Supply-side dominance refers to the idea that in many markets, the forces controling supply are more influential than demand. While demand-side analysis often gets more attention such as market growth, the supply side can tell a deeper story about the long-term prospects of an industry.
This blog will aim to delve deeper into the concept of supply side dominance and how impactful can it be.
What exactly is supply side dominance?
In layman terms, Supply side dominance is when a company controls the supply in the market, to such an extent that it develops the ability to control its pricing and margins. Supply side dominance is the difference between a company that is a price taker to a price maker.
Let's understand this with a few examples:
All of you want to buy apples, but I am the only seller. Suppose the price of the apple right now is 10 rupees, do you really think that I as the sole supplier of Apple will maintain the same price? definitely not. I am easily selling it for 4-5x of the current price. Now after a few years, a hundred players start supplying Apples. What do I do now? I will have to fight for my market share and hence might end up selling for a cheaper price. This is the difference. At first, I had supply side dominance and hence I did whatever I wanted to but post the entrty of competition, I have to fight to keep my profits.
Each industry has a purpose and it is critical to someone. By being a leader in the market, you dictate the terms and ensure that your customers end up paying the price you want them to, instead of engaging in a pricing war.
The Supply demand graph
To understand the importance of supply-side dominance, let us look at the supply-demand graph, which is one of the first things taught in economics.
It basically means that the price of a product is decided by the intersection of the supply and demand curve. If demand increases, the curve shifts right, and hence, the price increases, and so does the quantity demanded. All companies are a product of this graph. Their earnings fluctuate as the demand graph fluctuates.
Let me give you some examples. Capital good companies are doing well because government is spending a lot on infrastructure. Auto companies did well because consumers had pent up demand. Hotels are doing well because the demand is outpacing the supply.
Each of these companies is a slave to the demand curve. This is essentially what a cycle is. The fluctuations of the demand for an XYZ good/service.
This is what should be the case for all companies, theoretically.
Capitalism and Economics dictate that companies should not make more than the cost of capital, yet hundreds of anomalies do so. This is called perfect competition.
Perfect competetion is a market structure where numerous buyers and sellers exist, offering identical products, allowing no single participant to influence the market price. It features free entry and exit for firms, perfect information among participants, and leads to efficient resource allocation and zero economic profits in the long run.
The definiton does sound familiar doesnt it? you might be thinking of commodity businesses or highly cyclical businesses (all businesses are cyclical though)
How does a company escape this influence of the demand curve and differentiate itself from perfect competetion and become a monopoly? its impossible to be completely immune to demand fluctuations but how do companies mitigate the problems in down cycles and maximize during an up cycle?
Supply side dominance. If the demand curve shifts and forces you to sell at a reduced price, you can theoretically reduce the supply and hence, charge a higher price. The ability to control the pricing of your products, reduce downside during down cycles and differentiating yourself is supply side dominance.
I hope this theoretically makes sense. Now let's understand the sources of this edge and then its advantages.
Developing supply side dominance.
Economies of scale
Economies of scale are a critical driver of supply-side dominance because they enable a company to lower its per-unit costs as production volumes increase. As firms scale up, they can spread fixed costs such as infrastructure, R&D, and marketing over a larger number of units, reducing the average cost per unit. This gives large-scale companies a significant cost advantage over smaller competitors, who often have higher per-unit production costs. The ability to produce more efficiently allows these companies to either lower prices to undercut competitors or maintain higher margins, thus sustaining profitability. Economies of scale in itself does not lead to supply side dominance. It will only matter if it manages to scale up to become a monopoly and hence actually end up controlling the majority of the supply. For example, OPEC+ is a group of countries that controls the global oil supply. Their policies and regulations decide the price of oil and hence, they enjoy supply side dominance in the global Oil market.
2. Regulatory Barriers
Regulatory barriers serve as a powerful tool for establishing supply-side dominance, particularly in industries where compliance with government regulations, permits, and licenses is necessary to operate. For example, industries such as energy, pharmaceuticals, or telecommunications often have strict regulations that require substantial investment in compliance and a deep understanding of legal frameworks. Firms that manage to secure early regulatory approval or gain exclusive operational rights through patents, permits, or compliance certificates can create high barriers to entry, making it extremely costly or difficult for new players to compete. Moreover, regulatory barriers ensure that dominant players face minimal competition, allowing them to control supply, pricing, and the overall market environment without much external disruption.
3. Technological Leadership
Technological leadership is a cornerstone of supply-side dominance, particularly in industries driven by innovation and cutting-edge technology. Companies that are able to develop proprietary technologies, whether through advanced research and development or through strategic acquisitions, can gain a massive competitive advantage by producing more efficiently, offering superior products, or operating in ways that competitors cannot easily replicate. Intellectual property protections, such as patents and trade secrets, act as legal barriers that prevent other companies from using similar technologies, effectively giving the technological leader control over supply in their industry.
4. Brand Power
Brand power plays a vital role in establishing supply-side dominance by influencing consumer perception and loyalty. A strong brand creates significant value by making the company’s products or services synonymous with quality, reliability, or prestige, which allows the company to command higher prices and retain customer loyalty. When consumers trust a brand, they are less likely to switch to competitors, even if alternatives exist, because the perceived value of the brand adds a layer of security and satisfaction. This brand loyalty results in consistent demand, giving companies greater control over their supply and the ability to maintain pricing power. Think about luxury brands like Dior and LV, they make their bags for dirt cheap prices but their brand ensures that stay differentiated and hence, charge a crazy premium.
5. Control Over Distribution Channels
Controlling distribution channels is another crucial factor in achieving supply-side dominance, as it allows companies to directly manage how their products reach consumers. Firms that own or heavily influence their distribution networks can ensure that their products are available to customers quickly, efficiently, and at lower costs than competitors who rely on third-party distributors. By controlling logistics, transportation, and retail channels, these companies can optimize inventory management, reduce supply chain disruptions, and better respond to shifts in demand. This control also allows them to negotiate favorable terms with retailers, secure premium shelf space, or engage in exclusive partnerships, making it harder for competitors to access the same level of market exposure.
Advantages of supply side dominance
Everything comes down to two things. First, maintaining profitability in times of distress. Second, dictating the market terms as per your wishes. These are the two advantagesd but lets delve a little deeper:
Influencing Supply Levels and ability to set pricing: As the name suggests, it is all about controlling the supply, and if you control the supply, you control the market. Tailwinds and Headwinds are temporary. If a company can control the market supply, it means that they have the ability to influence overall market conditions by adjusting their production levels. By controlling production, they can create artificial scarcity, which drives up prices during periods of strong demand. Conversely, they can flood the market with supply during times of weak competition to maintain market share or outprice smaller players. It can't be stated enough that one of the greatest advantages of supply-side dominance is the ability to exert pricing power. Companies that dominate supply in their industry can raise prices without losing significant market share. This is especially important in industries where demand is relatively inelastic (i.e., consumers have limited alternatives or substitutes). In such cases, dominant suppliers can pass on higher production costs to consumers without seeing a major reduction in demand. Think Apple Inc. as an example (we will explore it in detail)
Control over costs: Even when demand is weak during a recession, supply-dominant firms often have lower production costs due to economies of scale or access to critical inputs. This allows them to continue operating profitably, while weaker competitors struggle to survive. In expansion phases, they are well-positioned to capitalize on rising demand without facing significant supply constraints.
Weak markets leads to higher market share: Economic downturns tend to force less efficient competitors out of the market. Supply-side dominant companies, with their cost advantages, are able to absorb market share during these periods, coming out stronger when the economy rebounds.
Defining Cost Structures: These companies often determine the cost structure for an entire industry. By producing at scale or using proprietary technology, they set the benchmark for costs, which other competitors must match. Smaller firms or new entrants, which lack the same level of control over their supply chains, struggle to achieve similar cost efficiencies, leading to a more concentrated market.
Maintaining Margins During Input Cost Fluctuations: Supply-side dominant companies are better positioned to manage cost pressures because they often control or have favorable terms on key inputs. In industries where input costs fluctuate significantly (like commodities), firms that control their supply can either absorb cost increases without impacting margins or pass them on to consumers due to the lack of alternatives.
Past case studies
Pharmaceuticals: Why is it that once a drug's patent expires, its price drops drastically? It is because the innovator no longer has the supply side dominance and hence falls prey to the supply-demand curve. However, it is visible that patents and regulatory barriers can be a huge source of supply-side dominance and allow companies to reap a lot of profits. For example, Humira generated 14 billion dollars in sales in 2023 alone! Ozempic, a drug that can be a megatrend of the future, generated 14 billion dollars in 2023. The innovator companies made a lot of money because they had 100% access to the supply owing to their patents.
Apple Inc: Apple started as a personal computer company and has made immense wealth for its shareholders. Why is it that Apple succeeded and its peers like IBM etc failed? A primary reason is their access to MacOS. Having their own OS, which could only be sold by them, allowed them to start differentiating from the rest of the competition. This way, they controlled the MacOS market and developed a supply-side dominance. With the same philosophy, they have expanded into multiple personal tech products and used various strategies such as ecosystem, OS, brand power, etc, to continuously differentiate themselves and command a supply-side dominance.
Walmart: Walmart established supply-side dominance through its mastery of logistics and supply chain management. The company invested heavily in its distribution centers and technologies that allowed it to track inventory and optimize product distribution to stores with unmatched efficiency. Walmart’s ability to buy in bulk and negotiate favorable terms with suppliers due to its sheer scale helped it secure lower prices than competitors. This cost advantage was passed on to consumers, reinforcing Walmart’s position as the low-price leader.
Amazon Inc: Amazon achieved supply-side dominance through its unmatched control over logistics and fulfillment, which allowed it to offer faster and cheaper delivery than most competitors. Amazon’s investment in a global network of warehouses, distribution centers, and delivery infrastructure has allowed it to dominate the e-commerce supply chain. In addition, Amazon Web Services (AWS) became a dominant player in the cloud computing industry by providing scalable infrastructure-as-a-service (IaaS) solutions that became the backbone of many businesses and applications.
Luxury goods : Luxury market is all about controlling the supply. Each of the luxury players diffrentiate themselves by brand and design and hence, you will not find a legitimate replica of their products but only them. This way, each deals in a niche market where they control all the supply. This allows them to manipulate prices at exorbitant levels.
Now lets look at companies in the Indian context
Indigo:By streamlining processes and staying consistent with its effective cost structure, Indigo ended up gaining a market share of 62.4% in domestic flights. Due to this, Interglobe Aviation holds a very strong supply-side dominance and can be the price maker of the whole industry. For example, it can keep prices very low, and since it commands 62% market share, the rest will be forced to do so unless they want to lose the whole market. With this, they can operate at razor-thin margins, bleeding the competition dry. Another scenario would be that they increase the price and make immense profits; others will match them to improve their balance sheet strength.
Zomato:Zomato has been a great wealth creator and looks to be on the trajectory of increasing its profits. It possesses the power to consistently hike the fees (which it has started to), which will flow directly down to its PAT. Because of the fact that it is the market leader, Swiggy, more often than not, will match that price and just try to make more profits. These two have a supply-side dominance. If they increase the price, what will the users do? Just suck it up and use their service because there is no alternative now.
Telecom sector : We all know about this, Jio cracked the market and now its a oligopoly with two primary players and a laggard. Because of the fact their is essentially no competition, Jio and Airtel can continuously hike prices as per their willling and users have no choice but to purchase because it is an essential product and you have nowhere to go.
Precision engineering: Why do you think that companies like RACL have such high EBITDA margins? This is because the product that they work on is extremely complicated, and they are one of the few companies capable of making it. Hence, due to their technological superiority, they have developed a supply-side dominance which allows them to maintain higher margins and influence the pricing (need to consider that they deal with huge automobile companies, though)
I hope the idea is clear now. Let me clarify one thing, I always look for sectors where the demand is outpacing the supply because of chances of high alpha creation, however these businesses will do extremely well when they are part of such sectors as they are the dominant player. I hope you guys learnt something interesting, do subscribe if it was worth your time.
Thank you!