The law of supply and demand is a principle that is as basic as it is powerful and can have an impact on almost all the decisions we make as entrepreneurs. However, what does it actually mean and how can it affect your business? Throughout this article, we will see how this fundamental economic principle can affect various areas of your business and how you can take advantage of this to make more informed strategic decisions.
What is the law of supply and demand?
Firstly, we provide a little financial education and a review of the basic theory. Basically, the law of supply and demand explains how the prices of products or services are determined depending on the relation between the quantity available (supply) and the people who want to purchase them (demand). If the demand is high but the supply is low, prices tend to be higher. On the other hand, if there is great deal of supply but the demand is low, prices drop.
Basically, the price of a product is adjusted until the number of consumers is equivalent to the quantity that producers want to sell. When demand rises, prices tend to increase and when there is a great deal of supply and demand is low, prices tend to drop. This balance is what keeps markets operating efficiently.
Although at first glance it could seem to be a simple concept, its impact can be profound. From price fixing to the way in which you manage your stock or adapt your marketing, everything is influenced by this dynamic. Now you know what it consists of, we will deal with the details of how it could have an impact on your business.
How does supply and demand influence prices?
We will provide an example so that you know how the law of supply and demand works. Imagine you have a clothing shop. If you launch a new line of jackets for the winter and demand is extremely high, (perhaps due to an unexpected cold snap), you could probably raise the prices without losing customers. This is the law of demand in action: consumers are willing to pay more for the jackets because they need them.
On the other hand, if you have a surplus stock of shorts in the middle of winter, you will probably need to offer discounts to promote sales. In this case, the high supply and low demand means the price must be lower to attract buyers and thus achieve the targets you have set.
This is a dynamic that is constantly repeated in any kind of market and with any kind of product or service; hence understanding this will help you implement a suitable strategy from time to time.
The elasticity of demand: How do your customers react to price changes?
It is important to bear in mind that not all products or services react in the same way due to changes in the market. Here is where the concept of elasticity of demand comes into play.
Elasticity shows how demand for a product is sensitive to the fluctuations in their price. If you have an article with high elasticity this means that consumers are very attentive to the price. For example, if you raise the price of a cup of coffee in your cafe, you could lose customers because there are many other options for them to buy it elsewhere.
However, if you sell a product with low elasticity, such as specialised medicinal products, you can raise the price without this affecting its demand too much because consumers need this product and there are not many other alternatives available. Therefore, understanding this concept can really make a difference when defining your price strategies.
How can you adjust your supply according to demand?
One of the most common mistakes that entrepreneurs make and that have an impact on the financial health of their businesses is not adapting their supply to market demand. We often think that because we have a good product, customers will automatically compare it, without worrying about market conditions. However, the real situation is the demand for a product can vary for various reasons: seasons, trends, global economy, among others.
For example, if you manage a restaurant and find out the customers prefer healthy dishes in the summer, you may need to adapt your menu to cover this demand. On the other hand, if you sell technological products, you should be aware of the trends and life cycles of the products so that you are not left with obsolete stock.
Flexibility and the capacity to adapt your supply to what consumers are actually looking for at any time will enable you to maintain a competitive edge and ensure your business is successful.
Competition and supply: What happens when everyone is selling the same product?
When there is a great deal of competition, the supply shoots up quickly. This means the price of the products tend to be lower because the competitors are struggling to obtain the same customer base. Imagine once again that you manage a bar and you are focussed on breakfasts, when new cafes begin to open in the same street you will see a surplus supply. In order to remain competitive you must hence offer something special so that you can stand out: offering a better service, a differentiated selection or lower prices.
The key factor to survive in a highly competitive market is not only to pay attention to what your competitors’ offer, but also the demand of consumers. Ask yourself, what are my customers seeking that others are not supplying? Or how to place yourself in a unique position?
What impact do changes in the economy have?
The law of supply and demand is not only determined by a local relationship between the services and products offered and potential consumers, it is also deeply related to external factors, such as the global economy, governmental policies or unexpected events. When the economy shows an upward trend and people have more money to spend, the demand for goods and services usually increases, which can result in higher prices. On the other hand, in times of recession, demand can drop drastically, which leads to lower prices and difficulties for businesses.
It is crucial to be attentive to changes in the economy and how these affect both the supply and demand in your sector. Factors such as purchasing power, consumer trends and fluctuations in the global markets can quickly change the scene. If you sell luxury products, you could see a decrease in demand during a recession whereas you could see an increase if you offer more affordable products.
Strategies to balance supply and demand
We already know that this relation can directly affect your prices, stock and, in the end, your profits. So how can you use this knowledge to your benefit? We provide some useful strategies here in the law of supply and demand.
- Constantly monitoring the market: Consumer trends change and so do their needs. Ensure you know the changes and adapt your supply accordingly. If you see demand is rising in an area, take advantage of this opportunity before your competitors do.
- Price flexibility: Do not be afraid to adapt your prices depending on demand. Offering discounts for products with low demand and increasing the prices of those more in demand could help you increase your profits.
- Stock management: Ensure that your stock is in line with your current demand. Surplus stock can mean losses whereas a shortage of products when demand is high could mean you will lose customers. Seek a balance and always ensure you have good financial control.
- Differentiation: In over farmed markets, offering something unique could be a key factor so that you are not involved in a price war. Whether it is an innovating product or an outstanding service, seek a way to stand out so that you do not only depend on the price.
As we have seen, the law of supply and demand is a crucial concept that affects all the areas of your business, from price fixing to stock management and marketing strategies. Even minor variations in the supply or demand could have a significant impact on your profitability and the manner you relate to your customers.
Understanding how this principle works will allow you to make more informed and strategic decisions, helping you to adapt to market changes and keep a competitive edge. Therefore, the next time you are faced with an important business decision, think about how supply and demand is influencing your situation and use it to your advantage.
