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Increased Supply & Lower Demand Drive Prices Down

There is an interesting story unfolding around Australian iron ore production – group A states that groups B & C are oversupplying the weak market to drive down iron ore prices and push smaller players out of business. This is an interesting business strategy. Note: this post does not address the accusation of collusion.

Micro-Economic Supply & Demand Graphs

A simple micro-economic graph for demand shows that a commodity like iron ore will fall in price given lower demand. The less people want something, the less they are willing to pay.

An equivalent supply graph would show that increased supply also pushes down the market price of iron ore. And if there is increased supply of iron ore causing the iron ore prices to fall then the quantity of iron ore demanded will increase. Because, when you think about it, cheaper iron ore means cheaper steel means cheaper projects. And voila… projects that weren’t viable become viable. The equilibrium for quantity demanded in the market increases; customers want more iron ore.

Scarcity, the Shrinking Pie & Strategy

Scarcity brings higher prices. Scarce goods are worth more because they are harder to obtain. Most of us know this to be true.

The Australian iron ore industry is experiencing the opposite of scarcity – high supply.

Imagine, as a major player, the industry you have successfully exploited for a decade has started to shrink. Less pie. Less money. The same number of open mouths at the trough. Otherwise it’s still a healthy industry that can support the old profit margin… if only your company had a larger share of that smaller pie to squeeze out a lesser-per-unit revenue.

Strategically, as the potential market pie shrinks you might like to drive away those smaller players. The niche exploiters. The ones who came into the industry in good times to lap up any cream while the cow was being milked. Leaner times support fewer mouths. Thus, competition increases.

A Legitimate Strategy

I don’t know whether there’s been collusion in the Australian iron ore industry. That needs to be proven. But if there isn’t collusion then one would have to accept that this can be a legitimate strategy to end up with a greater portion of the smaller iron ore pie. Drive prices down, squeeze out smaller players and take smaller profits per unit across a greater number of units. At the same time increasing demand for the lower priced iron ore because projects become cheaper.

Funnily enough, this is pretty close to the downward price strategy that our major supermarkets have waged against independent food stores in Australia for decades. More of the market share with a smaller profit per unit at sale. The small player can’t compete. It’s a war of attrition. Kind of like the Germans at the Battle of Verdun in World War 1 with an objective to “bleed France white.” Yes, an interesting strategy.

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Steven Clark Steven Clark - the stand up guy on this site

My name is Steven Clark and I live in the Derwent Valley in Southern Tasmania. I have an MBA (Specialisation) and a Bachelor of Computing from the University of Tasmania. I'm a mazer & a yeast farmer (making beer, fruit wine and mead as by-products of continuous improvement in my farming practices). I'm a photographer, although my film cameras are currently silent. I do not tolerate idiots. I do not tolerate bigotry. I do not tolerate excuses. Let's be clear, if you sit with my enemies you my are my enemy for life.

Blogger. Thinker. Brewer. Drinker. Life partner to the amazing and incredible Megan.

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