The Law of Demand
In economics, the Law of Demand tells us that when prices are lowered people will want to buy more of something. Inversely, it also tells us that when prices are raised people will want to buy less of something. This fundamental law of economics is a valuable tool when top-level managers are deciding how to price their products, goods, and services. One industry where I believe the Law of Demand is often overlooked is the service industry. Let me take a second to thoroughly define what I mean by the “service industry” in this context. A business in the service industry has many attributes.
The most important attribute of a business in the service industry is the fact that past a certain point of “customer count” equilibrium, the quality of service, as well as customer satisfaction peaks. Therefore there is an almost quadratic relationship between quality of service/customer satisfaction and the number of people being served.
The fact that marginal customer satisfaction decreases beyond a certain point (we’ll give this a name later on) is a serious problem for service-based businesses that are trying to scale. Before we discuss how these businesses can use price as a way to combat this issue, let’s look at some examples of this problem occurring in the real world and identify their roots. A good example of a business that has historically faced these problems and still struggles to manage these issues today is the Walt Disney Corporation, specifically with their theme park properties.
Disney has been combating overcrowding at its theme parks since the original Disneyland opened in 1955. The first day Disneyland opened was plagued by many disasters, one of which was that Disneyland had grossly underestimated the number of attendees that would show up to the park on their opening day. There were so many people and Disney was so understaffed to handle the masses that people actually started throwing their children over the crowds to get them on to rides.
The Limitations of Disneyland
Let’s break down the challenges that Disneyland faces when considering the service that they provide and their efforts to scale up.
The most obvious challenge that they face is space: the actual geographic area that Disneyland occupies and the land that is available to them to use to operate the park. Obviously, ten million people would not be able to go to Disneyland at the same time. The size of the property would not permit ten million people to even physically occupy the space that the park occupies. There are not nearly enough parking spots, even if you account for an average of four visitors per car. The highways in Anaheim, California would not be able to handle the traffic generated by ten million people, trying to go to Disneyland all at the same time either. Long story short, all those people simply wouldn’t fit.
You can only serve so many people...
The next challenge that they have that threatens the quality of their service is staff. Disneyland is known for its excellent hospitality and helpful crew members. Their property is well staffed in both quality and quantity. Now imagine the scenario we talked about earlier where ten million people try to go to Disneyland.
How many people would Disneyland need to have on staff to even handle a crowd like that? One-hundred thousand? Five-hundred thousand? Forget trying to hire that many employees to work on site at one property. Imagine training half a million employees and cast members to give each and every Disneyland visitor a quality experience.
What I’m trying to get at here is that Disneyland is confined to the area that it occupies and, while this number may be difficult to derive, there is a limit to how many people can visit the park and how many people can work in the park in a single day.
Earlier, we talked about a point of customer equilibrium. We will revisit this concept while simultaneously introducing the concept of employee equilibrium. Customer equilibrium is important. For example, Disney must do a good job at determining how many people their Disneyland theme park can comfortably hold.
How far can Disney push it?
Let’s take a second and define what comfortably means in this context. Imagine what Disneyland would be like if there was nobody there. It would not be that enjoyable of an experience. Being there all alone or even with a small group is not how most people want to enjoy the park. Hearing children laughing, other visitors screaming, and seeing other families having a good time is a part of the experience.
Standing in line is also a part of the experience. Taking a couple of minutes to cool down, make some new friends, check your phone, and relax is crucial. Also, how else would you find where they were selling the turkey legs if you didn’t have random strangers to walk up to and say “Hey! Where’d you get that?”
Inversely, there is clearly a point where there can be too many people inside Disneyland. Anyone who has been to Disneyland on a holiday weekend can attest to this. When the park is extra crowded it can take hours and hours to make it on to your favorite ride. The wait times can fluctuate to such extremes that there is an app that visitors can use to see what the wait times are for each ride.
Waiting in line is just a part of going to a theme park or amusement park, but no one wants to spend more time in line than doing literally any of the other wonderful things that Disneyland has to offer.
When acknowledging that there can be too few and too many visitors at Disneyland, we know that there exists a happy medium; an equilibrium point. This equilibrium point is the point where if one more or one less visitor bought a ticket or was admitted into the park it would marginally detract from the experience of all existing visitors. While their customer equilibrium probably doesn’t always perfectly align with the supply and demand equilibrium of their tickets, Disneyland is well aware that it exists.
Tying in Economic Equilibrium
Let’s briefly tie employee equilibrium into this. For the sake of continuity, let's continue using Disneyland as our example. Disneyland has a lot of visitors doing a lot of different things and they offer a variety of services. This is why they need a large and diverse staff. Like any business in the service industry Disneyland needs maintenance people, concierges, information people, security, etc. However, Disneyland is unique in the fact that the park draws themes from their media franchises. Disneyland employees hundreds of “cast members”. These cast members are tasked with dressing up as characters from Disney’s vast list of franchises and entertaining the park’s visitors. Cast members are a great employee category to discuss employee equilibrium.
Disney has been having people dress up and interact with the visitors since the beginning and without them, the experience would never be the same. They are an essential part of the magic and a staple of the park. You don’t want to have to go running around the park looking for them. However, on the flip side you would not want to feel overwhelmed or “heckled” by the cast members. Large men in costumes can often be frightening to small children and having an excessive amount of them would be chaos. Disney finds a happy medium, an employee equilibrium, with their cast members.
So, what does this have to do with inventory?
Think about it. Disneyland sells popcorn, candy, and balloons, but what really is their inventory? They are in the service industry. Their inventory is their ability to serve. How many waves Mickey Mouse can give to children on a given day is a factor of inventory. However, like we talked about earlier. Changing “inventory” levels at Disneyland can be very difficult. It is not as simple as putting in another P.O. for more products that you are going to sell. They’d have to go through a process of firing, interviewing, and hiring or even worse have to conduct expensive and time consuming construction projects to build new attractions or to increase the attractions and space needed to facilitate them.
Instead, Disney can use a powerful tool to regulate the flow of visitors to the park: price. Starting in October of 2018, Disneyland now prices tickets differently depending on the day that your ticket allows you entrance into the park. They are using price as a form of inventory control. In their case they aren’t just using price as a form of inventory control, they are also using price to uphold the integrity of their “inventory” and ensure that the Disneyland “experience” is maintained.
Disney knows that their customer base is very broad. They have visitors from all over the world with different tastes, preferences, income levels and budgets. They recognize that while everyone that walks through their gates likes Disneyland (that is why they are there), some people like Disneyland more and some people like Disneyland less. Given this understanding, price could be a major contributor as well as a major inhibitor when one is deciding what day to plan their visit to Disneyland.
So how and why is price sometimes a contributing factor to the number of tickets purchased? The Law of Demand! As stated earlier, for most goods, at a lower price consumers will tend to demand more of a good. Disneyland tickets are no exception. Alternatively, at a higher price, less tickets will be demanded.
How’d Disney figure this out?
Let’s review and break down the processes and steps that Disney most likely went through in order to form a strategy to use price as a tool to control their inventory.
- Disney determines the maximum numbers of persons that can reasonably fit inside Disneyland. This includes staff at all levels and all visitors.
- How many visitors is too many? (i.e. what number of visitors creates zero marginal “enjoyment” at the park) In economics, we call this the point of satiety.
- How many employees are too many? (i.e. what number employee adds zero marginal “enjoyment” for the visitors) (This is a function of the point of satiety of visitors. See graphic below.)
- Test a variety of prices over a given period of time.
- Use the data collected from step #4 to determine the elasticity of demand for a Disneyland ticket.
- Raise or lower the price of tickets on different days accordingly with the goal of using price to entice prospective visitors to buy or in some cases to refrain from buying tickets so that the park’s visitor count is equal to the visitor count point of satiety every single day.
Are there any adverse effects from this inventory control strategy?
Yes, but only in the short run. You will have people arguing that a practice like this is immoral and that it should not be fair to charge people more money on days of higher historical visitor counts. They may argue that this is because the days that have higher historical visitor counts are most likely the days when a majority of people have days off work and school. At these higher prices on the high volume days, lower income Disneyland goers would be disincentivized to go at arguably higher rates because of the concern of cost.
I would argue that these concerns are false and unfounded. This is why:
It is wrong to simply assume that price is the only factor that drives all people to either buy or not buy a Disneyland ticket. People who love Disneyland love it at different rates. People have different tastes and preferences that can be relative or totally independent to their budget and income. Someone who makes $100,000 per year might be willing to spend more money on a product than someone who makes $1,000,000 per year simply because they like it more. The key is that people are all uniquely different and that’s what makes us all human!
Visitor Equilibrium = Better Service
Secondly, if Disney is successful in creating visitor equilibrium they have the ability to drastically increase their customer satisfaction rates. While the possibility of undersaturation exists, I think it is safe to say that Disney’s main problem is overcrowding. Disney has a very specific way that they want their visitors to enjoy the park.
Like we talked about earlier, Walt Disney closed down the park the day following the grand opening so that a select group of people could experience the park “properly”. By increasing the ticket prices and thinning out the crowds to a point of equilibrium Disney has maximized their average visitor’s personal value for their tickets. At first, visitors might be weary of paying more for their tickets, but in the long run, if Disney has done a good job with this strategy, people will feel like the value added outweighs the downsides of the price hikes.
Lastly, incentivising people to go to Disneyland on days that have a historically low visitor count will shift the demand for tickets on different days. In the long run, once people get accustomed to this new system of ticket pricing, ticket purchases will shift with more tickets being sold on low density days and less tickets being sold on high density days compared to how things were before this strategy was adopted.
While it is unlikely that Disney can pull the strings effectively enough to create a pure equilibrium (i.e. the park has the same exact number of visitors each day), they will surely move closer than they were before. In the long run this might actually raise prices of the tickets on low density days as they slowly become high density days due to the attractiveness of the ticket prices on those days. Inversely, as the days that were previously considered to be high density thin out, the prices will likely drop as visitors count inches towards perfect equilibrium.
Some Closing Thoughts
So what does this mean for other businesses in the service industry? Look towards optimizing your customer base and the size of your staff before trying to scale. Having too many customers is only a bad thing when you can’t provide the service you want to provide to that many people. It also means that your prices are too low! Capture that hidden value and listen to your customers! The perfect price for your services that allows you to have healthy inventory numbers (staff and facilities needed to provide your service) and the perfect number of customers who love and appreciate your company exists, you just have to find it.