Price Elasticity measures the response of demand to a change in price (Begg & Ward), and adopting pricing strategies relevant to a particular product or service remains one of the biggest challenges faces by managers. The demand side drivers of price must therefore be clearly understood, taking into account the end objectives, so as to measure performance against these. It is however worthwhile to note that from the case study [Ref. A], the demand for GM cars is seen to be price elastic as an increase in car prices – by way of retracting 'employee discounts' in this case – resulted in less demand.
Conversely a decrease in the prices would have resulted in an increase in the demand for the cars. It can be inferred that the demand would have been either anticipated to be very high, or would have been very high from historical trends as the discount scheme was for a limited time, to prevent the risk of potential financial losses as a result of excessive discount car sales. KEY DEMAND SIDE DRIVERS OF PRICE FOR VEHICLES The figure below shows the price elastic demand curve for GM vehicles. In economics, the price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in price.
(a) Movements in the Demand Curve (b) Shifts in the Demand Curve Several factors would affect the demand of GM vehicles, which would ultimately lead to an increase or decrease in the price, which would invariably result in the demand moving or shifting to the right or left. Amongst these include: The Effect of Market Conditions on GDP Growth The gross domestic product (GDP) is a basic measure of a country's overall economic output (Wikipedia, 2009), and a key determinant in the demand side drivers of price for vehicles.
There is a positive correlation between the GDP growth rate and vehicle demand, which means that vehicle demand, increases with increases in GDP growth. The economic downturn is a perfect example of how a decline in GDP growth (with an increase in unemployment, and inflation (resulting from prices being hiked to meet the increase in manufacturing costs etc), has led to a reduction in economic activity and disposable incomes available for purchasing new vehicles. GM had been so badly affected by the recession that introducing a new pricing strategy, which reflected new spending trends was their only way to stay afloat.
It is seen that this reduction in price (from P2 to P1) resulted in an increase in demand for their cars (albeit possibly only for a limited period). This would result in a movement in the demand curve to the right, i. e. from DQ1 to DQ2. Price of Alternative and Complement Goods Alternative goods are substitute and / or rival products that exist in the same market (Begg & Ward). In the case of GM, rival brands such as BMW and Toyota would benefit from a hike in their prices, resulting in the movement in the demand curve to the left from D2 to D1.
On the other hand, an increase in the prices of alternative goods would lead to a rightward movement in the demand curve, from D1 to D2. This indicates a positive relationship, where an increase in the price of alternative goods will result in an increase in demand for GM vehicles, regardless of the price. Conversely, there is a positive relationship between the prices of complement goods, as a decrease in their prices would cause an increase in demand from D1 to D2. For example a decrease in the cost of diesel will result in an increase in the demand for diesel and for cars which use diesel.
The company may therefore need to incorporate prices of substitute and complement goods into its pricing strategies in order to stay competitive. Consumer Needs, Tastes and Spending Trends The needs and tastes of the end user and their spending trends will affect the demand drivers of price for vehicles, as shifts occur in customer reactions and perceptions. The advancements in technology are very good examples of this, as future advancements could reduce the demand for older products.
If consumers developed an improvement in preference or taste for GM vehicles, this would result in an increase in demand regardless of the price, resulting in a shift in the demand curve from D1 to D2. If on the other hand consumers regarded GM vehicles as being 'out-dated' for example, the demand would decrease, even if there were a reduction in prices to remain competitive. This would result in a leftward shift from D2 to D1. Environmental Factors Environmental factors can affect the demand for vehicles. For example, GM thrives on manufacturing vehicles that are environmental friendly, and with lower CO2 emissions.
Many of the company's objectives rely on this, and this is a reason why several consumers remain faithful to GM brands, e. g. Chevrolet. Awareness of other alternative or 'green' means of transport could have an adverse effect on the demand for their vehicles, which in turn would result in the company adjusting its pricing to stay afloat. CONCLUSION Whilst the factors mentioned above could affect demand either negatively or positively, more trends would need to be analysed to measure how demand is affected in terms of actual quantities.
These measurements would then be the real demand side drivers of price, as once the quantities are understood, pricing strategies could be adjusted accordingly. QUESTION 1B INTRODUCTION During a recession it may be tempting to introduce discounts so as to raise revenues more quickly. As mentioned in 1A above, a recession will affect disposable incomes and the spending power of the consumer. In the case of General Motors (GM), the company's main objective is to optimise its long-term financial returns, and has faced several challenges achieving this to date.
Note here however that although a reduction in the car prices would ultimately have led to an increase in Revenues, the company needed to maximise profits, and could only do this by achieving its full-price sale targets. This is why the employee discounts were scrapped. It was later seen that this pricing strategy was not effective and a balance was struck halfway by re-introducing the discounts for a limited time – therefore addressing the need to achieve full-price sales, and generating increased revenues in the short term.
EFFECTIVENESS OF PRICE DISCOUNTING DURING RECESSION In a survey conducted by the Yankelovich study, it was found that discounts are not always beneficial to sales in the long term, as end-users tend to have negative reactions to recession discounts. 70% of consumers responded it signified long-term overpricing, whilst in contrast 64% of consumers responded that non-discounted products indicated extreme product popularity (Dollars & Consumer Sense, 2009).
It can be inferred from GM that the employee discounts were significant discounts – large enough to be detrimental to the consumer view of the product, by thinking GM cars were worth far less in value (overpricing as discussed above) than their sale prices, but also significant enough to be used to generate revenue during the recession, as there is clear evidence to suggest that this discount yielded large demand for the cars. In a recession, as the spending power drastically reduces, the spending trends observed will mostly be need-based, with consumers only buying what they have a genuine need for.
This would mostly affect goods that are elastic (such as GM cars), as they are usually expensive with lots of substitutes in a very competitive market. Therefore a small change in price will invariably lead to a significant change in the demand. Cost-plus pricing should however be taken into account where possible to at least recover costs, to prevent losses. The figure below shows price elastic demand curve, which illustrates how total revenue is affected by reductions in prices and increases in the demand for GM vehicles.
It can be seen that for a small discount in the price of the vehicles, i. e. from P2 to P1, there is an increase in demand from DQ2 to D Q1, and for a larger discount, from P1 to P3, from DQ1 to D Q3. The rectangle shows the total revenue represented by the corresponding price change, and the impact of the price reduction on the total revenue is the difference in size between the two rectangles. PRICE DISCRIMINATION Pricing discrimination is likely to provide useful benefits if discounts are to be adopted in the long term.
So whilst the recession may have affected the US, and Europe, and discounts could be adopted, prices may be hiked in other regions, e. g. Africa, where different groups of consumers exist which very dispersed spending trends. CONCLUSION Pricing discounts should be used to exploit price elasticity, but should only be used in the short term, as this can be financially unhealthy if production costs are not met, and can also adversely impact a company's market share. Pricing strategies should therefore elude from blanket pricing, so as to appease both cost-conscious and value-conscious consumers without cutting prices.