Episode 6: Scarcity & Demand

Intro

Hey, it’s Dallas, and I have a question for you.

Well, actually I have two questions for you. And for each of these questions, we need to take a little bit of vacation to get ourselves in the proper mindset.

Let’s imagine that you and your best friend are sitting on the beach in Puerto Vallarta, Mexico. It’s a hot day, the sun’s shining, you’ve been piling chips and guac into your face for the past hour, and all of a sudden you’re dying for a nice, cold, Mexican beer.

Just then your best friend says that they’re gonna go get a can of beer, and offers to pick one up for you as well. They mention they saw an Oxxo just down the beach – and if you’re unfamiliar with an Oxxo, it’s basically Mexico’s version of a 7/11. It’s a small gas station.

So anyway, your friend tells you that they’ll grab you a beer and you can pay them back later. And they tell you that they’ll only buy you the beer if it costs as much or less than whatever price you say you’re willing to pay for it. But if it costs any more than what you say you’ll pay, they won’t buy it.

So with that in mind, while you’re sitting on the beach in Mexico, how much are you willing to spend on a beer from the nearest gas station?

Take a second and consider it….

Okay got it?

Now for the second question.

So, same setup. Mexican beach, hot day, chips and guac, you’re thirsty. Your friend stands up and says the same thing, which is again, they’ll get you a beer for the price you’re willing to pay, or less, but they won’t pay any more than what you’re willing to pay.

But here is where things get different, rather than an Oxxo gas station, the nearest beer is at one of those big, fancy, oceanside resorts.

So now given this context – a nice resort instead of a gas station – what price do you tell your friend you’re willing to pay for the beer?

Take a second and consider that one…

Okay. So again, there is no difference in your beer drinking experience. Whether the beer came from the dingy gas station or the fancy resort, you’re still drinking it on the same beach. It doesn’t take any longer to get – you’re not even the one getting it. And there’s no difference in the quality of the beer, it’s still the same beer, out of the same can consumed in the very same place.

But despite literally no difference in the beer drinking experience, the majority of you said you’d pay more for the beer from the fancy resort than you would from the gas station. And quite a bit more.

So why is this? Why do we willingly pay so much more for the very same can of beer when the only variable is which refrigerator it’s coming out of?

There are actually a lot of variables here. Some are obvious and you’re probably already thinking about them – and some aren’t so obvious.

So with that, let’s take a break and then we can dig into this one…

The Research

The question I opened this episode with is the exact scenario laid out to research respondents by Nobel Prize winning behavioral economist, Richard Thaler in his 1985 research paper titled, “Mental accounting and consumer choice.”

And unlike you, respondents in his research were in one group or the other, they didn’t get asked both questions so there was no comparison taking place. It was a much more accurate representation of how the given context of a transaction impacts the purchase price.

For example, he found that people who were put in the fancy resort group were willing to pay an average of 76% more for their can of beer compared to the group getting their beer from a gas station. Crazy right?

Again the resort group was told nothing of a gas station, and the gas station group knew nothing of a resort, so it was a cleaner comparison for researchers.

To put their differences into actual, inflation adjusted dollars, the people who were in the gas station group said they’d pay $4.28 for a can of beer. Which, I mean, feels about right to me.

Now, compare this number to the group who was told the nearest beer was at a fancy resort. This group said the average price they would pay for a can of beer from the resort was $7.56. I don’t care where you are, that’s definitely an overpriced can of beer. But, I’ve almost paid a lot more than that for a beer.

So, when you compare these numbers – $4.28 for a gas station beer and $7.56 for a resort beer – you can see just how much the context of the transaction can influence the price people are willing to pay for the very same product even when the product or service isn’t experienced within the context of where the product or service came from, and even when the product is identical.

Think of how different buying a cellphone from the Apple store is compared to buying the same phone inside of a T-Mobile store. It’s just not as fun, right? Or what about buying a used car from the certified BMW dealership compared to the same car, but from one of those skeezy used car lots. Or buying a pound of bananas from the farmer’s market, compared to a higher-end grocery store with chandeliers in the aisles like a Byerlys.

And in those examples the buyer is physically experiencing the change in context, which can come in many forms such as the quality of the customer service, the atmosphere of the location, or even the demographics and psychographics of other customers within the store, and how a buyer associates themselves to the other buyers.

In our beer-on-the-beach scenario, even though our respondents didn’t physically experience this context switch, they still considered the context of where that transaction was going to occur. A resort has a better proverbial brand, or brand expectation than a gas station and that brand comes with a premium price tag in the buyer’s mind.

Another factor was that people associated gas stations with ubiquity. Meaning, if there’s one gas station, there’s likely more gas stations within a reasonable distance. Alternatively, resorts were associated with seclusion. And this is the first example of scarcity entering conversation… the thinking of, “well, there’s probably several gas stations, but only one resort…” drives an increase in what a buyer will expect to pay, partly because they think it’s the only one around who has what you want.

Fairness was another consideration. When potential buyers have a reference point in mind – and in this example, people will likely know a reference price for a can of beer – a potential buyer will find it incredibly unfair if a gas station charges $7.50 per beer. The buyer will feel like they’re being taken advantage of and they’ll simply refuse the purchase. However, that same price point is a little more “fair” when a resort asks for it – partly because the resort has earned it, at least that’s the perception, and that perception exists because of trust.

In the mind of potential buyers, trust of an individual brand, or the category of the business matters. Naturally a buyer trusts a big fancy resort more than a gas station, and this perceived trust has been established over decades of cumulative buyer experiences. It’s similar to how we trust large established banks more than a PayDay Loans for example, or even more than some of these new online-only banks. We’re willing to open our wallets a little bit more to engage with the more trusted brands.

Lastly and most importantly, one of the biggest differentiators in what a buyer was willing to pay was the state of their personal finances. That might seem obvious. But when you dig in deeper and think about why, it becomes a little bit more nuanced.

While high-income participants said they’d pay more for a beer from the resort, low-income participants were really unchanged in what they’d pay. They said they’d pay roughly the same for a gas station beer or a resort beer. It didn’t matter to them where it came from because they could only afford to spend so much on any given beer.

Again, this is scarcity. But, this is financial scarcity. And this is the type of scarcity that we need to dig into. Because, this is what’s influencing the buying decision of every one of your customers.

And that could be a good thing, or it could be a bad thing….

Why It Works

Let’s talk about scarcity in its more broad sense for a minute.

We tend to think of scarcity in general terms. Like how 1.2 billion people live without electricity, 663 million don’t have access to clean water, and how nearly 11% of the world’s population lives with less than $2 per day.

Thankfully things that likely aren’t personally impacting the listeners of this podcast.

But we’re all still impacted by scarcity because it shows up in a lot of other, less noticeable places. Your time can be a scarcity for example. If you own a business, qualified labor could be scarce. If you’re unemployed, job openings could be a scarcity. Products and services can also be a scarcity. Like… medication, the new iPhone you can’t get your hands on, or even toilet paper it turns out.

So we too deal with scarcity, everyday. And when we’re dealing with a scarcity of some sort, the scarcity of that resource begins to consume our available mental resources. Things like our attention, memory, and executive control are all negatively impacted until that want, that need, or desire is fulfilled.

I’m sure you can all remember a time when you were trying to buy a product, or a concert ticket, or get reservations at that cool new restaurant, only to find out it was sold out. Then you wanted it more and it became all you could think about.

That’s because scarcity does two strange things to us. The first is a little less surprising, it’s called attentional awareness – and it explains almost every advertisement you’ve ever seen.

For example, people who are hungry are more likely to detect food-related cues on a computer screen, compared to people who have recently eaten. People who are thirsty are more likely to focus on water-related cues. Alcoholics and dieters are more likely to notice alcohol and food-related cues. And people with retirement or financial anxiety are naturally more responsive to retirement or money-related cues on a screen.

Just turn on Nickelodeon and you’ll see ads for all of the things teenagers are anxious about, then switch to CNN and you’ll see everything a 65 year old is anxious about.

Again, that’s not super groundbreaking stuff, but it’s important to understand to make sense out of the other thing that happens to us, which is called inattentional blindness.

Inattentional blindness is what occurs when we’re so focused on our most scarce resource, that basic visual cues, even when they occur directly in our field of focus, go unnoticed.

For example, imagine you’re pitching a client a new paid media lead generation program. A client who is dealing with a cash shortage – or financial scarcity – they won’t be able to focus on anything you’re telling them about your amazing lead gen program except for how much it’s going to cost them. Your pitch will struggle to land until their scarce resource is no longer scarce.

Or for example, a business owner who has a major time scarcity problem, may decline a potential invaluable meeting or business opportunity because all they can think about is how they don’t have the time for it.

Scarcity drives our behaviors. Scarcity controls the cues that get our attention, and the things that don’t. It wears down our memory, it steals our attention and it causes us to miss vital information even when it occurs right in front of us. And it’s impacting all of us all the time in one way or another, because we never have all of our needs, or all of our resources met at the same time.

So, if we’re dealing with scarcity issues – our time and our money for example – and our potential customers and clients are dealing with the same or similar issues, how do we possibly get them to spend those scarce resources with us?

What To Do About It

I’ll get the obvious one out of the way early – get better customers. Customers who will understand the impact of your work and pay you more to do that work.

For example in our beer-on-the-beach example, the high-earners were the ones who drove the price increase between the gas station and resort groups. The low-earners didn’t pay any more or less for the gas station beer or the resort beer, because they couldn’t. They have financial scarcity.

And now that we’ve talked about how their scarcity is stealing their attention and controlling their decision making, we can better understand what’s happening with them internally when that friend asks how much they are willing to pay for the beer.

Instead of thinking about how amazing that beach is, how tasty a Mexican beer is, how it would create such a memorable experience, they’re consumed by their financial scarcity and shift into a cost-analysis mode. They start to do mental accounting. They move into a budgeting process and they think about where else they will need to cut back if they spend more for a beer than they should have. This scarcity and this mental accounting is what pulls down the price they are willing to pay.

And this is exactly what your smaller customers or clients are doing to you. This is why the smaller clients seem like the bigger headache at times. Because everytime they’re talking to you, emailing with you, working with you, they are doing mental accounting. They are doing a cost analysis of your services. When you show them an amazing report and you think you’re killing it, or you’re telling them how much time your software has saved them, all they are doing is mapping that performance to what their expense is. They have this death grip on their expenses because it’s directly depleting their most scarce resource. And even if your work is the thing replenishing that scarce resource, they can’t see it. They have blindness due to their scarcity.

On the other hand, high-earners in our beer-on-the-beach example didn’t have a financial scarcity. While the low-earners paid the same for the gas station beer and the resort beer, the high-earners paid significantly more for the resort beer. They didn’t do a mental accounting and they weren’t performing as stringent of a cost-analysis. They still wanted to pay less at the gas station because of other factors, but they were willing to pay more when they felt they needed to. They wanted the beer. They wanted the full experience, and they were willing to pay for it.

So, how do we get better clients? How do we attract buyers who are expecting and willing to pay more for our products and services, while also potentially excluding the buyers who have financial scarcities and want to spend the whole relationship fighting over price?

Think about how simply the thought of buying a beer at the resort impacted the buyer’s willingness to pay more – at least among those who could afford to. I’m not a branding guy, but the brand does matter. And it goes beyond the logo.

The resort’s brand is stronger than the gas station’s brand because of years of accumulated brand reputation, customer experiences, overall brand awareness and recognition, customer service expectations and quality of the offerings. Each of these items compound to create a better perceived brand. A brand more people are willing to pay more to engage, when compared to a brand who has a poor reputation, inconsistent or poor quality products, poor performance outcomes, bad customer service and so on.

How the brand is experienced is incredibly important as well. Again, think back to our Apple Store versus T-Mobile and how different they are and how much better the Apple Store experience is. Think about why the waiting room of a plastic surgeon feels different than the waiting room of an urgent care, and the type of clientele each attracts and what they are expecting to pay. Think about the in-store experience of Target compared to Yves Saint Laurent and which one has a line down the street to walk into – which is intentional by the way.

The physical context of where the shopping and transaction happens, matters. It matters three-fold. For one it’s what allows you to create higher demand and charge a higher price, and two it naturally attracts the buyer who is able to pay your higher prices. And three, the financially scarce buyers won’t even enter the store. They are appalled at your prices – the cost to do business with you – and that’s okay. You want to price them out because more often than not, they’re not worth dealing with them.

The same goes for your website or in-app experience. If your website feels cheap. If it’s a poor user experience, if it’s difficult to navigate. If your differentiators aren’t clearly articulated or your copy is overly salesy – your potential buyers will notice.

Just like the physical shopping space, if your digital space is where you’re expecting your main transactional process to take place, you can’t have a website that looks like a proverbial gas station and expect to charge resort prices. You’ll be attracting the gas station audience who won’t be willing to pay the prices you’re charging, while the audience who can pay what you’re charging, won’t be attracted to your business.

So, we’ve talked about building a brand with high market awareness, sustaining and building trust over a long period of time. We’ve talked about creating an exceptional customer experience that helps your brand rise to the top in the physical and digital space, and charging a premium for that experience. We’ve discussed how these few things will create a gravitational pull of higher-value clients, while helping the lower-value clients self-select out.

Another tool to raise your prices without explicitly raising prices at the expense of good will, is finding ways to break price reference points.

Like we talked about, customers who have previously purchased a product or solution similar to yours will have an established reference point when they begin shopping. For example, if you’ve spent the last 10 years getting a sandwich on your lunch break, you’ll know a sandwich should cost about $6. If all of a sudden you see a restaurant selling a $20 sandwich, you’ll scoff at the price, lose trust in the business and think it’s unfair pricing because you know what a sandwich should cost. And since sandwiches are not scarce, you’ll just get one somewhere else.

This type of internal reference point – if you let it stay in place – will become your buyer’s price anchor for all future purchasing decisions, meaning you’ll have to fall within the boundaries of this established reference. In marketplaces, this is called the clearing price.

But you can break these reference points, in a few different ways, creating the perception of value and scarcity, and charge more.

One way is to sell your product or service offering in different sizes, quantities, or in a new format. Something where it’s harder for the buyer to establish a reference. For example, movie theater candy comes in sizes you don’t see offered anywhere else, so it’s harder for the buyer to know what it should cost. So, per ounce, the movie theater is able to charge more, demanding a higher net margin.

You can also raise the perceived price of a product or offering by adding excessive luxury. This can be in terms of the quality of goods offered, such as having a Louis Vuitton leather interior option in a new car. It could be offering a dedicated team of internal support members at a certain price point. Or it might be a private tasting experience at a nice restaurant where the sommelier comes out and sabers a bottle of champagne tableside. People who can, will pay for these types of things.

Another, slightly more sneaky but effective way to charge more, is to integrate the price increase into a larger number. You see this a lot. For example, Super Bowl tickets are often sold in bundles including hotel and airfare. This obscures the reference point. As the buyer, if you want to compare each element to a reference point, you’d have to price each one independently – which is what the buyers with financial scarcity will do. But less financially scarce buyers will just pay the bundled price which is where the NFL hides the additional markup on the tickets. These buyers also typically don’t care and just consider it a convenience fee.

Hotels have a variation of this too. Over special event weekends, like college graduation, they’ll require a three night minimum stay. Hotels know that the demand is only for two nights, but they’ll require three. So let’s say on a typical weekend they charge $250 per night for two nights, which is $500 of revenue. With a three night minimum they can say they charge only $200 per night – tricking all of those online search filters and falling below or within a buyer’s established reference point – but over three nights it’s actually $100 of additional revenue.

Lastly, be one of one. When you’re just one of many, buyers know there are a lot of options just like you, where they can go to buy a similar service or product, so they go price shopping. But when you’re one of one, they will pay what you ask them to pay because if they want you, you get to tell them what it costs to have you. You get to decide what you’re worth, relative to the value you’re able to create.

So again to recap, build a brand that is loved and trusted by those who matter most. Create exceptional customer experiences in-store and online. Find ways to create a service offering, offered and priced in a way that is unique to the market, fair to the buyer and allows you to charge more for the value you create. And be the best in the world at it, or at least try to be the best in the world.

There are not a lot of businesses checking all of these boxes. There aren’t a lot of brands offering exceptional customer service, exceptional customer experiences and best-in-class services. Most aren’t even trying.

This has created its own kind of scarcity, which I’ll call brand scarcity.

This brand scarcity is driven by the fact that clients are demanding better and better services and experiences, and there are less and less businesses able to meet those demands. In other words, there is asymmetrical supply and demand for great businesses. High demand, low supply.

And remember, when in a scarce market – one where there is more demand than supply – buyers will willingly pay an exceptionally high price for the goods and services that are able to meet their demands at the exact moment their demands need to be met.

That’s the business you want to be, that’s the buyer you want to have.

Dallas McLaughlin