The Smart Manager Series:
When applying the supply
and demand law by the
book will in fact...
crash your revenues
By Yohan Albo
I remember my microeconomics classes while I was studying for my MBA at the Hebrew University… so many good memories despite the fact it was a period of my life when, in retrospect, I was trying to juggle too many balls at once (a wonderful family, the EMBA studies, a very demanding job @ Sun Microsystems, and more…).
I remember being passionate about studying the supply and demand for specific products, the macro and micro-economics interdependence, or the effects of regulations on a business… while some would claim all of these apply or don’t in a small monopolistic market with high societal disparity, such as Israel. We were lucky to be taught by a super interesting professor who knew his stuff, how to teach it, and how to tease us with real-life examples…
I also remember this period well since Behavioral Economics studies were very new to me at the time. Yes, not a big secret, but my bachelor degree was actually in Computer Science. I was learning tools and theories I was not familiar with at the time, and was systematically trying to scan all I’d seen in my short business life at that stage, trying to identify the underlying mechanisms responsible for these observations… a series of “aha” moments troubled by many questions. It was fun.
If you look on the web for a quick explanation of the supply and demand law, a driving factor in the capitalist system since 19th century, a good pick would be the following definition and accompanying chart :
“In economic theory, the law of supply and demand is considered one of the fundamental principles governing an economy. It is described as the state where as supply increases the price will tend to drop or vice versa, and as demand increases the price will tend to increase or vice versa. Basically, this is a principle that most people intuitively grasp regarding the relationship of goods and services against the demand for those goods and services. When supply and demand are in balance, the economy is said to be in equilibrium between price and quantity.”
Since senior management is responsible for pricing strategy and managing inventory, they need be super vigilant when it comes to popularity versus availability of products and services. Improperly applying the supply and demand theory can mean the difference between high profitability or missed revenue.
“The supply and demand theory sounds simple and intuitive at first glance, and is indeed applicable in many use cases, but not in all cases… and here are some examples to consider “
Reduced Cachet or
the "Louis Vuitton" Case:
In case of premium/prestige products or services such as luxury fashion goods or even high-end consulting services, the well-oiled law described above may not apply. In such a case, the more you drop your prices hoping to instinctively increase your sales volumes, the more the demand for this specific product or service will… drumroll… fall, yes fall due to reduced cachet…
Winning a sale in the short-term could have a catastrophic impact on a brand equity in the long-run. This is also why some premium brands, like Louis Vuitton, by far prefer to destroy unsold goods than selling them at a discounted price. Depending on your positioning, you may consider this aspect for your business.
Product Democratization or
The "PC" Case:
In other instances, a rising demand for a given product (for instance in the electronic products category, such as a PC machine or a DVD player) will lead to improvements in production lead time (directly correlated with labor costs), economies of scale on product components, technological advancements resulting in further cost reduction and production process improvements, distribution channel efficiency optimization, consolidation of the market players (series of horizontal/vertical integrations) resulting in savings shared with the end-customers; all of which will drive prices down.
Perception is the reality, or
the "post-9/11 Gasoline price" case
Sometimes some would perceive the supply of a given good to be dramatically reduced, even if no change actually occurs in the market. An example of this occurred immediately after the terrorist attacks of 9/11 2001. The public immediately became concerned about the future availability of oil. Some companies took advantage of this and temporarily raised their gas prices. There was no actual shortage, but the perception of one artificially increased the demand for gasoline, resulting in stations suddenly charging up to $5.00 a gallon for gas when the price had been less than $2 a day earlier.
For a firm, having experienced managers that understand the various market forces in their respective sectors AND being equipped with smart models capable of predicting the impact of a set of market factors on the business based on historical data, are strategic assets
For Yes, the 2nd largest Pay TV operator in Israel, had to take a serious cut on its monthly subscription fees last week due to fierce competition from the emerging Cellcom TV over-the-top operator. It would be interesting to investigate how “Yes”‘ management decided on the timing of this pricing adjustment… Whether it was a sudden defensive move or a calculated decision triggered by reaching a specific number of lost customers? Any thoughts?
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