By: Aaron Rubin, Founder & CEO of ShipHero
Have you ever tried to buy a popular product, but found that its prices rose almost overnight? The increase in price can be due to a number of reasons, but chances are the price went up due to the product being almost out of stock.
For example, luxury goods are an interesting topic of discussion in economics because they violate the law of demand. Unlike conventional goods, luxury items enjoy high demand because of their exclusivity and financial barriers, and making them more accessible decreases their demand.
What drives this unorthodox behavior, though? Well, the experts define it as “scarcity”.
How scarcity works
Scarcity arises when there’s a mismatch between the supply and demand of a commodity; the demand surges, and the supply doesn’t keep up. As a result, the commodity’s price rises, which is termed scarcity pricing.
Scarcity pricing is subject to the scarcity principle, which states that the good’s price will increase until its supply and demand reach equilibrium.
Scarcity can arise naturally, because certain products have limitless demand, while supply always has limitations. A good example of limitless demand is resources, like gas, electricity, and water, which have limited available reserves. When the supply for these resources doesn’t match the demand, scarcity arises naturally.
Sometimes, suppliers may introduce scarcity to influence the price of certain goods. For example, if rice prices drop significantly, suppliers may stop producing as much, so the demand increases and the price hikes.
Brands may use scarcity to drive sales, which is especially common for luxury brands. Luxury goods are priced exceptionally high, which should discourage sales as per the law of demand. However, brands use scarcity to sell luxury goods instead.
High-demand luxury products as an example
The high demand for luxury products is a prime example of how businesses use scarcity and the scarcity principle to drive sales. Luxury goods are made more desirable by implementing scarcity; the products are out of reach for most consumers, making them more appealing.
Because of the discrepancy gap in supply and demand, luxury goods providers can freely charge premiums and keep their products’ demand response high.
In fact, the more inaccessible a luxury product is, the more its demand may surge. This is perceived scarcity.
Take Ferraris for an example – to buy a high-end one, you don’t just need to match the high price point. The company vets each prospect and requires you to have owned a less-expensive Ferrari before you can buy a more exclusive model.
What happens when products become a commodity?
When products become a commodity, they lose their exclusivity and uniqueness – customers perceive the goods’ price as their only differentiator. The result? Brands are at risk of losing their customer base, and the demand for the now-commodity goods starts to drop.
Let’s take the Ferrari example again, and assume the luxury car becomes a commodity. If price became the only differentiator, Ferrari would struggle to sell any cars. Since the car is no longer perceived as a luxury, exclusive good, prospects will purchase cars that are more affordable instead.
The effects of scarcity on pricing
Depending on the industry and the nature of the product, scarcity influences pricing in interesting ways.
Higher supply costs
When raw materials become scarce, their prices increase, leading to higher supply costs. For example, T-shirts are always “scarce” products because their demand is limitless, while their supply may fall short. If cotton becomes scarce, the price for the fabric will spike, increasing the costs for manufacturing T-shirts.
Increased shipping prices
Scarcity isn’t limited to luxury goods – necessary machinery, transportation, resources, and goods can follow the scarcity principle too in certain situations.
For example, the global shortage of containers has led to a massive 300% hike in shipping costs as a result of scarcity. In this scenario, it’s not the containers themselves but shipping that’s suffering from scarcity.
With fewer container reserves, logistics providers can transport fewer items, leading to an imbalance in the supply and demand of shipping. Thus, delivery costs skyrocketed, so only consumers that pay the high fees can have their orders delivered.
Longer wait times
When products become scarce, businesses introduce longer wait times, meaning buyers cannot instantly satisfy their demand. For example, COVID-19 introduced a shortage of microchips, leading to longer wait times.
Some businesses use longer wait times to influence customer decision-making; for example, luxury brands introducing long waiting lists to:
- Increase the perceived value of the product – to create the impression that it takes more time, care, and effort to produce the desired product
- Maintain exclusivity
Another interesting effect of scarcity on wait times can be seen from services scarcity. For example, when the demand for Uber rises exceeds the supply, the service introduces a surcharge.
Thus, only consumers willing to pay the extra expense can satisfy their demand immediately. Otherwise, they are effectively experiencing a longer wait time. Services scarcity of this kind influences consumer decision-making; each customer makes a cost-benefit analysis, and decides whether to pay the premium or continue waiting.
Higher customs fees (for international shipments)
Governments may impose higher custom fees on exports for scarce products to regulate their movement. When certain goods become scarce, governments may take measures to encourage brands to cater to the local population rather than international customers.
By imposing higher custom fees, brands have more incentive to sell scarce goods to locals. Additionally, increased fees may make it difficult for brands to compete in the international market, further incentivizing them to sell locally.
For example, let’s say T-shirts become scarce in country A, so the government imposes high custom fees to ship T-shirts to country B. Now, if a business in country A tries to sell T-shirts in country B, they may not be able to compete with the local cost of T-shirts.
Scarcity affects everyone in some shape or form, arising naturally as a consequence of limitless demand, or synthetically by cultivating perceived scarcity.
Perceived scarcity is important for luxury brands because they must maintain a degree of exclusivity without encouraging their customer base to pursue alternatives.
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Aaron Rubin, Founder & CEO
About the author: Aaron Rubin is the Founder & CEO of ShipHero. He is responsible for planning and executing the overall vision and strategy of the organization. Rubin’s greatest strengths are leadership, change management, strategic planning and a passion for progression. He is known for having his finger on the pulse of ShipHero’s major initiatives, his entrepreneurial spirit, and keen business acumen. His leadership of ShipHero is grounded in providing excellent customer service that drives improved business operations. His passion for ShipHero comes from the culture and his ability to have an impact on the lives of employees, customers, partners, and investors.
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