Online prices depend heavily on the supply of what’s being sold.

Understanding the way supply and demand function in online business is crucial, whether you’re starting an online business or you’re a consumer.

In every case, the Internet expands the demand for a good or service by increasing the number of potential customers.

A URL is reachable by almost everyone in the world. To the extent there is a demand for an online product, everyone who wants the product has access.

The old adage of “location location location” that defined businesses attached to real estate obviously doesn’t apply on the Internet.

In a world where demand is maximized and location is irrelevant, the key factor in establishing the online price is supply.

How Supply Affects Similar Services

AirBnB and Uber are classic examples of supply affecting price. Both services allow you to share one of your most valuable assets with strangers for a price. But one service increases prices while the other lowers prices.

AirBnB – An Up Market Example

AirBnB is an excellent example of a company that has significantly increased the price people will pay for a short term rental.

Prior to AirBnB, Vacation Rentals by Owner (VRBO) and similar services, owners of real estate wanting to attract short term renters had access to a much smaller market of buyers.

In the old days, owners had very few economical ways to advertise. Whether the owner advertised directly to the market by placing a sign on their home or engaged the services of a realtor, the chances of finding a tenant for a short term rental were small.

The prices I paid for a vacation rental in pre-VRBO days were low and vacancy rates were high. It was a buyer’s market.

AirBnB and VRBO have been so successful that in some markets they are being blamed for driving real estate prices higher and disrupting the market for long term rentals.

In the case of AirBnB, the supply of real estate has remained relatively the same but the demand has gone up wildly, causing prices to go up.

Uber – A Down Market Example

Uber and Lyft are classic examples of companies slashing prices by attacking regulatory frameworks. They are the “barbarians at the gate”, smashing down regulatory barriers imposed on the taxi industry.

Many services have taken this path. Netflix has smashed through regulatory barriers to entry enjoyed by Cable TV providers. Crowdfunding services have attacked SEC regulations. By circumventing or blatantly ignoring regulations that previously kept supply low, these companies have increased supply and lowered prices.

In the case of Uber and Lyft, they can count on a virtually limitless supply of drivers and cars. Unlike the real estate market, there is a huge reserve of supply waiting in the wings if the supply of drivers drops off.

Beware of Geography

Goods and services that appear to be in low supply prior to going online can suddenly become oversupplied.

For example, many years ago I gave my mother an annual Christmas gift of a Waterford Crystal tree ornament. Each year Waterford Crystal produced a limited edition ornament on the theme of the 12 Days of Christmas. One year I left my shopping too late and the store was sold out.

I checked with all the local stores and I reached out to Waterford Crystal. but I couldn’t buy the ornament at any price. Supply was effectively zero.

A few years later, eBay came along and suddenly the supply of the missing ornament was greater than the demand. Ornaments were selling at below their original sticker price!

A good that was previously in extremely low supply was in abundance.

The same has happened in the service industry. Companies like Upworks have made it possible to hire labor from all over the world. Employers are no longer restricted to their local employment market and can access a vast array of highly qualified people at a fraction of the cost of local labor.

Obviously, hiring someone in Bangladesh when you live in Vancouver won’t help if you’re looking for someone to mow your lawn. But the supply of labor ranging from clerks to computer programmers and lawyers has been vastly increased in markets formerly constrained by geography.

When a good or service goes online it can expose an imbalance, where there is an oversupply in some locations and an under-supply in others.

4 Questions you Should Ask Before you Set your Price

  1. Is the supply of the good or service low and unlikely to grow significantly if the price climbs (economists refer to this as inelastic supply)?
  2. Do you control the intellectual property associated with the good or service? A patent, copyright or trademark can be useful for limiting supply, if it can be effectively enforced. For example, the world supply of handbags is huge, but companies like Coach can command a high price by creating a brand that is associated with a limited supply.
  3. Is the supply of your goods or services regulated, causing an artificial supply shortage? Are you circumventing these regulations (thus opening the supply floodgates) or working within the regulatory framework (benefiting from supply management)?
  4. Will the elimination of distance impact the perceived supply of your good or service? Is the shortage of supply simply a function of an imbalance created by geography? (Waterford Crystal or Upworks)

A limited supply isn’t a guarantee of high prices and should never be taken for granted. Charging too much can invite competitors or alternatives into the market. Consumers may opt for an alternative option that may not be as good as the one you’re offering, but may be worth the sacrifice if your price is too high.

How to Avoid Competing on Price

In cases where supply is high and you cannot control supply, you have a few alternatives to competing on price:

  1. Branding create the perception of higher value.
  2. Production Cost – Become the lowest cost manufacturer so your margins allow you to compete on price.
  3. Value – Value add by adding a component that distinguishes you from your competitors (e.g. service).
  4. Quality – Create a higher quality of goods or services.

The best protection you have for high prices and high margins is a limited supply.

In a frictionless world where location doesn’t matter, the mantra for the 21st century should not be “location location location”, it should be “supply supply supply”.

Photo Credit: Emanuele