Demand is a measure of how much of your product your customers want. (Supply is a measure of the availability of the product to satisfy the market demand.) Direct demand is driven by end customers who consume the product and do not use it for any type of resale. The family that buys cornflakes and eats cornflakes is part of the direct demand served by cereal companies. Derived demand is the purchase need of customers who use the product as a component, or as a part of the manufacturing of a product for resale. For example, the lawn mower manufacturer who buys wheels and motors and handlebars (to build lawn mowers) represents derived demand to wheel makers.
Understanding the difference between direct demand and derived demand is critical. Companies selling into direct demand markets can influence that demand with advertising, promotions, coupons, price-offs. Direct demand is typical for a consumer products company. The direct demand consumer decides for herself whether she needs or wants to buy food, beverages, clothes, appliances, or holiday trips. The direct demand marketer’s success potential is based on the number of consumers. (This is why consumer products marketing is driven totally by demographics.)
The marketer selling into derived demand markets cannot influence demand. The lawn mower wheel maker cannot make more consumers buy lawn mowers. The lawn mower wheel maker depends on the lawn mower manufacturer for demand. If the lawn mower manufacturer isn’t selling any lawn mowers, the lawn mower wheel maker is sucking swamp water.
When a derived demand marketer cuts price, customers demand is unaffected. If the lawn mower manufacturer isn’t selling lawn mower, the manufacturer is not going to buy wheels no matter what the price. When derived demand marketers cut-price, they cut revenues and profits.
Too many companies do not understand their demand dynamics. If they did, they would not cut down prices in the face of softening demand or a slowdown. Cutting prices is almost always a bad move in a slow market. When a direct demand marketer cuts price to gain business, the cuts are copied by competitor. When one airline cuts its fares from one city to another, the price cut is immediately matched by the competing airlines. When one of six gas stations on the street cuts its price, the other five stations cut their price. This is good for consumers but dramatically hurts company profits and does not change market shares.
Marketing superstars understand demand dynamics. Unlike weak players, marketing superstars do not react to softening demand with price cuts. They are not the first in their industry to cut prices (although they do lead with price increases). Superstars plan and execute to increase market share by outselling and out promoting, not by underpricing their competitors.
