1. Take advantage of the law of supply and demand

The balance of supply and demand determines prices in a market economy. This blog explains how procurement should leverage the strong law of supply and demand.

Why is it called a law, anyway? The law of supply and demand isn’t a law like the traffic law—it’s more like the laws of physics. The law of supply and demand works with 100% certainty, just like gravity. No one should question the laws of physics—they should be used to your advantage.

In its simplest form, the law of supply and demand is this:

• If demand exceeds supply, prices rise and it’s a seller’s market.

• If supply exceeds demand, prices fall and it’s a buyer’s market.

This law applies both at the macro level and at the company level. At the macro level, a seller’s market turns into a buyer’s market when enough sellers increase their capacity. Conversely, a buyer’s market turns into a seller’s market when enough suppliers reduce their capacity.

A few examples of major price impacts from supply-demand imbalances at the macro level:

• In 2010, major earthquakes in Chile shut down pulp mills that normally operate 24/7 for weeks. Chile produces about 10% of the world’s market pulp. As a result of this supply disruption, global pulp prices nearly doubled.

• In 2020, the COVID-19 pandemic hit global supply chains. Companies tightened their budgets and bought less. Initially, demand for electronics also dropped. But as people were stuck at home, they began ordering all kinds of electronic gadgets. The microchip supply chain was too empty due to the early-stage bullwhip or Forrester effect, leading electronics manufacturers to fiercely compete for chips. Chip prices multiplied.

• In 2022, Russia attacked Ukraine, and the EU countries stopped buying Russian steel. Russia’s steel production volume was about 30% of the EU’s. With demand in the EU remaining roughly the same and supply dropping, carbon steel prices quadrupled.

The law of supply and demand also applies at the company level. Let’s look at it from the procurement perspective.

Companies procure all kinds of things: raw materials, services, equipment, electricity, heat, transportation, laptops, company cars, occupational health services, etc. In every procurement category, there may be more demand than supply—or vice versa. What can procurement do to improve the supply-demand situation and shift from a seller’s market to a buyer’s market?

Procurement can’t really influence demand: your customers will buy more or less depending on your company’s performance, your competitors, and other buyers of the same product or service.

But procurement can significantly influence supply. Globally, almost everything imaginable is available—if you know who supplies the product or service you want. The problem often lies in your current supplier being too tightly integrated with your company, for example by differentiating themselves or building strong relationships with your production or management. This makes switching suppliers difficult, even if they raise prices beyond what you’re willing to pay.

Procurement can turn the law of supply and demand to its advantage by increasing supply. How? You need to search for, test, and get as many suppliers approved by your production as possible.

Once you have multiple approved suppliers in every procurement category, and you regularly run competitive bidding and allocate purchase volumes to the cheapest reliable suppliers, you can keep purchase prices and suppliers in your control. A good start is getting a second supplier approved—then you’re in a duopoly instead of a monopoly situation. But aim to find all relevant suppliers so you’re not a customer for a monopoly, duopoly, or even oligopoly.

For raw materials and other physical goods with clear specifications, leveraging the law of supply and demand is easier than with harder-to-define services. But even with services, it’s possible to clearly describe the service need, find and develop supplier options, and run competitive biddings. Of course, supplier selection should always consider many criteria beyond just price.

In summary:

Procurement should improve the company’s profitability, cash flow, and competitiveness. It should leverage the law of supply and demand. While procurement can’t influence demand, it can influence supply—by searching for, testing, and approving multiple interchangeable suppliers in every relevant procurement category. Suppliers will desperately try to differentiate themselves so procurement can’t switch to cheaper alternatives. Procurement should stay calm, use market dynamics, and run regular competitive biddings. By doing so, your company will ultimately pay less for purchases, thus improving profitability, competitiveness, and cash flow—because effective tendering also helps you negotiate longer payment terms from suppliers, regardless of your size as a buyer.