We know that the laws of supply and demand play a big role in determining the price of a product or service.
Like every other product or service on the face of the earth, our labor has a price. Obviously, it’s our wages.
So, think of an employee that works at a local supermarket. Our hypothetical store grows and opens up a power tool department.
With the new arrangements, a need for a new employee has emerged. When she came to help, the workload on our old-timer has declined. In other words, demand for his work has decreased. Would you expect a decrease in his wage too? Don’t think so.
The reason behind the stability is that wage is a sticky price.
What is price stickiness?
Price stickiness refers to the resistance of the price of a product or service against the changes in costs, supply, and demand.
For economists, it’s a market inefficiency. Meaning, it’s an element of the market economy that makes it less close to perfection.
To better understand what it means, let’s look at a well-known example.
Perhaps you’ve noticed that the demand for iPhones has been decreasing during the past few years. However, its price was sticky. Even if the demand continued to fall, the prices remained high until the release of the iPhone11. If it were to decrease sooner, the company could preserve some part of its customer base. However, that wasn’t the case.
Now that we understand what price stickiness is, let’s learn the two types of it.
Price stickiness can be both downwards and upwards. Looking back to our wage example, we see that our wages can increase, but they are highly unlikely to decrease. Wages have downward stickiness.
Downward sticky pricing
In downward sticky pricing, there is a resistance to prices adjusting downwards. Then, when “when the market-clearing price drops (due to an inward shift of the demand curve or an outward shift of the supply curve), the price remains artificially higher than the new market-clearing level, resulting in excess supply (surplus).”.
Upward sticky pricing
In upward sticky pricing means that there is resistance to the prices adjusting upward. Therefore, when the market-clearing price rises (due to an outward shift of the demand curve or an inward shift of the supply curve), the price remains artificially lower than the new market-clearing level, resulting in excess demand (shortfall).
You must wonder, what’s the relation between sticky prices and the e-commerce industry?
How does this relate to e-commerce?
Research suggests that sticky prices are costly. The firms with stickier prices experience greater volatility of returns, especially after monetary shocks.
To put it more simply, if you are able to react to changes in demand and supply with price adjustments, you can compensate for your loss. How so?
Say, a new competitor entered the market. Her prices are somewhat cheaper than yours. Maybe her firm’s operational costs are lower than your company’s. You can’t singlehandedly level the playing field, but you can lower your prices to sell more than her.
Even if your profit per unit decreases, you can still boost your sales and profit more than her, with the right price adjustments. But sticky prices prevent you from testing different price points that yield different levels of demand.
Why e-commerce is well-suited for frequent price changes?
You know as well as any shopper how frustrating it is to buy something and the next day see it reduced in price.
Your customers are no different.
This doesn’t mean, however, that they’re completely against price changes. They understand for example, that the price of seasonal products may change throughout the year.
Often, too many e-commerce retailers are far too cautious when it comes to changing their products.
You see e-commerce vendors have an advantage over brick and mortar stores. In a physical store, you need to get new labels printed and add them to the system.
However, online, this entire process is much simpler. In fact, prices can be changed with the click of a button.
Because of this e-commerce retailers have a better advantage when it comes to changing prices to scoop up some of the profits generated.
On the other hand, we can even assume that changing prices is not optional. Harvard Business School economist Alberto Cavallo published a research paper pointing out that the competitive pressure from Amazon forces a greater amount of price changes and more uniformity in prices across different locations.
So, even traditional retailers like Walmart apply price changes frequently, but more importantly, you can’t risk being left out of the competition when you don’t adjust prices against competitors. Furthermore, no matter where you operate your business, competitor prices have an impact on your sales.
That’s why we offer price tracking software service for our customers, a one that doesn’t only track competitor prices, but also automatically adjusts your prices against theirs.
A quick wrap up
Sticky prices can be hurtful for e-commerce businesses. First, because price adjustments are necessary to stay competitive, and second, price changes are not very costly for online retailers. While every other e-commerce owner frequently change prices, why wouldn’t you? Perhaps you are trying to avoid annoying your customers, but you might even alienate them with your above average prices if you stick to them for too long. Instead, try to keep up with competitors and offer competitive prices.