Supply vs. Demand: Stop Focusing On The Wrong Problems | Ep 899
In this episode of The Game, Alex Hormozi breaks down a fundamental business principle: companies are either limited by their supply or their demand, but never both at once. He explains how businesses can identify their main constraint by examining what would happen if they doubled their advertising spend, and outlines the key strategies for managing each type of constraint.
For supply-constrained businesses, Hormozi details approaches like raising prices and improving service delivery methods. For those facing demand constraints, he explains how to properly allocate marketing resources and optimize sales processes. Throughout the episode, he emphasizes the importance of correctly diagnosing constraints, as businesses often waste resources by focusing on solving the wrong problems.
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1-Page Summary
Understanding Business Constraints
Alex Hormozi explores the fundamental concept that businesses are either constrained by supply or demand, but never both simultaneously. He explains that businesses can identify their constraint type by considering what would happen if they doubled their advertising budget—if this would create chaos rather than doubled sales, it's likely a supply problem.
Managing Supply Constraints
When businesses have more customers than they can handle, Hormozi recommends three key strategies. First, raising prices (sometimes by 50-100%) can quickly align demand with limited supply. Second, adjusting service delivery methods can increase capacity without adding resources. Third, developing efficient training systems for new personnel can expand service capabilities. Hormozi notes that even teaching existing employees basic sales skills can significantly boost revenue without additional hiring.
Addressing Demand Constraints
For businesses with excess capacity but too few customers, Hormozi advocates shifting resources from product development to marketing. Using a software firm as an example, he highlights how underfunding marketing (spending only 5% compared to competitors' 20-30%) can stifle growth. For online businesses, he suggests optimizing sales funnels, improving ad campaigns, and selling complementary products to existing customers. For restaurants, he recommends adjusting pricing and extending service hours to increase customer flow.
Adapting to New Constraints
Hormozi emphasizes that businesses often struggle by focusing on outdated constraints instead of addressing current ones. As companies solve one constraint, new ones emerge—requiring constant adaptation in strategy and resource allocation. He illustrates this with an example of an enterprise software company that remained stuck because it misdiagnosed its growth problem as a sales team issue when the real constraint was demand-related.
1-Page Summary
Additional Materials
Clarifications
- In business theory, the concept that businesses are constrained by either supply or demand, but not both simultaneously, suggests that a company's primary limitation in achieving growth or efficiency typically stems from either not being able to meet customer demand due to supply limitations or not having enough customer demand for the available supply. This idea helps businesses focus their strategies on addressing the specific constraint they face, whether it be related to production capacity or market demand, to optimize their operations effectively. By understanding and identifying whether the constraint lies in supply or demand, businesses can tailor their actions and investments to alleviate the bottleneck and drive overall performance. This framework encourages businesses to analyze their operations holistically and prioritize actions that directly target the key constraint to maximize their potential for growth and success.
- When identifying the type of constraint a business faces, doubling the advertising budget can help determine if the constraint lies in supply or demand. If doubling the advertising budget leads to chaos rather than a proportional increase in sales, it suggests a supply constraint. Conversely, if doubling the advertising budget results in a significant increase in sales without causing operational issues, it indicates a demand constraint. This exercise helps businesses understand where their primary bottleneck lies and guides them in implementing appropriate strategies to address it.
- When a business doubles its advertising budget and experiences chaos rather than a significant increase in sales, it suggests that the issue lies in the company's ability to meet the increased demand generated by the advertising. This chaos could stem from challenges in production, distribution, or other aspects of the supply chain, indicating a supply constraint within the business.
- Underfunding marketing can hinder growth for a business because marketing plays a crucial role in attracting customers and driving sales. When a company allocates a significantly lower percentage of its budget to marketing compared to competitors, it may struggle to reach and engage its target audience effectively. This can result in lower brand visibility, reduced customer acquisition, and ultimately slower business growth. By investing more in marketing efforts, a company can increase its market presence, generate more leads, and potentially outperform competitors in terms of customer reach and revenue growth.
Counterarguments
- Businesses may experience both supply and demand constraints simultaneously in different aspects of their operations, challenging the idea that they are mutually exclusive.
- Doubling the advertising budget may not be a definitive test for identifying supply versus demand constraints, as other factors like market saturation or brand perception could influence the outcome.
- Raising prices to manage supply constraints could potentially alienate customers and damage long-term brand loyalty.
- Adjusting service delivery methods to increase capacity might compromise the quality of the product or service, leading to customer dissatisfaction.
- Efficient training systems are beneficial, but they may not be sufficient to address deeper issues related to supply constraints, such as limited physical resources or production capacity.
- Teaching existing employees basic sales skills assumes that all employees have the potential to be effective in sales, which may not be the case.
- Shifting resources from product development to marketing could lead to stagnation in product innovation, potentially harming the business in the long term.
- The recommendation to spend more on marketing assumes that increased spending will lead to increased effectiveness, which may not always be true due to diminishing returns or poor marketing strategies.
- Optimizing sales funnels and ad campaigns may not address the root cause of demand constraints, such as market needs or competitive offerings.
- Extending service hours for restaurants to increase customer flow may not be feasible or profitable in all locations due to varying labor laws and customer habits.
- The idea that businesses often focus on outdated constraints may overlook the fact that some constraints are persistent and require ongoing attention rather than a shift in focus.
- The concept of constant adaptation in strategy and resource allocation may not account for the benefits of stability and long-term planning in certain business models.
- The example of the enterprise software company misdiagnosing its growth problem could be an oversimplification, as businesses often face complex issues that are not easily categorized as solely supply or demand constraints.
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Identifying a Business Demand or Supply Problem
Alex Hormozi delves into the common misconceptions around business constraints, explaining that a business can either be constrained by supply or demand, but not both simultaneously. He further clarifies how to diagnose these issues and suggests strategies for businesses that are supply-constrained.
Businesses: Supply or Demand-Constrained, Not Both
Hormozi elaborates on what he calls the accordion effect where businesses fluctuate between being supply- and demand-constrained. He clarifies that it's not possible for a business to be both at the same time. To determine the type of constraint a business is facing, Hormozi suggests considering what would happen if the business doubled its advertising budget. If doing so would lead to disarray rather than a doubling of sales, the business likely has a supply problem.
Supply-Constrained Business: Too Many Customers, Not Enough Capacity
When a business has too many customers and not enough capacity to serve them, it's supply-constrained.
Strategies: Raise Prices, Adjust Service-To-delivery Ratio, Add Headcount
Hormozi outlines three strategies for businesses to address supply constraints: raising prices, adjusting the service-to-delivery ratio, and expanding the workforce.
Raising Prices Rapidly Aligns Demand With Limited Supply
Raising prices, especially during peak times or for certain high-demand services, can quickly bring demand in line with the limited supply. For example, raising prices on Fridays and Saturdays when restaurants are busiest can significantly boost profits because of traditionally low margins in the industry, which can result in the same earnings with fewer customers and less work. Hormozi suggests that businesses experiencing a supply constraint consider increasing rates by 50 to 100 percent. Even if some clients are lost in the process, the overall profit could still increase.
Changing the Service-To-delivery Ratio Can Increase Capacity
Although Hormozi does not explicitly discuss adjusting the service-to-delivery ratio in the provided content, it's suggested that actions like changing business hours to stay open later can help manage the capacity constraints. By expanding how many customers one can serve—possibly through one-to-many services—a business ...
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Identifying a Business Demand or Supply Problem
Additional Materials
Clarifications
- Expanding customer service capabilities through onboarding new consultants or personnel involves the process of training and integrating new hires into the existing workforce to enhance the business's ability to serve customers effectively. This includes teaching new employees the necessary skills and knowledge to provide quality service and support to customers. By onboarding new personnel, a business can increase its capacity to handle customer inqui ...
Counterarguments
- Businesses can experience both supply and demand constraints in different areas or at different times, challenging the idea that they cannot be simultaneously constrained by both.
- Doubling the advertising budget may not always be a clear indicator of supply constraints, as other factors like market saturation, brand perception, and the effectiveness of the advertising itself can influence the outcome.
- Raising prices to manage supply constraints can potentially alienate loyal customers or position the business as less competitive, especially if competitors do not follow suit.
- Adjusting the service-to-delivery ratio may not always be feasible for all business models, and it could lead to a decrease in service quality or customer satisfaction.
- Adding headcount to address supply constraints assumes that the market demand will remain constant or grow, which may not always be the case.
- Efficient training systems are beneficial, but they require time and resources to develop, and there's a risk that they may n ...
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Strategies For Solving a Demand-Constrained Business
Alex Hormozi offers a bounty of strategies to help businesses facing a common pitfall: more capacity than customers. He elucidates avenues for software firms, restaurants, and online businesses to overcome this challenge and balance the scales of supply and demand.
Demand-Constrained Business: Too Much Capacity, Not Enough Customers
Hormozi delves into the plight of companies with excess capacity and insufficient clientele. He recommends reallocating resources from product enhancement to marketing, especially when the product already exhibits a low churn rate, implying the real issue lies not in product quality but in market awareness. This shift in strategy is vital, as even quality products stagnate without sufficient consumer awareness.
Demand-Constrained Software Firm Emphasizes Marketing Over Development
Highlighting a software firm as an example, Hormozi reveals the firm’s misstep: only 5 percent of its budget went to marketing, in sharp contrast to rivals investing 20 to 30 percent. His prescription is to divest from product expansion — which was wrongly perceived as slow user growth's remedy — and concentrate on marketing efforts, as the company was overly dependent on word-of-mouth and grossly underfunded in marketing.
Restaurant Strategies: Adjust Pricing, Pay to Skip Line, Stay Open Later
Although he predominantly discusses software companies, Hormozi also touches on restaurant strategies to increase customer flow during off-peak times through pricing changes and extended service hours.
Demand-Constrained Online Business Strategies: Optimize Sales Funnels, Improve Ad Campaigns, Sell Complementary Products/Services
For online ventures, Hormozi talks about enhancing cash flow by leveraging distribution channels to vend ancillary goods like warranties or to offer services such as gym floor design. He endorses using the current client base to peddle these extra offerings, thereby maximizing an already saturated service delivery capacity.
In tackling the dilemma of a company floundering with sales conversions from demonstrations, he suggests bettering the conversion rate instead of expanding the sa ...
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Strategies For Solving a Demand-Constrained Business
Additional Materials
Counterarguments
- Reallocating resources from product enhancement to marketing assumes that the product is already meeting market needs and expectations, which may not always be the case. Continuous product improvement is crucial for long-term success.
- While increasing marketing efforts is important, it should not come at the expense of product quality or customer service, which can damage a company's reputation and long-term viability.
- The effectiveness of marketing spend is not guaranteed; it requires strategic planning, targeting, and continuous optimization to ensure a good return on investment.
- Restaurants adjusting pricing and extending service hours may not always lead to increased customer flow if the underlying issue is the quality of food or service.
- Online businesses focusing solely on optimizing sales funnels and ad campaigns might overlook the importance of product-market fit and customer experience.
- Introducing premium versions of products could alienate existing custo ...
Actionables
- You can partner with local influencers or bloggers to create buzz around your product or service, offering them a free trial or sample in exchange for a review or mention on their platforms. This approach leverages the existing audiences of these influencers, potentially increasing consumer awareness without the need for a large marketing budget. For instance, if you run a small bakery, send a selection of pastries to a food blogger in your area and ask them to share their experience with their followers.
- Consider implementing a referral program where current customers can refer friends or family and receive a discount or free product in return. This strategy turns your existing clientele into advocates for your brand, helping to grow your customer base organically. For example, if you have an online store selling eco-friendly products, offer a 10% discount to both the referrer and the referred for every successful referral.
- Experiment with creating an online quiz or tool tha ...
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Prioritizing the Right Problem As a Business Scales
As a business grows, concentrating on the right issues becomes crucial for continued scaling. Hormozi stresses that businesses often stick to outdated constraints instead of adapting to new ones.
Businesses Struggle By Focusing On Outdated Constraints
Solving one Constraint Brings Another, Requiring Adaptive Solutions
Hormozi points out that businesses frequently remain stuck because they concentrate on a constraint that's no longer relevant instead of identifying and tackling the current primary limitation. He emphasizes the need for businesses to pivot their efforts and resources to address new challenges that emerge. For example, as companies become proficient in product development or marketing, the supply chain often becomes the new constraint they face. Hormozi suggests that solving one issue can lead to another, and businesses need to adapt by teaching their personnel to upskill to increase revenue and profits.
Ignoring the Current Constraint Keeps Businesses Stuck
Focusing heavily on product development at the expense of customer acquisition can lead to stagnation, even with an excellent product. Hormozi underscores that failing to address supply chain issues can prevent growth, illustrated by an enterprise software company owner who remained stuck due to a lack of emphasis on customer acquisition. The company leaders wrongly assumed that hiring more salespeople would resolve their growth issues. Hormozi disagrees, indicating that the actual problem—a demand constraint—was not being addressed.
Diagnose Business Constraints and Adapt Resource Allocation
Businesses must accurately diagnose whether they are supply or demand-constrained to adapt their strategy and resource allocation. Hormozi advises reallocating resources like cash flow and talent from less critical areas, such as continuous product investment, to areas that can drive growth, such as improving sales skills o ...
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Prioritizing the Right Problem As a Business Scales
Additional Materials
Clarifications
- Hormozi is a business expert and author mentioned in the text. He provides insights on how businesses should prioritize the right problems as they scale. His advice focuses on the importance of identifying and addressing current constraints to drive growth and success. By reallocating resources and adapting strategies based on the actual business constraints, companies can overcome challenges and achieve sustained success. Hormozi emphasizes the need for continual strategic shifts to navigate evolving constraints in a business environment.
- In a business context, supply constraints occur when a company struggles to meet the demand for its products or services due to limitations in production capacity or resources. On the other hand, demand constraints arise when there is insufficient interest or need for ...
Counterarguments
- While focusing on new constraints is important, sometimes businesses may need to reinforce their solutions to old constraints to ensure they don't re-emerge as issues.
- Adaptive solutions are necessary, but consistency in certain business strategies can also be beneficial; not all new constraints require a complete strategy overhaul.
- In some cases, businesses may intentionally focus on a specific area, like product development, because it aligns with their long-term strategic goals, even if it seems to be at the expense of immediate growth opportunities.
- Diagnosing business constraints is complex and can be influenced by subjective biases; what one may identify as a constraint, another might see as a strategic choice.
- Resource reallocation should be done carefully, as moving resources away from areas like product investment could potentially harm the business in the long run if product quality or innovation declines.
- The idea that the real obstacle may differ from the perceived one could lead to constant second-guessing and lack of action; sometimes the perceived constraint is indeed the real one and should be addressed as such.
- While addressing new constraints is essential, it's also import ...
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