The Pricing Behaviour of Goods

Understanding the pricing nature of goods is critical when you are managing them as a supply chain professional. As a buyer of goods, you have to understand the seller's ability to control pricing and the good's pricing behavior.

Pricing Power

A commodity refers to a good that is fungible, meaning there are essentially no distinguishing features from one vendor to another. Therefore, the goods in this category can be interchanged between them with little consequence. The seller is said to have no pricing power (the ability to influence pricing). On the other side of this spectrum is a custom product that no other vendor can produce. With these products, the seller have the ability to increase pricing as much as the demand market can bear. Negotiations become increasingly important as the good moves away from being a commodity to a one-of-a-kind good.

Demand Behaviour

In economics, a normal good is one where the lower the price, the higher the demand. For example, a $500 phone will have less demand if the price rises to $800 but will have more demand if the price decreases to $200. The price elasticity refers to the sensitivity of demand to changes in pricing. For example, toilet paper will have lower price elasticity than a phone because it is a daily necessity.

A Veblen good, named after economist Thorstein Veblen, is a good that has an opposite price-to-demand relationship than a normal good. Luxury goods are the typical Veblen good. For example, an Audemar Piguet Royal Oak or Birkin Bag is desired because it is expensive. The high price increases its status and exclusivity. Luxury brands intentionally create scarcity to create demand competition that raises the prices of their products. When managing materials that go into a Veblen good, availability, efficiency, and value become less important while quality, uniqueness, and rarity become more important.

An inferior good is different from a normal good in that its demand decreases as income increases, whereas a normal good will see demand increase with income. Public transport and generic branded grocery products are examples of inferior goods because people may elect to commute by vehicle or eat out more often if their income increases. General income and economic data can be used as a proxy to predict inferior good demand.

These concepts are typically studied in economics courses. It is vital to understand the nature of the goods you are buying because it will help you get the best deal and give your business more predictability. For commodities, generally, you should understand the overall market supply and demand for the specific commodity you are looking to manage. Be aware of the market indices that exist for the commodity and the types of financial instruments (futures) that are available. For more complex goods, understand the features and attributes of the product along with the history and strategy of the suppliers you are planning to purchase from. Have an awareness of their ability to leverage and the risks they are exposed to. I will introduce the Product Life Cycle in a future post. This will add to your ability to approach the acquisition of goods in a more strategic way.