What happens to the demand of a product if consumers think there will be a shortage in the future?

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A successful business adapts to supply and demand and even influences it. This guide will help you understand supply and demand and why it matters for your business.

As a small business owner, you're constantly thinking about supply and demand, even if not specifically in those terms. You're wondering if people will buy a new product you're developing, for example, or you're trying to figure out if you have enough units on hand to fill all the orders customers made after a marketing campaign.

While we all implicitly understand the importance of supply and demand in the business world, it's worthwhile to explore exactly what it means on a practical level for achieving your business goals.

Whether you run a seasonal business, own a vacation property for passive income, or operate a more standard business entity, basic economics like supply and demand should matter to you. Here are seven reasons in particular that should drive your thinking as you plot out your business's future.

1. Pricing

The supply and demand curve has an inescapable effect on the pricing of the products and services you offer. A lack of market demand will force you to lower prices in order to move products off the shelves, while a lack of supply may cause prices to skyrocket.

Businesses attempt to achieve equilibrium quantity and optimal pricing by placing it at just the right point in the supply/demand intersection -- a tricky task to be sure, and a constantly moving target.

Example: McDonald's Dollar Menu revolutionized the fast-food industry when it rolled out in the early 2000s. However, rising costs forced the chain to change it to the $1 $2 $3 Menu in recent years, and move nearly all items out of the $1 category.

2. Competitiveness

Supply and demand has a big impact on the competitiveness of a company. For example, if a firm loses access to supply, they are unable to satisfy customer needs and risk seeing them flee to a competitor. A plunge in demand for a product provides an opening for a competitor to offer an alternative to customers and take market share. A rival may also cut prices in an attempt to drive demand.

Example: Amazon has grabbed a stranglehold on the online retail market by driving prices as low as possible, often selling items at a loss. After subtracting the profitable Amazon Web Services and Amazon Prime portion of the business, the retail portion of Amazon loses billions of dollars annually. This has given Amazon the power to force many smaller retailers out of business and take over more market share in their absence.

3. Expansion

An organization’s ability to expand is highly dependent on supply and demand. Greater demand for a product or service gives the firm the opportunity to grow the business, hiring more workers and increasing capacity to match the demand.

On the other hand, oversupply and low demand forces businesses to contract, laying off staff and closing factories. Companies must achieve the appropriate balance for consistent and sustained expansion.

Example: Blockbuster once owned more than 9,000 video rental stores across the nation, but by 2010 they had declared bankruptcy. The chain was done in by the fact that people no longer wanted to rent physical DVDs, thanks to competitors like Netflix, who created DVD-by-mail and eventually video streaming. Essentially, Blockbuster saw demand for their product drop to almost zero in just a few years and failed to respond quickly enough.

4. Marketing

A company can drive demand for a product or service through marketing. A good marketing campaign can make a customer aware of a product or service and create a desire for it, causing demand to emerge out of nowhere. This creates a justification for a company to create a supply to fill that demand. Marketing and demand create a relational loop that feeds itself.

Example: When Apple’s iPhone came along, it filled a need people didn’t know they had. Through extensive marketing, Steve Jobs was able to convince the world that they needed more than a phone -- they needed a handheld computer that could make calls, play music, browse the Internet, and do all sorts of other tasks. Now, it’s hard to find a non-smartphone, even if you try.

5. Inventory

Inventory is a major logistical challenge for all companies selling a physical product. Supply and demand greatly influences the profit margins of companies that have inventory -- oversupply and low demand results in high inventory costs for the company, while undersupply and high demand will cause the company to be constantly running out of items and displeasing customers.

Inventory management is critical for forecasting supply and demand and planning accordingly.

Example: Back during the Christmas season of 2011, Best Buy had a major catastrophe on its hands. Due to poor forecasting, it had failed to have the proper level of inventory to fill all orders customers had placed -- even those made as early as November. The company made an announcement just days before Christmas that many customers wouldn't get their gifts in time -- despite having been promised on-time delivery -- causing an explosion of outrage that made a major dent in the retailer's reputation.

6. Financing

Strong supply and demand increases the attractiveness of a company to investors, prompting banks, lenders, and inventors to offer their financial assistance to improve and expand the business in exchange for a stake in the company.

On the flip side, a lack of strong demand for a product or service will cause a company to struggle to attract outside investment to turn the company around. Successfully securing financing may help a company boost demand and build a stronger supply chain.

Example: Airbnb leveraged its success in creating a booming online home-rental business into a massive public investment spree. The company went public in December 2020, and on the first day of trading, its Initial Public Offering (IPO) topped a staggering $100 billion.

7. Salaries

Strong demand and the supply to handle it will cause extra revenue to flow into a company’s coffers, giving it more freedom to pay higher salaries in an attempt to attract top talent.

Higher salaries lead to greater worker retention and satisfaction, and improve workers’ confidence in the business. This, in turn, can boost productivity and improve the performance of the business and its products -- which can further increase demand.

Example: In 2015, Gravity Payments CEO Dan Price made headlines by announcing that the company would raise the pay of all employees to at least $70,000 per year while cutting his own salary from $1 million to $70,000 to cover the increase. Today, he boasts arguably the most loyal staff in the country -- when the COVID-19 crisis hit and revenue plunged 50%, loyal employees offered to take pay cuts in the interim to keep the company humming, with about a dozen offering to take no pay at all. It’s hard to imagine that happening at a typical company.

Set aside time to plan for your company’s future

One of the best small business tips you can get is to properly prepare your company for any scenario when it comes to supply and demand. Too many small business CEOs are caught up in the thick of putting out daily fires and don’t carve out time to really plan for the growth of their business.

They don’t take time to ask themselves the big questions. What are the factors impacting demand in my business? What are the potential disruptions to supply? What backup plans can I create to weather -- and even thrive in -- any storms?

Take some time in the coming days to sit down and plot a new path forward for your business. Conduct a business impact analysis to determine what threats are out there and how you can respond. Draft a gap analysis to determine where you are and where you’re going. It will give you peace of mind to know that your company is prepared for anything.

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