Chain of Derived Demand

The discovery of gold in California resulted in the need for picks, shovels and other supplies necessary for gold mining. The demand for these products was derived from the demand for gold. This is the chain of derived demand.

The chain of derived demand is the knock-on effect of people buying a product on other products down the line. When somebody buys a shirt, it creates a demand for many products and services that are required to get the shirt into the hands of the final consumer. If it is a cotton shirt, there is the requirement to grow the cotton, spin, weave and tailor it into a shirt. Then the shirt needs to be sold through wholesalers and shipped to the retailers where a purchase can be made.

It is important for companies within the value chain to understand where they sit. If they are towards the left hand side of the chain they will be subject to a high level of price sensitivity because the product is commoditised.

At the right hand side of the chain the shirt has a functional value and there is also an emotional value attached to the design and brand. The design and brand may be worth more to the customer than the materials from which the shirt is made. This has significant implications for marketers who can exploit the loyalty to the brand by exacting a relatively high price for the finished product.

In marketing terms, the products at the left-hand side of the chain of derived demand are undifferentiated (the products here are seen to be of a similar ilk) while those at the right hand side of the chain are differentiated (especially by the brand).

At the left-hand side of the chain of derived demand there are likely to be a relatively small number of companies and so marketing tools and techniques will be different. For example, Dun & Bradstreet's Hoover's directory tells us there are only 532 cotton spinning mills listed in the world. At the other end of the spectrum there are many millions of people buying shirts.

The tools of marketing are different at the left-hand side of the spectrum compared to the right hand side. Companies selling products and components that are used in the chain of derived demand are more likely to use personal selling and relationship building than those at the right-hand side. They can do so because they are targeting far fewer customers. In contrast, companies selling shirts promote their products through advertising and promotions that hit thousands of potential customers.

The chain of derived demand is also sometimes referred to as the value chain because at each point in the chain, value is added by a process. Understanding the “captain” of the value chain is important. In the case of diamond jewellery, the De Beers company has a large and controlling influence on the supply of diamonds. They are in a very strong position to influence companies involved everywhere in the value chain.

The framework for the chain of derived demand is important in determining the strengths and weaknesses of the industry in which you are located. In the days of the gold rush it was thought there was often more profit to be made from selling picks and shovels to gold miners than taking the risky decision to prospect for gold itself. If you are a jewellery manufacturer and feel trapped by the price and supply of diamonds, you may make the decision to use alternative precious stones. The demand for artisan coffee may result in a manufacturer of chefs' clothing identifying a market opportunity for making baristas' aprons.

Some things to think about:

• Where does your company sit in the chain of derived demand?

• Who is the "chain captain"? Which organisations dictate what is happening in the chain? (Think supermarkets dominating the chain in the supply of food from farm to fork).

• What leverage do you have individually in the chain? How can you increase this leverage? What are the options for joining forces with other people in the chain like yourselves?

• What factors can change the dominance of people in this supply chain? (For example a poor harvest could result in a short supply of food and increase farmers' power to demand better long term prices from the dominant grocery stores).

• An examination of the value chain is a good complement to the chain of derived demand - https://www.b2bframeworks.com/frameworks/value-chain