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Increasing Demand: Counter-intuitively

A July 30, 2012 Reuters report stating that “Two of the country’s major airlines, Kingfisher and state-owned Air India, are reducing capacity, which helped other carriers like SpiceJet push up fares” brought back memories of a favorite restaurant that was destroyed by fire, then rebuilt.  What’s the connection?

When the restaurant was rebuilt, a few blocks from its original location, it had the same seating capacity as the previous location.  Initially I was dumbfounded by that fact given that there was always a waiting list to get in.  Why wouldn’t the owners build a larger restaurant to serve more customers?

Then I realized that it was my original reaction that was dumb.  By limiting capacity, while maintaining the high level of quality and service their customers enjoyed, the owners were assuring that demand would remain high.  It also gave them great pricing flexibility.

Price increases would be readily accepted by customers because their perception of value was affirmed, if not enhanced, by the number of people waiting to be seated.  This strategy would also make it easier for the owners to resist the temptation to reduce prices during challenging economic times.

Finally, limiting capacity would increase the sales of both food and drink.  More drinks were sold to waiting patrons.  More drinks typically lead to a greater appetite for food which increases food sales.  Clever folks, these restaurant owners.

What does that have to do with the Reuters report on India’s airlines?  At least a couple of these airlines are learning that decreasing supply will help them raise airfares.  By increasing demand in relation to supply, the airlines will become more efficient in providing the routes customers truly desire and enable themselves to command higher prices based on that demand.  This is the point I’ve tried to make repeatedly in my blog posts on the airline industry’s dynamic pricing model.

In both instances, the restaurant and the airlines, limiting capacity (creating scarcity) is a key to long-term revenue growth and profitability.  Unfortunately, that’s counter-intuitive, the opposite of what our human nature suggests.  Our natural ‘belief’ is that growth means serving more and more people when, indeed, it involves increasing demand by limiting supply.

I’ll give you a chance to gnaw on that a bit as I head to my favorite restaurant and the inevitable wait it requires.

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