Price-quantity relationships and price elasticity under in-store experimentation

price.Quantity Relationships attd Price Elasticity under In-Store Experimentation Sidney Bennett, The University o[ Alabama J. B. Wilkinson, University of Cali[ornia, Los Angeles

Previous pricing experimentation has focused primarily on such problems as brand-switching patterns associated with price changes and price-quantity relationships. Several studies also have touched on the nature of the demand curve itself [10, 11, pp. 74-125; 12, 18-]. Most of these studies indicate tilat consumers' reactions to price changes are highly dependent oll their psychological perception of die product and brand itself, tile competitive position of tlle brand, tlle relative price change, and tile extent to which the product's quality is associated with its price. That demand curves are smooth and negatively sloped in real buying situations is open to question. Many of tlle "demand curves" resulting from the work of Pessemier and Tull show such characteristics as positive slope, kinked configurations, and sudden backward bends. These studies suggest tilat further research designed to reveal the nature of short-run ~ price-quantity relationships under realistic conditions would lie of interest to experimentalists working in pricing research. As an extension to prior research, the purpose of tiffs exploratory study was to examine the pattern of price-quantity relationships under actual market conditions. Thus, prices of selected branded products in different product categories were systematically raised or lowered for the purpose of determining tile sales response at varying prices and tile effect of these price changes on the sales of competing brands.

Research Design A discount store selling tile products selected for experimentation served as tile experimental laboratory." The particular discount store selected for the study was a member of a regional chain and

Volume 2, Number 1

January, 1974

28

Journal o~ Business Research

had about 34,000 sq. ft. of selling space. Average sales volume of the store for tlle period of the experiment was $20,000 per week. The researchers were given complete freedom in setting the conditions under which the test was to take place. All experimental conditions including selection of products, the degree of price change, allocation of shelf space, and advertising were controlled by the research team. Price reductions below their cost were permitted by the discounter for several of the test products. Prices of the selected items were progressively changed each week for six weeks by a constant percentage and current prices were advertised in the local newspaper. During this six-week period, other competing and complementary products were not advertised or changed in price. 3 The allotted shelf space for the test brands and competing brands renmined unchanged and no new competing products or package sizes were introduced during the experimental period. Announcements of the new prices appeared each Thursday afternoon in the regular newspaper advertisement with one-fourth of the page being devoted to the five brands under study. Tile only changes permitted in this part of the advertisement each week were in the prices of the five brands. Three brands first were offered at their highest price which was successively reduced, while the remaining two brands were initially priced at their lowest price of the experiment. Inventory was taken for the test products and their prices changed each Thursday morning. 4 Sales data were collected for the time period beginning on Thursday morning and ending the following Wednesday night. Brand sales figures were adjusted by multiplying them by the weekly index of sales activity. The weekly index of sales activity was computed as the ratio of the average weekly sales activity for the six weeks of the experiment to the actual sales for the week in question. The index of sales activity was used to lessen the effect of random influences on sales volume. The five test products selected for price changes are listed in column one of Table 1. Every effort was made to select products in product categories characterized by little physical or use differentiation. Further criteria were high replacement rates, ease of identification in advertisements, and popular appeal. 5 The constant percentages by which the prices of these products were changed and the direction of the changes are listed in column two of Table 1. The weekly sales of all brands which were close competitors to the products undergoing price changes also were monitored for the purpose of determining a n y sales effects from the price changes. These competing brands are listed in column three of Table 1. Adjusted weekly sales for test products and each competing brand are shown in Table 2.

29

Price-Quantity Relationships Table 1 : Procedural Summary Percentage Change

Test Products

Competing Products

Quaker State Motor Oil - qt. can

15

Pennzoil, Havoline

Gulf,

M&M Candy - 8 oz. pkg.

15

Hersheyettes

Bayer Aspirin - 50, 100, 200, 300 tab. pkg.

i0

St. Joseph,

Sylvania Flashcubes 3/pkg.

i0

Westinghouse

10

Formula 409

Norwich

-

Janitor in Drum Cleaner 1 and 2 qt. size

Table 2: Adjusted Weekly Sales Figures for Products Week

Motor Oil Quaker State Pennzoil Gulf Havoline

qts. qts. qts. qts.

Candy* M&M candy Hersheyettes

1/2 lb. pkg. 1/2 lb. pkg.

Aspirin* Bayer 100 tablets St. Joseph 100 tablets Norwich i00 tablets Flashcubes Sylvania Westinghouse

1

2

3

4

5

6

26 159 17 53

70 139 43 54

216 108 37 65

305 103 49 55

871 104 49 52

726 341 17 26

61 31

30 0

17 3

1 5

8 11.2

7 2.4 6

17 1 0

10.5 2.6 2.6

7.4 1 2.5

12 0 2.2

5.2 0 0

5.3 8

3/pkgs. 3/pkgs.

25 0

23 0

14 0

13 1

ii 0

7 0

All-Purpose Cleaner* Janitor in Drum qts. Formula 409 qts.

0 16

0 11

1 6

8 12

12 14

5 8

*These items had multiple sizes. Therefore, sales units are expressed in terms of a standard unit. For candy, all sales units are expressed in 1/2 lb. pkgs. For aspirin, all sales units are expressed in 100 tablet units. For the all-purpose cleaners, all sales units are expressed in terms of qt. sizes.

Findings

Graphs of price-quantity relationships were constructed :[or each product category. Care must be exercised in the interpretation of these graphs since the design of this study was not compatible with the assumptions associated with classical demand theory.

30

Journal o/ Business Research

Motor Oil The price of Quaker State Motor 0il was set at $.73 during the first week's test and then was dropped by 15 percent increments for five consecutive weeks to the final price of $.32. The sale of Quaker State Motor Oil responded in a manner suggested by economic theory. At the upper price, unit sales were low and, as price was reduced, unit sales increased gradually until at a price price of $.45 the graph flattened dramatically [Chart 1]. The last price reduction, however, produced a decrease in (adjusted) unit CHART ! PRICE-QUAA'TITY SCI~DULE FOR qUAKER STATE ~ R

OIL

Price P e r ~ar$

.~0 ~

.73 .62 .53

price .32.,,,~.,~ , ' ~ " ~35

~.'~ntity - ~eze_uded

sales. Tile "kinks" at 8.4.5 and $.38 are interesting. The first signals a very dramatic increase in sales resulting from an additional reduction in price, while the latter indicates the ineffectiveness of a further reduction. The backward bend at tile lower limit may indicate stockpiling at the previous price by customers who did not anticipate further price reductions. Ahernatively, it suggests that the extent of the market for this discounter had been reached. Interestingly enough, price changes in Quaker State hardly in. fluenced the sales of other brands. Total departmental sales, excluding Quaker State, remained relatively constant until the final price change occurred. At that time Pennzoil experienced an increase in adjusted weekly sales of more than 200 percent. Unfortunately, no data were collected which could explain the sales increase for Pennzoil. Candy The price of M&M candy (one-half pound bags) began at a low of $.31 and was increased each week by 15 percent until it finally sold for $.71. Below the regular price of $.51, the graph for M&M candy indicates that unit sales are highly sensitive to price changes (Chart 2). Since the initial price was extremely low, buyers probably

Price.Quantity Relationships

31 ~t,tJ~T l

blSM

PRICE-QU~ITY SCHEDULEFOR

Ck~DY

Price Per

.~0, .71

.E,9

.60

~egularprice ~ . 3 7 .31

.20 ~8.utity Ee=~ded of ~ lb. ~acka~e

made large initial purchases which prevented a downturn in the curve such as that experienced by Quaker State at its lowest price. Above the regular price, however, sales do not follow a consistent pattern. A price increase from $.51 to $.60 produced a positive slope for the grapil and a further increase to $.71 caused a backward bend. The irregular sllape of the graph probably cannot be explained in terms of rational buyer behavior. The low level of sales at the regular and higher prices make the shape of the graph particularly vulnerable to small changes in sales for whatever reason. Of primary interest to those making pricing decisions is that the regular price of $.51 does not seem to be a "good price." Sales were expanded considerably in response to lower prices indicating that the product is suitable for frequent promotional efforts. It was noted that at the lowest price for Quaker State Motor Oil, Pennzoil experienced a very dramatic increase in sales. The same phenomenon occurred with ttersheyettes. At the low price of $.31 for M&M candy, sales of Hersheyettes were large compared to the following weeks. This type of behavior suggests that dramatic l~rice reductions may have "spillover effects," and it may mean that the effect on primary demand offsets that on brand share. Aspirin The price of Bayer Aspirin began at $1.02 (100 tablet size) and was reduced by 10 percent each week until it reached $.61. The graph for Bayer Aspirin illustrates an interesting point (Chart 3). Shoppers who bought Bayer Aspirin evidently were not particularly influenced by price. When prices for Bayer Aspirin were declining, sales for Norwich and St. Joseph aspirin remained about

lournal o/ Business Research

32 ClOT ] PRICE-qU)LVTIT'f

SCI~ULEF0R

BAYER J~SPIRIN

Price Per ~00 Aspirin

1.29

~ 1. 02

"1.00.

. 92

.E3-

price

~

.67

.03.

.,tO.

a

~a~tity Deza=ded "in ~00 U~its

constant, indicating that those buying competing brands were not influenced by the price reductions in Bayer Aspirin. These resuhs suggest that aspirin is not a good promotional item. Flashcubes Tile price for a package of Sylvania flashcubes began at $1.09 and was increased by 10 percent increments until tile package sold for $1.84 during the last week. The sales volumes at $1.09 and $1.21 were fairly close and appeared somewhat insensitive to tile price change (Chart 4). At $1.34 buyers seemed to cut back drasti. cally on purchases. From $1.3~1~ to 91.84 (regular price is $1.49), the curve for Sylvania flashcubes looks quite smooth and normal. At the $1.21 price it seems likely that shoppers, having recognized file lower price for flashcubes, bought in larger quantities and perhaps satisfied their requirements for flashcubes. Westinghouse only sold one package of flashcubes during the six-week period, and it was sold when a package of Sylvania sold for $1.34. Therefore, sales of the competing brand did not appear to affect sales of Sylvania. Looking for a moment at the practical considerations, flasllcubes appear to be a poor promotional product except for carefully selected and infrequent time periods. They did not, for instance, demonstrate the same sales response and spillover effects as candy and motor oil. Household Cleaner The price for Janitor in a Drum (1 qt.) started at $.95 and was decreased steadily by 10 percent intervals to $.56. At the two highest prices no sales were made (Chart 5). At the regular price of $.77 the graph "kinks" and looks fairly predictable

Price-Quantity Relationships

33 C}L~T 4

Price

Fer F~g. os 3

1.EO-

PRICE-qI.IA.Vi'rI~' SCIIT.I~LF FOR SYLV.tk3;IAFLASIL-tlSI;S

1.84 ~l1.66

q.60.

1.49

1.34

,I. t 4 0 .

1.21

9~. 2'0.

.09 q.OO.

~3~tity i

9 |

i

Ee=amded Of F~gS.

until $.62. The kink at the normal price may indicate that customers knew tile price at which Janitor in a Drum usually sold. Tile part of the graph from $.77 to $.62 indicates responsiveness to lower prices and, from the seller's view, shows that Janitor ill a Drum could be a fairly good promotional product--l)ut in another store with a higher sales volume for the product. The backward bend from $.62 CHART S I'RICI:-QUA.VrIIT 5C}IEDULE FOR J.t~ITOR IN A 0RU~I

Price Per .95 .85 .80-

.60.

.77

regul pricear

.82

.~0

.20.

I

m

/

5

10

15

Q'J.~=t i t y ~e~~-a.=de ~. in ~arCs

34

Journal o] Business Research

to $.56 could imply that the market was saturated at an earlier point and at higher prices. Sales of the competing brand, Formula 409, seemed stable except for the period when Janitor in a Drum sold at its regular price of $.77. During this week, sales of Formula 409 dropped. Discussion and Critique

For most of the products tested, price changes under real buying situations produced encouraging results to marketing researchers, economic theorists, and practitioners alike: when prices were reduced within certain ranges, sales increased in the predicted manner. However, the "kinks" evident in normal price ranges and the backward bending and positi~ slopes at the extreme price ranges are interesting even though the works of Pessemier and Tull clearly indicated that such configurations were likely. All of the graphs are "kinked" and, with one exception, are backward bending in some segment. In Pessemier's study, most of the "demand curves" were kinked at the normal price [10, 11, pp. 74125]. Kinks in tile curves derived for this study appeared at other than regular prices/ The relevant explanation is probably that Pessemier's subjects were aware of the nature of the experiment and knew the normal price. In this study, shoppers were unaware of tile experiment and therefore did not know the exact regular price. Thus, in this study, kinks appeared either above or below the normal price and represented that price which had psychological significance to the shopper. In several instances, a "kink" in tile mid.price range of a graph (Sylvania at $1.34, Quaker State at $.45, and Bayer at $.75) preceded a "psychological low price" to buyers. This "psychological low price" (that price which generated a high sales volume) was not the lowest price, indicating that sellers can reduce a price too low for maximum promotional-profit benefits. Tile positive slopes and backward bending at the extreme ends of the M&M candy, Quaker State, and Janitor in a Drum graphs are difficult to interpret and seem to imply an "uneconomic reaction." However, backward bending at extremely low prices may be caused by market saturation. Alternately the backward bend at the higher price on the M&M graph may have resulted from a short replacement cycle. A strong suggestion of price confusion loomed behind much of -the sales-responses. Did buyers know tile regular price? Should advertised and reduced "special prices" be accompanied by the regular price as a memory aid to consumers who do not know the exact regular price? Are successive price changes a good policy? Probably not.

Price.Quantity Relationships

35

A low price seems to prompt stockpiling, satiating market demand regardless of the direction of subsequent price movement. Finally, this study suggests that some products are poor promotional items. In terms of units sold, Quaker State Motor Oil experienced the most dramatic sales increases from file regular to the lowest price. In terms of percentage increase in sales over the same price range, M&M candy experienced the greatest increase. Even though adjusted sales of Sylvania flashbulbs were almost 100 percent greater at the lowest price than at the regular price, unit sales were low. Sales of Bayer aspirin were erratic. Sales of Janitor in a Drum were low throughout, and tile product appears to be a poor choice for a price promotional item. Some caution is advised in evaluation of the findings of this study, however. Sales volumes were low for all products except motor oil, and thus tile findings are somewhat tenuous. Further, the weekly index of sales activity was not validated to insure positive and high correlation with the "normar' sales of tile experimental products. Suggested changes to eliminate these deficiencies in the research design are discussed belov/. Still, when the study is viewed as an exploratory effort, the resuhs are seen to provide preliminary insight into the feasibility o f in-store experimentation. Also, some of the findings of previous laboratory research concerning the characteristics of price-quantity relationships are tentatively confirmed.

Methodological Recommendations Almost any research study attempting to derive a short-run pricequantity relationship nnder realistic conditions will be unable to satisfy tile assumptions underlying economic demand theory. Any methodological change which makes tile research design more compatible with these assumptions is a desired improvement. In this respect, several research design improvements deserve mention and should be considered in further investigations. 1. Tile use of control stores which are matched to test stores with respect to store and customer characteristics would provide data for construction of an index which could be used to adjust sales of selected brands in test stores. The possibility of a substitution effect does exist, however. Customers who would otherwise shop at the control stores might be attracted to the test stores by lower 9 prices. Therefore, control stores and test stores should be inde9pendent samples. 2. The use of several matched and independent test stores would shorten the time period of the experiment, since all necessary price changes for brands would not have to be run in each store.

36

Journal o] Business Research

3 . Product categories and brands which have high sales volumes should be chosen. The sparse sales of aspirin, household cleaner and flashbulbs severely limited tile reliability of data obtained for these products, since random influences could have accounted for much of the variation in sales volume. 4. If a control group of similar stores cannot be used, the experiment should be preceded by.a preliminary validation of the sales index used in this study. Store sales and brand sales should be observed for several weeks to insure positive correlation. 5. Each price level should be in effect for a longer period than was Used in tiffs study both to allow demand to stabilize at each level and to allow more units to be sold at each level. 6. Experimental price levels should be separated by periods in which the regular price is charged. This will help account for stockpiling which is suspected to have occurred in the current experiment. If this recommeudation and the previous one are adopted, however, adjustments might be considered for seasonal and secular changes, ahhough the index of store sales activity should minimize these effects. Although other recommendations could be mentioned, the above changes in the research design will greatly improve the validity of future efforts to investigate price-quantity relationships in the field. The current research study was intended as an exploratory attempt to investigate the problem.

Foot!!otes 1Short-run as used in this paper refers to a period roughly corresponding to the sales.promotion planning span for small retailers. In this ~nse, the short-run differs from the point-ln.time concept of classical demand theory and t'rom long-run statistical demand analysis.

Price.Quantity Relationships

37

2Most of the research on file effects of price changes has relied on simulated shopping trips or controlled environments for their data collection methods. However, as Stout [17] concluded, simulation techniques have difficulty in creating a natural buying environment for the consumer. In this study the in.store experiment provided better price-volume data because subjects ~vero requircd to pay for their merchandise out of their own income and this requirement places price changes in their proper setting-neither alerting shoppers to the intent of the experiment nor emphasizing price changes. aThese efforts represented an attempt to hold constant all in-store factors which could affect ~les. In addition, no promotions involving the test products and competing brands were noted in competing stores. 4For products with multiple sizes, prices for each size were adjusted to maintain a constant relationship. For example, at any one time all Dayer Aspirin sold for so many cents per 100 tablets. This was done to avoid a situation in which the customer might find it advantageous to switch to a smaller size because of its lower unit cost. 5Product and brand selection for a study of this type pre~nts a number of problems. One of the most troublesome problems is that less homogeneity exists in consumer branded products than is commonly supposed. A different additive or viscosity for a motor oil, for example, creates a new product. In addition to real product differentiation, perceived product differentiation existing in the mind of the consumer also contributes to product heterogeneity. Therefore, e,en though products were selected on the basis of homogeneity between the competing brands, some heterogeneity did exist and conceivably could bias the results of the experiment:, CRegular price for the test products in this study was the price regularly charged by the discount store for the item. In the charts, this price is indicated by an arrow.

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38

Journal o/ Business Research

8. Leavitt, Harold J. "A Note on Some Experimental Findings about the Meanings of Price." Journal o] Business (July 1954) : 205-210. 9. McConnell, J. Douglas. "The Price-Quantity Relationship in an Experimental Setting." Journal o] Marketing Research 5 (August 1968) : 300-303. 10. Pessemier, Edgar A. "An Experimental Method for Estimating Demand." Journal o! Business 33 (October 1960): 373-383. 11. Pessemier, Edgar A. Experimental Methods o] Analyzing Demand /or Branded Con. sunter Goods with Applications to Problems in Marketing Strategy. Pullman: Washington State University, 1963. 12. Pessemier, Edgar A. "Forecasting Brand Performance through Simulation Experiments." Journal o! Marketing 28 (April 1964): 41-46. 13. Pessemier, Edgar A. "A New Way to Determine Buying Decisions." Journal of Marketing (October 1959): 41-46. 14. Peterson, Robert A. "The Price-Perceived Quality Relationship: Experimental Evidence." Journal o/ Marketing Research 7 (November 1970): 525-528. 15. Scitovsky, Tibor. "Some Consequences of the llabit of Judging Quality by Price." The Review o] Economic Studies 12 (191-t.-45) : 100-105. 16. Shapiro, Benson P. "The Psychology of Pricing." Hart ard Business Retiew 46 (Jul)'August 1968): 14-25. 17. Stout, Roy G. "Developing Data to Estimate Price-Quantity Relationships." Journal o] Marketing (April 1969): 34-36. 18. Tull, D. S.; Boring, I~. A.; and Consior, M. tl. "A Note on the Relationship of Price and Imputed Quality." Journal o/ Business (April 196t): 186-191.