opportunity 106 of 150

I am amazed at how many business people are still wedded to the law of supply and demand. You know the one. It goes something like this:

  • The law of supply and demand is the theory explaining the interaction between the supply of a resource and the demand for that resource. Thelaw of supply and demand defines the effect the availability of a particular product and the desire (or demand) for that product has on price. Generally, a low supply and a high demand increases price, and in contrast, the greater the supply and the lower the demand, the lower the price tends to fall – INVESTOPEDIA

In 2017, the relevance of this ‘law’ is highly questionable. Certainly, any simple application of the law of supply and demand is open to serious question.

The law of supply and demand would suggest that:

  • If a competitor’s price is lower, the competitor will attract higher demand.
  • If the price of a product is reduced, more of that product will be sold.
  • Increasing supply will necessarily drive prices down.

The facts are, however:

  • Price is only the critical factor when all else is equal. Lower prices will really only drive the demand for commodities. When two products are indistinguishable, price will naturally become a differentiator.
  • Certainly, with commodities, lowering the price can increase demand, but with a brand, the opposite can also be the case. Increasing the price can increase demand for a brand. Equally, there are examples where changing the price of a brand has no impact on demand.
  • There are many examples where increasing supply has no impact on price. Take for example the Apple iPhone, which is sold for a premium despite being as readily available as any other smartphone on the market.

The law of supply and demand can really only be applied when:

  • There is equal access to information.
  • There is equal access to the product.
  • It is a product, and not a brand, being sold.

The fact is consumers have varying access to information and varying abilities to utilise that information. For example, few consumers have access to the information, or can interpret the information, that would enable them to accurately compare health insurance products. Hence, the rise of businesses like iSelect.

Not all people have equal access to products, and if a consumer does not have access to a product, it matters not what the price is. Jack Ma has attributed much of the growth of Alibaba in China to the fact that China does not yet have the bricks and mortar infrastructure – forcing them to shop online.

If one hotel room is $100/ night and another is $200 a night, the laws of supply and demand would suggest that consumers will almost unanimously opt for the $100 option. If, however, the first hotel was a Travelodge and the second was the Westin – the comparison is not so simple. Effective branding changes the game.

Embracing the lesser relevance in 2017 is a necessary condition of developing an optimal pricing strategy. There are far more powerful factors at play, and these must be taken into account.

Embrace the lesser relevance of supply and demand.

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D. John Carlson – Adviser and Speaker – 0402 273 350 or johnc@lincintegrated.com .

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