Cross-price elasticity measures the relative demand change of one offer when another offer’s price changes.
Cross-price elasticity measures the relative demand change of one offer when another offer’s price changes. A positive value suggests substitution; a negative value, complementarity. The sign alone is insufficient: volume gained by a low-margin substitute may not compensate the repriced offer’s loss, and a common correlation can imitate interaction. Use a directional matrix estimated from a credible variation, then convert every transfer into portfolio contribution.
Decision and method.
Change a price only after simulating volumes transferred to substitutes and complements and their net effect on margin, acquisition and range architecture. Include internal offers, competitors, non-consumption and complements likely to move; set segment, channel and period. Build actual net price, availability, promotion, season, distribution and exposure data. Estimate log demand change of offer B divided by log price change of offer A, with an interval; test lags, increase/decrease asymmetry and segment stability, reserving zero for effects that cannot be distinguished. Apply responses to baseline volumes and recompute net price, unit margin, transfers and costs under central, prudent and adverse scenarios before piloting.
Worked example.
A range sells 10,000 Premium units at €120 and 18,000 Standard at €80, with unit contributions €62 and €34. A 5% Premium increase has own elasticity −1.4 and Standard/Premium cross-elasticity +0.35. Premium loses 10,000 × 7% = 700 units; its new unit contribution is €68, so contribution is 9,300 × 68 = €632,400, versus €620,000 before. Standard gains 18,000 × 1.75% = 315 units, or €10,700 contribution. Gross portfolio gain is €23,100. But 240 new Standard customers would have bought Premium later; lost future value at €120 is €28,800. Immediate gain becomes −€5,700. Limit the increase to 2% in a pilot segment and add a service fence.
Checks and limits.
Keep the matrix directional and segmented; use an identifiable price change near the decided range; convert transfers into contribution and future value; ensure adverse intervals fit accepted risk. Elasticities change with price size, direction and duration; unobserved competitors can absorb transfers; an aggregate model poorly describes heterogeneous individual substitution.
Resources and sources.
Download the cross-elasticity matrix. Related: own elasticity, simulate cannibalisation, arbitrate the portfolio. Sources: Deaton & Muellbauer (1980); Berry, Levinsohn & Pakes (1995); Bijmolt, Van Heerde & Pieters (2005).