Detergent price cut at Sairam Stores
Sairam Stores, a neighbourhood grocer in Berhampur, sells a popular 1 kg detergent pack. In January it sold 800 packs a month at ₹120, earning a gross margin of ₹30 a pack over the wholesale price of ₹90. In February a large supermarket opened two lanes away. Sairam cut the price to ₹100 and sales rose to 1,000 packs a month. The owner is pleased that monthly sales revenue has increased from ₹96,000 to ₹1,00,000 and wants to make the cut permanent. His accountant points out that shop rent, electricity and staff wages are fixed at ₹18,000 a month and that the detergent shelf space could instead carry a masala brand earning ₹8,000 a month in contribution. Sairam asks whether the price cut actually made him better off and what he should check before deciding.
1. Calculate the price elasticity of demand for the detergent using the initial-value method, and interpret the number. Does the elasticity estimate by itself justify the price cut?
Read the worked answer
Using the initial values: percentage change in quantity = (1,000 - 800) / 800 = 25 per cent. Percentage change in price = (100 - 120) / 120 = -16.67 per cent. So Ed = 25 / (-16.67) = -1.5, and the absolute value is 1.5. Demand is elastic: buyers respond more than proportionately to the price fall, which is why sales revenue rises from ₹96,000 to ₹1,00,000. The midpoint formula gives a slightly lower figure, about 1.22, but the elastic conclusion survives. However, elasticity alone does not justify the cut. It predicts revenue, not profit. The owner must compare the extra contribution from more packs with the lower margin per pack, and must consider whether the sales gain came from the new supermarket's customers or merely from existing customers who would have bought anyway.
2. Using the cost data, work out monthly contribution before and after the price cut. What should Sairam do, and what evidence would change your advice?
Read the worked answer
Before the cut, contribution per pack = ₹120 - ₹90 = ₹30, so total contribution = 800 × ₹30 = ₹24,000. After the cut, contribution = ₹100 - ₹90 = ₹10, so total contribution = 1,000 × ₹10 = ₹10,000. Fixed shop costs are ₹18,000 either way. Profit before = ₹24,000 - ₹18,000 = ₹6,000; profit after = ₹10,000 - ₹18,000 = -₹8,000. The cut therefore reduces profit by ₹14,000 even though revenue rises. If the shelf could earn ₹8,000 elsewhere, the opportunity cost makes the position worse still. The cut should not be made permanent unless it generates at least ₹14,000 of extra contribution from other goods bought on the same trips. At a 20 per cent margin on other groceries, that needs ₹70,000 of extra monthly sales. Evidence of such a basket effect, or a fall in wholesale cost, would change the advice.
3. The supermarket later matches the ₹100 price. How does this affect the demand curve Sairam faces, and what non-price strategies remain?
Read the worked answer
When the supermarket matches the price, Sairam's sales gain from the cut largely disappears because customers can buy at the same price nearby. The demand curve facing his individual shop becomes more elastic at prices above ₹100: a small increase above the rival's price now sends many buyers away. At exactly ₹100, the shops are in a price stand-off, and further cuts would mainly transfer customers rather than expand the market. The original elasticity estimate described market demand under a particular competitive gap; it is not a permanent property of his shop. Non-price strategies become more important: reliable stock, home delivery, credit to regular customers, opening hours, service, loyalty schemes and bundling with other goods. The owner should also renegotiate wholesale terms and watch the contribution per shelf, not just the number of packs sold.