Price elasticity is a marketing theory that tries to calculate the magnitude of consumers’ reactions to a company’s change in prices. For instance, it can help a company like PepsiCo (NASDAQ:PEP) determine how many fewer beverages it will sell if the company increases prices by 5%?
A classic example of a very “inelastic” product is gasoline. A reduction in the price of gasoline doesn’t really increase demand much and an increase in price doesn’t hurt demand much either. People and businesses need gas to get around and will pay for it, whatever the price. The pricing of other products is more elastic, so price changes (even small ones) can cause substantial changes in demand or in supply.
Clearly, businesses would prefer that the price elasticity of what they sell be low. In that way, they can implement occasional prices increases without having much effect on sales volume. It’s also a complicated topic and there are lots of nuances involved, depending on the product.
What matters for this discussion is that PepsiCo has been implementing price increases across its portfolio of products, and so far it’s losing fewer sales than management anticipated.
PepsiCo is raising prices
PepsiCo management’s estimations on its price elasticity are likely informed by decades of proprietary data from tracking how consumers reacted to its past prices increases. The fact that consumers reacted better than management expected may be related to multiple factors, but it likely has to do with the weird effects the pandemic is having on the economy.
PepsiCo said it started increasing prices in the summer and will maintain the increases into fiscal 2022, partly to combat rising production costs. The coronavirus pandemic is causing disruptions to global supply chains that are then leading to price increases of materials, labor, and freight. Businesses like PepsiCo need to decide between absorbing the higher costs and accepting lower profit margins or passing those costs along to consumers. PepsiCo has chosen to increase the prices consumers pay.
In the company’s third-quarter conference call on how consumers are responding, CEO Ramon Laguarta said: “What we’re seeing across the world is much lower elasticity on the pricing that we’ve seen historically, and that applies to the developing markets, Western Europe and the U.S. So, across the world, the consumer seems to be looking at pricing a little bit differently than before.”
One reason for this change in consumer behavior, the CEO hypothesized, was related to brand loyalty and wanting products they trust in times of economic stress. Another reason he noted could be that consumers are shopping more hastily and paying less attention to competing prices.
That’s understandable. With a potentially deadly virus in circulation, the risk of infection is greater in stores where there may be groups of people gathered together in an enclosed space. The main concern of consumers could be to find the items on their list and exit the store as soon as possible. Those shoppers may be less likely to shop around, trying to find a much less expensive generic brand.
Price increases could boost revenue through 2022
This anomalous change in consumer behavior toward price increases is also partly why the company is raising revenue targets for the final quarter and for fiscal 2021 overall. Since it plans to continue price increases into fiscal 2022, if this consumer behavior toward those increases also continues, PepsiCo will likely deliver another excellent year of revenue growth.
Right now, the company’s stock is trading at a reasonable forward price-to-earnings ratio of 24.8. If you haven’t already done so, consider placing PepsiCo stock on your watch list and look for an opportunity to add shares of the international snack and beverage giant to your portfolio. It’s shaping up to be a potentially good year for the company.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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