Business Economics

How Elastic is Your Business?

Elasticity measures the change in demand of your product in response to the change in the price of your product. As competition increases in a given market, understanding how elastic your firm and its products are can help you better understand how to improve your competitive advantage and keep your customers loyal to your product.

Elasticity is an economics term that represents how demand for a particular product or service changes given a price change.

Your product would have an elasticity of -5 if for every 1% price increase; demand for your product decreased 5%. The smaller your elasticity, the less demand changes with respect to your price changes. Healthcare is a great example of an inelastic service where demand does not change with regards to price increases because patients have no alternative. Compare this to a price increase in Tropicana orange juice where you may be inclined to buy a different, less expensive brand of orange juice next time you go to the grocery store.

Factors that affect the elasticity of your product or service are the number and availability of substitutes for that good, the number of competitors, and how strong the demand or want for your particular good is. There are some substitutes for orange juice, such as grapefruit juice, lemonade, and maybe even coffee, but there are several brands that make orange juice making it a relatively competitive and elastic product. Healthcare on the other hand has no substitutes and has very little competition within it causing healthcare to be a very inelastic good since consumers are very unlikely to lower their demand in healthcare due to price increases.

Understanding the elasticity of your goods is a critical measure for your business that few too entrepreneurs factor into their overall business strategy. As an entrepreneur, you are creating something new, which has no brand recognition or presence in the market so it is important to understand how you can lower the elasticity of your product. Strong brands such as Apple, North Face, even your favorite cereal have strong brand recognition and strong customer loyalty making them less price sensitive to those goods than to a good that they are not familiar with.

Inelastic goods and services always yield the greatest profit margins. Exxon Mobil, quarter after quarter, reports record-breaking profits for any company worldwide. The simple reason for Exxon Mobil's huge profits is the inelastic demand of their products. Oil is a product that no matter what the price, consumers will be willing to pay for it. Having an inelastic good is a great competitive advantage, but providing an inelastic good does not necessarily mean that you have no competitive advantage. The way you build competitive advantage around your product is different depending on the elasticity of your good.

When looking at your business and your products or services, try to determine how elastic or inelastic your products and services are. Are you that doctor, lawyer, or accountant that can charge a premium because your services are inelastic, or are you providing a generic brand of orange juice that is very elastic and has no brand recognition with your customers? Knowing where you fit along the elasticity line and how you compare to your competitors will help you assess what business strategy you should employ to help you compete more effectively.

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