WHEN ELASTICITY CHANGES: STAYING AHEAD OF THE CURVE
Limes are a notoriously inelastic fruit given their necessity in many cocktails. HLB Specialties, Fort Lauderdale, FL, only imports organic limes, which Andres Ocampo, director of operations, believes brings more protection against price responsiveness.
“But also in conventional limes I remember three years ago when they were hitting crazy numbers like $150 per box,” he says. “They had become staples so foodservice and some retailers had to have the limes anyway.”
“Some people were trying to replace limes with lemons, but just temporarily. They still had to have the limes as soon as they were made available. I would say with limes that threshold was very high.”
The threshold he is referring to is the point on the demand curve where elasticity starts to change, and this is perhaps the most complicated part of applying responsiveness-based pricing strategies; it’s where the science becomes more of an art.
“This sort of textbook illustration where we show a straight line and talk about elasticity and think people’s degree of sensitivity remains the same regardless of what today’s price is, I think that’s wrong,” says Brad Rickard, associate professor of applied economics at Cornell University.
“These threshold points are like little kinks in that curve, so you hit that threshold point, and all of a sudden, that line is just actually a little backwards escalator where it kinks in or out and that defines a new price elasticity,” he says. “That’s often how we try to model it.”
Ocampo says that threshold point where demand becomes more elastic is clearly seen in papayas.
“Let’s say we were selling papayas at $17 per box. If we got to $20-21, we don’t notice too much of a change in volume,” he says. “It seems to me that if it gets to a point where prices are beyond $23-24, then we see a significant drop.”
And the equation is often, but not always, similar in the opposite direction. You can cut price and volume doesn’t really move much, unless you’re undertaking a concerted effort to bring attention to the discount.
As is the case with bananas, Ocampo highlights the difficulties of moving extra volumes of other inelastic items.
“Let’s say the retail price for a lime is $1 a piece. If they drop it to 90 cents or 80 cents without doing any special ad or advertising, I don’t think there’s going to be an uptick on purchases of limes,” he says.
He explains the situation for a niche product like goldenberries is similar, having really only made significant traction in foodservice.
“You’re talking about hotels and restaurants that either use it or not,” he says. “If a chef tells his purchasing department that he needs that fruit, they are willing to make concessions and find it; only for the cheapest available price but the point is they need the product.
“The same goes the other way. If I don’t want it, I’m not going to buy it even if it’s almost for free. The more exotic the item, the less flexibility there is in price.”
Ocampo observes that elasticity can change from between seasons and sources of origin as well.
“I see that with mangos for example. During the Mexican season the prices of mangos are very low, and you can promote aggressively and move volumes,” he says. “When the season from South America is on, obviously the prices are different.”
THE ELASTICITY OF ORGANIC
Ben Campbell, assistant professor in agricultural and applied economics at the University of Georgia, has a focus on pricing strategies for labels, particularly for organic, local and sustainable items.
“There are groups of consumers that are highly price insensitive to organic,” he says. “It’s a relatively small group, probably 10-15 percent of consumers depending on the product.”
Campbell explains in fruit and vegetables the average price increase or premium for organic compared to conventional would be estimated at around 46%.
“If you start driving up price much more than that, you’re going to have a lot more people switch off than are going to stay, so revenues are going to go down,” he says.
“You have that group who you can charge those higher prices to and they’re not going to switch off if you raise the price a little bit,” he says. “The fine tinkering with price is how much can I drop price and grab that extra group that really cares about price but doesn’t really care about organic, but not lose the sales I get from this smaller group.”
Last year, researchers from the University of Kentucky’s Department of Agricultural Economics (GwanSeon Kim, Tyler B. Mark and Michael R. Reed) and the National Institute of Agricultural Sciences in South Korea (Jun Ho Seok), investigated price relationships between organic and conventional carrots, tomatoes and lettuce in the U.S.
Using Nielsen scanner data from 2006 to 2015, the authors found positive long-run price relationships between organic and conventional in carrots and tomatoes. The correlation was that a 1 percent rise in the price of organic carrots or tomatoes led to a greater rise in prices of the conventional product.
“We also find that there is no cross-price relationship between organic and conventional lettuce in all regimes, which implies that consumers tend to consider organic and conventional lettuce as different goods,” the authors said.
The researchers discovered U.S. consumers recognized organic and conventional carrots and tomatoes as “limited substitutable goods.”
“These results provide marketing opportunities to grocery store managers for these vegetables due to their limited substitutability,” the authors said.
“Managers could take advantage of this situation by setting higher price margins on lettuce and tomatoes between organic and conventional products to increase profits.”
For UGA’s Campbell, the right pricing strategy comes down to understanding your consumer base in order to make the right decisions.
“For example Whole Foods … they know who their shoppers are and they’re charging premiums because they know the customers coming in will pay a higher price,” he says. “Is an apple you buy at Whole Foods different to an apple you buy somewhere else? Probably not, but they know who the clientele is and they can charge those prices.”
He says products labeled as local also drive premiums, but the nature of demand is a bit different as the topic isn’t as controversial.
“In local you have the same thing, but I wouldn’t say the price premiums are as large as you see in organic,” he says.
“Now there are many retailers in organic, and it’s sort of lost some of its luster for a lot of people,” he says. “Local on the other hand hasn’t, and you have groups of consumers who will pay more for it compared to non-local, but generally local doesn’t have that dichotomy of perceptions like organic does.