Strategy Byte - Week 37 More Demand

Recap

During Week 36, we introduced Demand as

The desire or need of customers for goods or services that they want to buy or use.

Then we discussed the three aspects of demand as below:

1. There should be a want for a good or service
2. The good or service must be affordable
3. There should be a plan to buy that good or service

We then explored two variables used to measure demand :

1. Quantity - the quantity that customers plan to buy during a time period
2. Price - the amount at which the quantity demanded is bought or purchased

We then discussed the factors that affect demand as :

1. Price of good / service
2. Consumers' income
3. Consumer tastes / preferences
4. Prices of related or substitute goods
5. Price expectations

This week, we will focus on the the interplay of patterns surrounding the above factors through the Law of Demand.

Law of Demand

In simple terms, other things remaining the same*, if the price of a good or service increases, it's demand falls & vice versa.

(* we will revisit this assumption later)

People will buy less of something if it's price rises & they'll buy more when it's price falls.

Visualizing the above:

We see this everyday in our lives. Why should this happen?

1. If a good or service becomes more expensive, there could be other goods or services which satisfy similar needs. For e.g., if the price of Iphone increases & where affordability becomes an issue, people can go for Samsung or other models which have the same features as the Iphone & hence can be substituted. This is known as Substitution Effect.
2. Where the income levels of consumers remain the same while the price of goods / services rises over the same period, the price of goods rise relative to incomes. Hence, consumers cannot afford to buy all the things they previously bought. They decrease the quantity of goods / services demanded. This is known as Income Effect.

This relationship between price & demand for goods / services is represented by a Demand Curve or a Demand Schedule.

Demand Curve / Demand Schedule

A Demand Schedule is a table that shows the quantities of a good or service demanded at different prices during a particular period, all other things unchanged. (Source : here)

A demand curve is a graphical representation of the demand schedule. Thus,

A demand curve shows the relationship between the price & quantity demanded of a good or service during a particular period, all other things unchanged.

Let us now see the demand curve for the above demand schedule by putting the price on the X-axis & quantity on the Y-axis.

From the above graph, we can see that demand tapers off as price increases.

When the price of a good or service changes, the demand can be plotted as above.

Let us now revisit our "all other things unchanged" assumption. When demand is influenced by any factor other than price (2 - 5 mentioned above). This causes change in demand.

Change in Demand

When any factor that influences buying plans other than the price of goods / services, it causes a change in demand. For e.g., if consumer income increases, the demand for high value items increases. In such a scenario, the demand curve shifts right.

Conversely, if consumer income decreases, the demand for high value items decreases & the demand curve shifts left.

Visualizing the above:

It is worth noting that any increase or decrease in quantity demanded due to price change is shown within the individual curve while change in demand due to other factors shifts the curve to the right or left.

Now that we know changes in demand can arise due to price &/or other factors. But by how much does the demand change? Is there a substantial change in demand or is it negligible?

We will discuss this next under Elasticity / Inelasticity of Demand

Elasticity / Inelasticity of Demand

The elasticity of demand measures how demand responds to a change in price or income.

When a change in price or other factors leads to a significant change in demand, such goods are referred to as Elastic Goods. E.g., In a growing economy where income levels rise, consumers tend to have higher discretionary spending like upgrading to the latest phone or car etc.

But in a recessionary environment, consumers tend to spend less & discretionary spending is the first to be chopped off the spending list leading to reduced demand for such goods or services.

Where a change in price or other factors does not lead to a significant change in demand, such goods are referred to as Inelastic Goods. E.g., irrespective of whether the economy is booming or in recession, there are certain necessities which consumers will buy whatever the price is like gasoline, groceries etc.

The below visualization summarizes the above:

Understanding Demand

Now, what has the micro-economic concept of demand got to do with Strategy? At the base level, Strategy involves making the necessary choices to ensure customers prioritize our products or services over that of competitors & it involves understanding

1. Customer choices & preferences
2. The Market & Industry Dynamics
3. Macro economic variables impacting customer choices

The utility of a product / service to each individual will determine how much is purchased, at what price & not every consumer will have the same utility for a given product or service.

The sum total of all individual demand curves = Industry Demand Curve. (Source : Roger L Martin - Playing to Win)

Understanding factors that impact demand & where the products / services are placed with regard to their utility in various economic scenarios will help forecast demand which in turn will help a company plan it's supply of products / services to satisfy that demand in the most efficient way.

We will explore supply from next week onwards.