How the substitution effect impacts your sales
01/24/2022 - Price optimization
Changes to your business sales occur throughout the year depending on the season and purchase trends. Furthermore, fluctuations in pricing strategies directly affect what buyers want, making them prefer one product or another based on supply, spending power and type of need. The substitution effect is a phenomenon that can affect your business and your sales. However, you can also benefit if you apply the right tactics. Would you like to know how? Pay attention!
What is the substitution effect?
The definition of the substitution effect is the phenomenon by which buyers move to purchase a product en masse instead of an equivalent product due to a price reduction. With this reaction to the price drop, there is an increased demand for the product. There is also a decrease in sales of other products which used to be bought instead of the discounted ones.
The substitution effect can occur in two ways:
- Replacing basic commodities with cheaper ones when one of them drops in price.
- Purchasing more expensive products instead of more cost-effective options when the buyer’s spending power increases.
Microeconomics uses two terms: the substitution effect and the income effect. In both cases, buying trends in the market change, and thus also the state of supply and demand. A product price change causes the first, and the second is due to an increase in the buyer’s salary or spending power.
How to take advantage of the substitution effect in your e-commerce business
The substitution effect can be beneficial or detrimental to your business. Why? Well, because it depends on which side of the looking glass you are on.
In many theories, the substitution effect is a handicap for businesses, which see their products rival cheaper ones that fulfil the same function. However, it's also an opportunity to match your competitiveness, clear out your warehouse or even increase your sales thanks to cross-selling.
Let’s look at three examples of using the substitution effect in e-commerce businesses.
- Suppose you need to get rid of stock in your warehouse. You can generate the substitution effect by lowering the price of the products that need to go, to increase their sales. Price optimisation software will be your greatest ally to set the optimal price for these products and get the maximum profit for each sale.
- To beat your competition, look for a product in your catalogue for which users could use the substitution effect. Then exceed the competition’s sales with higher demand. With the help of catalogue intelligence tools it is possible to detect blind spots in your competitor’s catalogue and link them to buyers’ expected behaviour in the market.
- Another way to take advantage of this effect is to offer related products to accompany the main purchase. Knowing that you can increase sales of the basic product, increase the value of the average sale with product combinations that make sense. For example, in a grocery e-commerce business, if we know that a family consume pasta and rice in very similar ways. You can offer complementary products to make a recipe, such as tinned tomatoes or meatballs. This can be a good way to make the most of the increase in sales thanks to the substitution effect. Lower the price of one product and add additional products to increase the average sale total.
As you can see, despite the more classical theories, the substitution effect does not necessarily negatively affect your business. Finding a way to make the most of every opportunity in the market differentiates you from your competition. Ready to let Reactev help you sell more?
Category: Price optimization
