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  April 21st, 2016 | Written by

To Offshore or Not: Try a Price Elasticity Analysis

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  • Some goods are especially sensitive to pricing, but for others that is not the case.
  • PED can provide a systematic way to come up with estimates and the savings, if any, of offshoring.
  • Soft drinks exhibit high elasticity of demand: with even a small increase in price, demand goes down.

For very high volume products like toys, it’s usually quite apparent after a quick analysis that offshoring is a good choice. At the other end of the spectrum, production of low volume capital equipment like semiconductor test equipment can often be kept locally.

The vast majority of product designs fall somewhere in between, where the volume is perhaps low but growing and the complexity is more than a Christmas tree light, but less than an enterprise-class server. Determining when it makes sense to offshore the in-between products is often a complex decision.

Price Elasticity of Demand (PED) can provide an analytical framework that can bring clarity to some of the issues. Price elasticity refers to the concept that demand for some goods and services is especially sensitive to pricing, but for other goods and services that is not the case. An example of a product category with a high elasticity of demand is soft drinks: with even a small increase in price, demand goes down substantially. However, pediatrician visits are very inelastic; parents will still pay for these services even if the prices go up a fair amount.

Getting a good estimate of what the PED of your particular product is, and then figuring out a few different scenarios based on price and estimated demand is extremely useful in deciding when and if offshoring makes sense. There are plenty of products where a five- to 10-percent or even higher price won’t make any noticeable difference on demand, and conversely there are many products where a few percentage points increase in price will hand market share to the competition. Keep in mind though, that few markets are static and PED can change over a period of quarters as first mover advantage evaporates or a new feature is added to your product or your competition’s or new trade incentives start.

PED can provide a systematic way to come up with some estimates and then the savings, if any, can then be compared against the cost of the additional travel and support of a production process thousands of miles away. PED driven analysis is a great tool to have in your toolbox. It’s one of those tools that can bring sales, marketing, engineering, supply chain, and operations together with numbers, estimates, and a clear thought process to make a data-driven decision.

Charles Cox is managing director, Riverwood Solutions China. He has over 18 years of leadership experience in R&D engineering, manufacturing, and operations. Based in China, where he lives with his family, Cox works directly with suppliers and customers on a daily basis.