promotion as we would under the current Price, our Units would have to increase by 10% for every 1% Price Investment (-10 P/E x -40% Price Investment = 400% Unit Change to break-even on GP$).

Break-Even Price Elasticity Formulas

To express these two necessary Break-Even calculations mathematically:

Revenue Break-Even Price Elasticity = -(Current Price / New Price)

Gross Profit $ Break-Even Price Elasticity = -1 / (Current GP% + Price Change %)

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If you are a Pricing, Finance, or Sales Ops/Analytics practitioner, please add the B/E Price Elasticity sanity check to your Price Investment evaluation toolkit. It's a simple concept that can reaffirm a pricing decision or prevent you from doing something damaging to your Operating Profits.