When analysing a market from a demand perspective, there are a number of indicators available including penetration rate and elasticity. In this glossary post on demand analysis, we are looking at things from a generic point of view rather than from a B2B/B2C perspective.
The tools of demand analysis: penetration rate and elasticity
Demand analysis: definition of penetration rate and elasticity
The penetration rate of a product/service is the ratio of the current demand for that product/service to its potential demand. This rate varies from one geographical area to another and changes over time. It is used to assess the potential for growth in demand for a market.
A market is said to be saturated if the penetration rate is close to 100%. If the penetration rate is low, the market is said to be buoyant.
For durable goods (cars, household equipment, etc.), the equipment rate is used. The equipment rate is calculated by dividing the number of products in use by the potential demand. To calculate the renewal rate, the volume of replacement purchases is divided by the volume of total purchases.
Demand elasticity: this corresponds to the possible relationship between changes in prices and changes in quantities. In a nutshell, it consists of studying how quantities evolve according to price changes. The elasticity of demand in relation to price is calculated by dividing the variation (expressed as a percentage) in quantities demanded by the variation in price (expressed as a percentage):
e q/p = Variation in quantities demanded / Variation in price
For a unit price of 100 euros, the quantities demanded of a good are 2,000 units. If the price drops to 90 euros, the quantities increase to 2,400.
Price change = (100 – 90) / 90 = – 0.1
Change in quantities = (2 400 – 2 000) / 2 000 = + 0.2
Hence e q/p = (+ 0.2) / (- 0.1) = – 2
The price elasticity of demand is – 2.
If e < – 1: the demand is qualified as “highly elastic”. This type of demand is found for goods with many substitutes, as consumer brand loyalty is very low.
If e = 0, demand is described as “rigid”. This means that the quantities demanded are very weakly influenced by price variations, even strong ones. This type of demand is found for essential goods for which substitutes are rare or non-existent. This type of demand can also concern goods whose share in a household’s budget is very small and which, as a result, are not very sensitive to price variations.
If e > 0, demand is said to be “atypical”: price increases contribute to increasing the quantities consumed. Four cases can be distinguished:
- The Veblen effect: The higher the price, the more demand there is for the good as it becomes an ostentatious sign of wealth or financial comfort on the part of the consumer.
- The Quality effect: The price here constitutes a guarantee of the quality of the product or service sold. In a rational approach, the consumer in search of elements enabling him to judge the seriousness of an offer, associates the high price of the product with proof of quality.
- The Giffen effect: When the price of a necessity good increases (such as certain goods or services related to food or energy), the Scottish economist Robert Giffen demonstrated that some households can no longer buy more expensive goods. A “Giffen good” fulfils the following three conditions: it must be a basic necessity (bread, meat), represent a very large part of the consumer’s budget, and not be easily substitutable.
- The speculative effect: The consumer buys more of a good whose price is rising for fear that its price will rise again in the future.
The limitations of theoretical approaches
The concept of elasticity of demand was initially applied to prices. It was later extended to other variables. More generally, elasticity can therefore be defined as the measure of the effects of a change in one of the demand variables on the quantities demanded. Its general expression is then the following:
e q/v = Consequential change in quantities demanded/change in the variable under consideration.
We can also calculate the elasticity of demand for a product in relation to the marketing actions carried out by the company (the marketing plan designed and implemented by the company). This is known as cross-elasticity.
Similarly, the income elasticity of demand can be calculated. The change in expenditure on a product or service is then divided by the change in income of the customers of that product or service.
Trends and innovations
In the hotel sector, the performance of a hotel is calculated by the occupancy rate (OR) whose formula is: OR = Number of rooms sold / Number of rooms available.
The occupancy rate is a way of comparing oneself with one’s competitors. An indicator is used for this, the MPI (Market Penetration Index), also called the occupancy index. The MPI is calculated as follows:
MPI = Hotel occupancy rate / Occupancy rate of its competitive market
Thanks to yield management/revenue management techniques, the occupancy rate of a hotel establishment can vary greatly, the objective not necessarily being to push the occupancy rate to its maximum but to maximise the revenue per available room (RevPar: Revenue Per Available Room), which is obtained by dividing the overall turnover linked to rooms by the number of available rooms.
Tools and methods
The penetration rate of a product or service can be determined by age, gender, SPC or geographical area (trade area). These segmentation criteria are quite classic.
The penetration rate can also be calculated using the persona method. The target is then segmented according to its habits, practices, lifestyle and interests.