Price Elasticity: The Elephant Is in the Room
Household savings climbed higher in the first two years of the pandemic thanks to hefty government stimulus, robust stock market growth, and lower spending. Improvements in mobility have allowed consumers to release their pent-up demand in year three of the pandemic and spend at a higher level on just about everything.
As a result, retailers have allowed vendors to raise pricing without much pushback. Retailers readily acknowledge inflationary factors driving input costs higher and sound somewhat comfortable that U.S. consumers can absorb it. Unlike before the pandemic, retailers are raising prices together, so they don't see any signs of widening competitive price gaps.
Consumer goods companies could announce further price increases in the coming calendar reporting quarter, encouraged by the success of recent announcements above historical norms and a general lack of elasticity. However, it is possible companies, and consensus estimates for the majority of them, may underestimate one of three very likely outcomes:
- The inability of suppliers to achieve further price increases.
- The negative impact of pricing on volume.
- An increase in promotional activity.
Real wage growth is now firmly in negative territory, and headlines of war, gas, and grocery inflation are front and center in consumers' minds. A recent Dunnhumby (a global customer data science company) survey reveals consumer perception of pricing is far higher than the actual increases (18% perception vs. 7% reality). Possible early signs of slowing consumption trends in various discretionary segments and an uptick in private label purchases may be emerging.
Our contacts had a consistent opinion: elasticity arrives instantaneously, not progressively. Current and future price increases could negatively impact volumes- initiated with promotional activity increasing while raw material inputs remain elevated. A mix of factors puts margins at risk. Look no further than the margin compression of the mid-2010s for evidence of what happens when retailers push back at vendors for raising prices too high. At any sign of volume weakness, observers will look for retailers to re-introduce promotional levers and price pressure.