Advertising elasticity is the most important formula in sales

What is advertising demand elasticity?

Advertising demand elasticity (AED) measures the sensitivity of a market or sales to an increase or decrease in advertising saturation or advertising done by a brand. It quantifies the change in the amount of demand following a proportional change in advertising expenditure.

In other words, it is the degree to which a change in sales of a product is responsive to a proportional change in advertising. AED helps determine the impact of advertising on a product's sales. Needless to repeat the obvious: a direct increase in demand may not be the only result of an increase in advertising, but this index measures only this part of the effects of advertising, ignoring brand building, trust, and so on.

This concept is also known as promotional elasticity of demand, and it measures the sensitivity of sales to changes in advertising expenditures.

Factors influencing the elasticity of advertising demand

Understanding the factors that influence advertising elasticity of demand (AED) is essential to getting the most out of campaigns. The level of advertising elasticity is determined by the nature and amount of competition, the type of product being marketed, the target audience, the price of the product, and the availability of substitutes.

Competition plays a key role in determining AED. Markets with many competitors tend to have lower advertising elasticity than those with fewer competitors. In addition, the type of product marketed affects the level of AED. Products with low levels of brand loyalty, such as generic products, tend to have higher AEDs than products with high levels of brand loyalty.

This seems like a point in favor of generic (commodity) products, but don't be fooled! If low elasticity implies difficulty in generating purchases on command, too high elasticity may mean that people buy our brand only when we invest so much in communication or promotions. Translated: we may have a weak brand or be too commodity.

The target audience of an advertising campaign is also an important factor in determining the AED. For example, a campaign targeting a broad audience may have a higher DAE than a campaign targeting a more specific audience because of the larger potential customer base. Of course, price also affects AED, as products with higher prices often have higher AEDs than those with lower prices, if only because they are purchased less often. Finally, the availability of substitute products will also have an effect on AED. If a product has many substitutes, it is likely to have a higher AED than a product with few substitutes.

By taking these factors into account, companies can use the elasticity of advertising demand to better understand theeffectiveness of their campaigns and make more informed decisions about their advertising budgets.

Cross-elasticity

Substitute products can provide consumers with more options when it comes to making purchasing decisions, presenting equally good alternatives and thus increasing customer utility. However, from a company's perspective, the presence of substitute products can increase the competitive landscape, leading to increased marketing and promotional expenses in order to fight for market share. These costs can consequently reduce a company's operating profits and, in extreme cases, even drive it out of business if the substitute products offered exceed the company's own supply.

The demand for substitute products is a concept that is often discussed and studied in economics. It has a typical negative correlation: it means that when the demand and consumption of one product increases, the demand for the other decreases. An example of this phenomenon is transportation: if one needs to travel from point A to point B, one can only use a car, bicycle or other means of transportation.

In a broad sense, two or more substitutable products exhibit what we call cross-elasticity. It means that as the price of product x increases, the demand for the other product increases. For example, when the price of tea increases, the quantity demanded for coffee also increases.

Therefore, products with many substitutes have high elasticity. Both in terms of cross-elasticity and advertising demand elasticity. It means that they are incredibly responsive to market conditions and marketing actions, for better or worse.

Measuring the elasticity of advertising demand

Measuring the elasticity of advertising demand is an important part of understanding the impact of advertising on the market. One can determine the general responsiveness of the market to changes in advertising saturation with surveys, past sales surveys, or simply by looking at the data linearly. However, to measure theexact level of advertising elasticity, it is necessary to calculate the increase in demand resulting from an increase in advertising. This can be done by comparing sales of a product before and after a potential increase brought about by advertising activity. In this way, marketers can better understand how sensitive the market is to changes resulting from operational marketing actions and how these affect sales. By understanding the exact level of elasticity, campaigns can be better planned and optimized.

The advertising demand elasticity formula is usually calculated as the ratio of the percentage change in sales to the percentage change in advertising expenditure.

Formally:

Advertising elasticity
% change in quantity demanded / % change in advertising expenditures.

The impact of advertising demand elasticity on pricing strategies

One of the most important impacts of understanding and quantifying advertising demand elasticity is on pricing strategies.

When elasticity is high, it means that there is a significant consumer response when advertising spending is increased or decreased. The market is hyper-responsive to marketing solicitations. As we saw earlier, this is not absolutely good or bad, because it depends on many other variables. But, ceteris paribus, it should prompt management to consider lowering the prices of products or services. Think about it: if people normally buy much less than when they receive advertising solicitations, it means two things: 1) they are clearly interested in that product, 2) they don't normally buy it anyway. It goes without saying that there may be an entry barrier to purchase, and price is among the first ones to have to consider.

On the other hand, if the elasticity of demand to advertising is low, the company may have to raise prices to maximize profits. Again, we need to think concretely. If advertising has little impact on sales and still the company stands, it means that people seem to want to buy the product or service regardless of the rest. Perhaps there is room to raise the price therefore?

By understanding the impact of advertising elasticity of demand on pricing strategies, companies can then optimize their strategies to maximize profits.

Given a reasonable amount of time to allow marketing actions to achieve their effects on market inertia, elasticity can and should be calculated on the different marketing channels, independently. It can thus provide valuable insights into the individual form of communication, what our target audience is most sensitive to, and allow for optimization of spending.

Virtually all channels can be analyzed in this way. For example:

• Television
• Radio
• Outdoor Advertising (Billboards, Bus Shelters, etc.)
• Print (Newspapers, Magazines, etc.)
• Direct Mail
• Coupons
• Promotions
• Events
• PR
• Point-of-sale operations

Even easier for online channels, among them:

• Search engine marketing (SEM)
• Social media marketing
• Display advertising (such as FB Ads)
• Email marketing
• Video marketing
• Affiliate marketing
• Content marketing

You can learn more about techniques for setting a price in our dedicated article:

A realistic example

Suppose you are a small e-commerce of vegan cured meats (any reference to personal taste is purely coincidental).

You generate about 100,000 in sales per month with your current advertising investment. You decide to increase your digital advertising spend by 50 percent for six months(you are experienced marketers and know that the market has deep inertia and it takes time for the effects of a marketing action to manifest!). Also, having a scientific approach, you decide to "lock in the other variables" for this period, i.e., to put no other marketing, communication, PR actions in place and especially no discounts. You know perfectly well that any of these actions could artificially manipulate the results.

At the end of six months open an Excel spreadsheet and stick all the numbers in.

You realize that, when fully operational, every month in which the advertising investment was increased by 50% saw a 15% increase in revenue!

Let's put it all into our formula = 15% / 50%.

We obtain an elasticity of 0.3

Ask your trusted marketing agency (e.g., Deep Marketing), which confirms the feeling: it is an incredibly high elasticity. It can mean many things (some seen in this article), and you have to investigate it by exploring various hypotheses. It is definitely a job for a professional.

At the end of the analysis, your marketing consultant concludes that you realistically suffer from low brand loyalty and price perceptions that are lower than actual value. He recommends a decisive and urgent branding campaign with broad reach (to increase people who know about your products and potential customers) and raise the perceived level of your offering.

Scraping through the history of your advertising accounts, the agency also notices two of your original sins: in the past you relied on "self-styled experts" in marketing (some call themselves the highest paid marketers in the world), who pumped you full of funnel and marketing and direct response, and you are still paying the price for these digital marketing operations that should be avoided like death unless you are selling very low-cost, low-value-added goods and services. You absolutely must regain the respect of the market.

If you think we are exaggerating, we are sorry to disappoint you. Many small businesses in Italy have been ruined and failed because of this.

In summary

Advertising elasticity is important because it helps marketers understand how advertising spending affects sales. It helps determine how much money to invest in advertising and which marketing channels are most effective. By understanding the elasticity of their products or services, managers and entrepreneurs can make more informed decisions about their business strategy, positioning, and the pricing of their products.

This helps them maximize their return on investment and achieve the society's goals.