This article is about Promotional Elasticity of Demand (AED).
It defines, calculates and interprets Promotional Elasticity of Demand (AED) as well as explains the factors that determine Promotional Elasticity of Demand (AED) and its impact on company revenue. The graphs illustrate various stages of Promotional Elasticity of Demand (AED).
What is Promotional Elasticity of Demand (AED)?
Promotional Elasticity of Demand (AED) measures how a change in amount spent on promotion affects quantity demanded. Simply, how much demand for a product decreases or increases following an increase or decrease in the amount of money spent on promoting that product.
How to calculate Promotional Elasticity of Demand (AED)?
Promotional Elasticity of Demand (AED) is calculated using the following equation:
| %∆ Change in Quantity Demanded for Product A | |
| Promotional Elasticity of Demand (AED) = | ━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━ |
| %∆ Change in spending on promotion of Product A |
Where:
| Final Value – Original Value | ||
| %∆ Change = | ━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━ | x 100 |
| Original Value |
Different types of Promotional Elasticity of Demand (AED)
Promotional Elasticity of Demand (AED) is used to show the relationship that exists between spending on promotion of the product and the demand for this product.
It measures the responsiveness of demand for a product after a change in promotional spending.
Promotion Elasticity of Demand (AED) can be either:
- Perfectly inelastic
- Inelastic
- Unit elastic
- Elastic
- Perfectly elastic
The following descriptions of elasticities start from the situation when percentage change in spending on promotion of the product has completely no effect on quantity demanded of that product until the situation when even a tiny change in spending on promotion of the product rice has a huge effect on quantity demanded of that product.
1. Perfectly inelastic (AED = 0)
Value of Promotional Elasticity of Demand (YED) is 0. The product is to have perfectly inelastic demand. Demand does not react to change in spending on promotion.
Comment: The percentage change in spending on promotion of the product has no effect on the quantity demanded of that product. The same amount of product is demanded, no matter what the promotion is. Basically, an increase in spending on promotion of Product A does not lead to any changes in demand for Product A.
Examples of products: A good example of perfectly inelastic product is beer. Customers usually buy beer rather than buying a specific brand which they saw advertised. Advertising is based on brands rather than products.
How consumers behave? Consumers do not respond anyhow to a change in the promotion of this product.
Chart: The demand curve for perfectly inelastic products is vertical.
Calculations: A business increased its advertising spending on Product A by 10%. Product A sales recorded a 0% increase. What is the Promotional Elasticity of Demand (AED) for this product?
Step 1: Calculate the percentage change in Quantity Demanded.
%∆ Change in Quantity Demanded = 0%
Step 2: Calculate the percentage change in spending on promotion.
%∆ Change in spending on promotion =10%
Step 3: Use the AED formula:
Advertising Elasticity of Demand (AED) = 0% / 10% = 0
It is now important to explain this result. A Promotional Elasticity of Demand (AED) of 0 means that demand changes by 0.0% for every 1.0% change in spending on promotion. The demand changes the same as the spending on promotion of the product.
What should the business do? If a firm faces this kind of elasticity of promotion, it does not matter how much the firm promotes. It can either promote a lot or nothing at all – the demand will always remain the same. Hence, spending on promotion will only unnecessarily increase the costs without any impact on sales.
2. Inelastic (AED < 1)
Value of Promotional Elasticity of Demand (AED) is lower than 1. The product is to have relatively inelastic demand. Demand does not react strongly to change in spending on promotion.
Comment: The percentage change in demand of Product A is less than the percentage change in spending on promotion of Product A. An increase in demand in Product A is less than promotion spending on Product A. There is little point in increasing promotional expenditure as it does not increase sales very much. The demand for inelastic goods and services is less responsive to changes in promotional spending than others.
Examples of products: Products that are not very responsive to changes in their promotion have promotional inelastic demand. For example, any products that customers need to buy on daily basis such as rice, potatoes, flour, etc.
How consumers behave? Consumers do not respond greatly to promotion, so they will not buy more despite seeing more advertising. If the firm continues promoting, cost will increase while sales revenue will not increase much, hence profits will decline (considering other factors constant).
Chart: The gradient of the demand curve for inelastic products is steep. The more inelastic the product is (YED closer to 0), the steeper the curve.
Calculations: A business increased its advertising spending on Product A by 10%. Product A sales recorded a 2% increase. What is the Promotional Elasticity of Demand (AED) for this product?
Step 1: Calculate the percentage change in Quantity Demanded.
%∆ Change in Quantity Demanded = 2%
Step 2: Calculate the percentage change in spending on promotion.
%∆ Change in spending on promotion =10%
Step 3: Use the AED formula:
Advertising Elasticity of Demand (AED) = 2% / 10% = 0.2
It is now important to explain this result. A Promotional Elasticity of Demand (AED) of 0.2 means that demand changes by 0.2% for every 1.0% change in spending on promotion. The demand changes the same as the spending on promotion of the product.
What should the business do? A value of lesser than 1 indicates that the demand for the product is not responsive to changes in advertising expenditure. This means that an increase in advertising expenditure will not generate a greater increase in demand for the product. The firm should not spend more money on promoting the elastic product.
3. Unitary elastic (AED = 1)
Value of Promotional Elasticity of Demand (AED) is 1. The product is to have a unit elasticity or unitary elasticity. Demand for the product is equal to proportionate change in spending on promotion of that product.
Comment: The percentage change in demand of Product A is exactly the same as the percentage change in spending on promotion of Product A.
Examples of products: In reality, unitary elastic products will maintain a certain level of sales in direct relationship to the money spent on promoting them. For instance, when the firm spends USD$1 on promotion, then the demand will be 100 units. While when the firm spends USD$2 then the demand will be 200 units sold.
How consumers behave? Any change in promotion will lead to an equal change in demand and the total sales revenue as price remains unchanged.
Calculations: A business increased its advertising spending on Product A by 10%. Product A sales recorded a 10% increase. What is the Promotional Elasticity of Demand (AED) for this product?
Step 1: Calculate the percentage change in Quantity Demanded.
%∆ Change in Quantity Demanded = 10%
Step 2: Calculate the percentage change in spending on Promotion.
%∆ Change in spending on promotion = 10%
Step 3: Use the AED formula:
Advertising Elasticity of Demand (AED) = 10% / 10% = 1
It is now important to explain this result. A Promotional Elasticity of Demand (AED) of 1 means that demand changes by 1.0% for every 1.0% change in spending on promotion. The demand changes the same as the spending on promotion of the product.
What should the business do? If a firm faces this kind of elasticity of demand, it means that an increase in advertising expenditure will generate the exact increase in demand for the product. This means that an increase in advertising expenditure will generate a greater increase in demand for the product. Marketing managers will need to make decision how much more to spend on promoting that particular product.
4. Elastic (AED > 1)
Value of Promotional Elasticity of Demand (AED) is higher than 1. The product is to have relatively elastic demand. Demand reacts strongly to change in spending on promotion.
Comment: The percentage change in demand of Product A is more than the percentage change in spending on promotion of Product A. An increase in demand in Product A is more than promotion spending on Product A. There is a good reason to increase promotional expenditure as it does increase sales very much. The demand for elastic goods and services is more responsive to changes in promotional spending than others.
Examples of products: Products that are more responsive to changes in their promotion have promotional elastic demand. For example, any products that customers want to buy, but do not need them to survive such as cars, running shoes, soft drinks, cosmetics, deodorants, etc.
How consumers behave? Consumers respond greatly to promotion, so they will buy more after seeing more advertising. If the firm continues promoting, sales revenue will increase higher than costs, hence profits will grow (considering other factors constant).
Chart: The gradient of the demand curve for elastic products is not steep. The more elastic the product is (YED having high number), the flatter the curve.
Calculations: A business increased its advertising spending on Product A by 2%. Product A sales recorded a 10% increase. What is the Promotional Elasticity of Demand (AED) for this product?
Step 1: Calculate the percentage change in Quantity Demanded.
%∆ Change in Quantity Demanded = 10%
Step 2: Calculate the percentage change in spending on promotion.
%∆ Change in spending on promotion =2%
Step 3: Use the AED formula:
Advertising Elasticity of Demand (AED) = 10% / 2% = 5
It is now important to explain this result. A Promotional Elasticity of Demand (AED) of 5 means that demand changes by 5% for every 1.0% change in spending on promotion. The demand changes the same as the spending on promotion of the product.
What should the business do? A value of greater than 1 indicates that the demand for the product is highly responsive to changes in advertising expenditure. This means that an increase in advertising expenditure will generate a greater increase in demand for the product. The firm should spend more money on promoting the elastic product.
5. Perfectly elastic (AED = ∞)
Value of Promotional Elasticity of Demand (YED) is infinite. The product is to have perfectly elastic demand. Demand does react even to a slight change in spending on promotion – any change in promotional expenditure will see the quantity demanded fall to zero.
Comment: The percentage change in spending on promotion of the product has extreme effect on the quantity demanded of that product. Buyers are prepared to buy all they need, but only for a certain amount of promotion. An infinitely large amount is demanded at one level of promotion, but when the promotion is changed even by the smallest amount, then demand falls to zero.
Examples of products: Any good that needs a certain amount of advertising in order to get sold such as technologically innovative products which enter the market for the first time. With even a slightly less promotion, it will not sell as nobody will ever know about their existence.
How consumers behave? Consumers respond in an extreme way to even a slightest change in the promotion of this product.
Chart: The demand curve for perfectly inelastic products is horizontal.
Calculations: A business increased its advertising spending on Product A by 0%. Product A sales recorded a 10% increase. What is the Promotional Elasticity of Demand (AED) for this product?
Step 1: Calculate the percentage change in Quantity Demanded.
%∆ Change in Quantity Demanded = 10%
Step 2: Calculate the percentage change in spending on promotion.
%∆ Change in spending on promotion =0%
Step 3: Use the AED formula:
Advertising Elasticity of Demand (AED) = 10% / 0% = ∞
It is now important to explain this result. A Promotional Elasticity of Demand (YED) of ∞ means that demand is ∞ only at the certain expenditure on promotion. Demand will drop to 0 for any change in advertising.
What should the business do? If a firm faces this kind of elasticity of demand, it cannot change its promotional activities at all, otherwise it will lose all the demand. Keeping the same promotion and producing indefinite number of products will increase the firm’s sales revenue. Basically, buyers are prepared to buy all they need for a certain amount of promotion. While any changes in spending on promotion will reduce revenue to zero because the demand will change to zero.
Promotional Elasticity of Demand (AED) and Sales Revenue
Let’s see how to apply Promotional Elasticity of Demand (AED) into real business situations to help the business increase sales.
One of the biggest benefits of Promotional Elasticity of Demand (AED) for a business manager is that it can show whether the marketing budget is well-spent.
Managers can compare sales of the product before the advertising campaign, during the advertising campaign and after the advertising campaign. The results of this comparison, the sales performance before and after the promotion campaign, can be used to calculate the Promotional Elasticity of Demand (PES).
- If the demand for the product increased as a result of the promotional campaign, that is money well spent. This is because sales revenue increases as a result of higher quantity sold.
- If the demand for the product not increased as a result of the promotional campaign, or increased less than the increase in promotional spending, that is money not well spent. This is because sales revenue not increased, or not increased that much as expected.
Generally, it would be more effective for a business to increase spending on those products with a high promotional elasticity of demand and to cut back promotional spending on those with a low elasticity.
The determinants of Promotional Elasticity of Demand (AED)
There are many influences on Promotional Elasticity of Demand (AED):
- Nature of the product. Fairly inexpensive daily consumption goods such as hamburgers may result in a quick bump in sales after being promoted. Other luxury items such as diamond jewelry or a dream sports car will need a longer time to see the payback since customers need to first save money to purchase them. When the product belongs to a family of brands and the company promotes the brand rather than each product, the effect of the advertising spending on a single product will distort effectiveness of the promotional spending.
- Timing of the promotional activities. Some advertising campaigns are just one-time activities while other are ongoing throughout the whole year. Therefore, it may be difficult to isolate the impact of advertising expenditure to a specific time period.
- Type of promotional activities. High growth in sales depends on the effectiveness of the promotional campaign. Just because one of the promotional campaigns last year was successful using a certain medium, it does not guarantee higher sales this year as well if the media used have changed.
- Product life stage. When new products are launched to the market, the Promotional Elasticity of Demand (AED) will be high. At that time, the main aim of the advertisement is to create awareness of the product among customers to initiate first purchases. After the sales goes up, the Promotional Elasticity of Demand (AED) will decrease. And once the product is well-established among customers, the aim behind advertising is more reminding in nature to maintain sales.
- Purpose of promotion. The purpose of a lot of advertising may not be to directly boost sales, but to help build a certain brand image or increase brand loyalty, Hence, the Promotional Elasticity of Demand (AED) value will not be a very useful measure to show the effectiveness of promotional strategy.
- Promotional activities of competitors. In a market where all competitors advertise heavily, additional advertising may not have any direct impact on sales. In highly competitive markets, the effectiveness of the advertisement is determined by the amount spent and effectiveness of advertisements of competitors.
- Income. Income of the people of the region (state of economy): Expensive advertising may not bring good results in the poor region, in the area where many workers were laid off or in the country which has been recently hit by an economic crisis. People will not buy anyway as they have no money or very little money.
- Non-promotional factors. The main reason for using Promotional Elasticity of Demand (AED) is to make sure that advertising campaign expenses are justified by their returns. A simple price comparison of AED and PED can be used to calculate whether more advertising would maximize profit. If a company finds that their AED is high, or if their PED is low, it should advertise heavily because demand depends on promotion. On the contrary, if a company finds that their AED is low, or if their PED is high, it should not advertise heavily, but change the price as demand depends on price.
Summary
Promotional Elasticity of Demand (AED) looks at how the promotion spending on one product affects the demand for this product.
It is useful for companies which rely heavily on promotional campaigns to sell their products.
