I was recently discussing the labor market with the CEO of an industrial services company. He said they were having difficulty attracting enough qualified employees, and that was limiting their ability to grow. When I asked why he didn’t just offer more attractive pay packages, he said it would be counter-productive. There is a limited pool of qualified employees; and offering ever greater compensation just enables them take employees from competitors, who could do it back to them. He essentially described a reverse price-war, and correctly pointed out that nobody wins price wars. While I agree price wars are harmful, I believe there are lessons the CEO could learn from dynamic pricing.
The basic concept behind dynamic pricing is to charge more for a product or service when demand is high, and lower the prices when demand is low. Setting prices this way better enables supply and demand to match each other. The more price-sensitive customers can select off-peak situations to purchase when prices are lower. Customers who are price sensitive can pay more for the most popular times, events, situations, etc. The more important concept is higher prices for peak times and offerings encourage greater supply.
Of course, Uber is the best example of this. When demand is high relative to the supply of Uber drivers, surge prices apply. Those surge prices encourage more Uber drivers to accept passengers in peak periods, so they can make more money. Eventually supply and demand balance out.
Another great example comes from plumbers. I have heard repeatedly over the past several years that there is a shortage of plumbers. If you doubt that, just try to get one on short notice. We recently had a water leak that was flooding our yard, and we called several plumbing companies trying to get help. We finally got one to come on a Saturday, but he explained weekend rates apply. You see, plumbers are like most of us – they prefer to have their weekends off. If we want them to work on the weekend, we must pay higher rates. And if it is after 5pm on a weekend, the rates go up even more. Many plumbers will give up part of their weekend for premium prices, and many of us are willing to pay those rates.
But what about the CEO’s point that this just creates a reverse price war? Why would I argue that traditional price wars are a bad idea, but paying more for labor is acceptable? My answer is because of the way supply and demand are affected.
In a typical price war, competitors continue to lower prices to win more market share. They hope the incremental profit from capturing more customers offsets the lower margin rates they experience on each transaction. However, unless a company has a defendable cost advantage compared to their competitors, other players in the market can match the lower prices and retain their business. So, companies often are unable to keep the incremental business over time. In some instances, it is possible to stimulate more demand with lower prices, and thereby enable all the competitors to lower their costs and be profitable at permanently lower price levels. That is not the normal case, though.
I believe the converse of that is true in the labor market. When demand for specific products or services are high, companies have some flexibility to raise their prices, just like Uber or the plumber. Those higher prices should enable the firms to invest in more capacity, by increasing the amount they are willing to pay for labor. While the entire labor market pool does not adjust immediately because of the skills required, higher wages attract attention and interest in acquiring those skills.
There are several examples of the interest in acquiring skills for in-demand jobs. Coding boot camps offer to teach computer programming skills and expand the number of qualified programmers. HVAC schools are expanding as the higher wages available to heating and air conditioning technicians makes the jobs more attractive. Lastly, chemical and petroleum engineering degrees are now in greater demand as new graduates can make more than $100,000 in their first jobs.
There are basic economic concepts underpinning all of this. When prices adjust, supply and demand eventually balance each other out. Dynamic pricing demonstrates the economic concepts very well. Higher prices encourage the creation of additional supply, while also improving profitability. CEOs faced with tight labor markets can apply those concepts too. They do not need to change prices as rapidly as Uber; but by raising prices in the face of strong demand they can afford to invest in higher wages and increase the overall pool of talent available.
Leave a Reply
Want to join the discussion?Feel free to contribute!