Having a sophisticated understanding of the supply and demand of your goods and services is a crucial element in running a successful business.

Supply accounts for the quantity of goods or services your business supplies. Demand accounts for the amount of goods or services that will be purchased at a given price. Typically, if prices fall sharply, demand will increase because more buyers will be willing or able to purchase the product. Similarly, if the supply of a good or service is dwindling, the price rises; whereas if there is an excess of a good or service, the price falls because there are plenty of suppliers to meet the demand.

Analyzing supply and demand will lead you to a better understanding of your market and the needs of your customers, helping you find an equilibrium price for your product. Failure to properly analyze supply and demand could leave you with a product surplus or shortage, or it could cause you to price your product improperly.

What Factors Influence Demand?

When determining the demand for your product, you will want to take a number of elements into consideration. Researching your market (its size and scope), analyzing the sales of your competitors and determining how much your target audience spends on your product every year will help you understand the overall demand for your good or service. You will also want to research past fluctuations in demand and watch for trends that can help you gauge when demand may rise or fall.

If your business already has customer information, you have an advantage, as you can use sales records and information about where they live to segment your marketing and improve its effectiveness. You can also talk to your employees or look at your website’s analytics (here are some helpful analytics tools) to determine which items or services are frequently requested to gain a better understanding of your consumers.

Consider using surveys or interviews to gain more information about your customers’ experiences and desires. This will help ensure you are meeting your customers’ needs and will give you immediate feedback regarding their levels of demand for your offerings. Mail, email or telephone surveys can also be an effective way to gain information from customers or from people in your target market. You can also use secondary sources from trade associations, government agencies, public records, books or magazines to cross-reference your own research.

Ideally, you want to fulfill a demand that isn’t being fully met by the market or that simply has a high-enough demand that your product can be a part of the solution. Keep in mind, however, that a low demand does not necessarily signify an oversaturated market. Sometimes, your target market will be small, but because of their specific needs, they may be underserved by current competitors.

A large demand also does not mean a “sure thing” in terms of success; sometimes, a market has a high demand but also has a very large supply to meet it, along with a slew of experienced competitors focused on meeting this need.

What Factors Influence Supply?

Factors that can influence the supply will depend on your specific good or service. For example, the supply of agricultural products can be impacted by weather, insects and pests.

Other factors could include changes in the price of materials or a major change to the supply chain, such as the delay of products due to a natural disaster, a drop in the availability of the fundamental “building block” materials, or a change in the price of labor (for instance, due to outsourcing). In the digital realm, for example, the supply of software engineers has boomed with the advent of websites like oDesk, which increases the accessibility of outsourced and international workers.

AdWords Can Help Estimate Demand

Google AdWords allows you to check how many times a word or phrase has been searched for over the last month. If you see that a lot of people are searching for your product, it’s a good sign, but it doesn’t necessarily mean there is a high demand for what you’ll offer. Search for terms related to your product, and take into account local searches as well.

If you think there is a demand for your product based on these criteria, you may want to purchase a domain name and create a webpage. Create a landing page advertising the product you intend to sell; ask for the names and email addresses of your potential customers, and take note of the amount of people that show interest in your product.

Changes to Supply and Demand

When your business is up and running, it’s important to conduct regular supply-and-demand analyses in order to understand changes that have occurred to the supply and demand of your product or service. Regularly analyze your sales numbers; see if you have surplus supply or a shortage, and adjust your orders appropriately.

Check your current supply and demand against that from previous weeks, months or years, and look for trends. Try to compare from seasons that will match with the current market if seasonal conditions affect the supply or demand.

Changes to the economy and other factors that influence individual income can change the demand for a product. As disposable income rises, so too does the demand for products, and vice versa. This is known as the “income effect.”

Try to find the “sweet spot” in terms of meeting the demand of your customers at any given moment. If your product is perishable (e.g. food) or is only relevant for a short period of time (e.g. a t-shirt based off a fleetingly popular celebrity), consider how much of a surplus you can have at one time before your products are likely to go to waste. If your product is more timeless, you may consider having a “backlog” of supply in case of a sudden boom in demand.

Elasticity of Demand

Understanding the elasticity of your product will help you gauge how its demand will be affected by its price. An inelastic product is one whose demand is not affected by a change in price. Necessities (i.e. gas, medication, etc.) are typically considered inelastic: People will buy the product regardless of the price because they have to. On the other hand, a product with high elasticity will have its demand fluctuate greatly as its price changes. Non-essentials are typically elastic since people can choose to forego a purchase if they feel the price isn’t right.

Marketers use degrees to measure the elasticity of a product. For example, a product with an elasticity of 1 will have its demand increase or decrease at the same pace of its increases or decreases in price: If the demand changes by 10%, so too will its price. If another product has an elasticity of 2, when its demand increases by 20%, the increase in its price will only be 10% (20/10=2).

Doing a proper analysis of supply and demand can help your business find the correct equilibrium, where you have enough of your product to meet consumer demands and are able to set a price that maximizes profits.