Demand Destruction

Demand Destruction is a permanent or prolonged downward shift in the demand for a good, typically a commodity like oil or copper. This isn't your garden-variety price sensitivity where people buy less when prices go up and more when they fall. Think of normal demand like a rubber band: it stretches when prices rise and snaps back when they fall. Demand destruction is what happens when the price gets so high, for so long, that the rubber band breaks entirely. Consumers and industries are forced to make fundamental, lasting changes. They might switch to a substitute, invest in new, more efficient technology, or change their habits for good. Once these changes are made—a factory is retooled, a fuel-efficient car is bought, or a home is insulated—the old level of demand may never return, even if the price of the original good plummets back to its old levels. The demand has been, in effect, destroyed.

Demand destruction is a powerful economic force triggered by a significant and sustained price shock. It’s a multi-stage process:

1. The Shock: A commodity's price spikes and stays high. This could be due to a supply disruption (like a war or embargo), a speculative frenzy, or a fundamental imbalance where demand outstrips supply.
2. The Pain Point: The high price crosses a “pain threshold.” For consumers, this might be the price of gasoline making the daily commute unaffordable. For a business, it could be the cost of a key raw material making its products unprofitable.
3. The Scramble for Solutions: This pain forces a search for alternatives. This is the crucial step. Instead of just grumbling and paying up, people and companies actively invest time and money to escape the high price. They adopt new technologies (like electric vehicles), switch to substitutes (like natural gas instead of oil for heating), or make permanent behavioral changes (like embracing remote work to eliminate commuting costs).

The key takeaway is that these changes are sticky. Once a company has spent millions retooling a factory to use a cheaper plastic, or a household has installed solar panels, they are not going back. The initial investment has been made, and the new, lower-cost structure is locked in.

For the savvy value investing practitioner, understanding demand destruction is crucial for both risk management and identifying opportunities. It’s a concept that directly impacts a company's long-term earning power and competitive advantage.

A core part of value analysis is assessing a company's resilience. Businesses that are highly dependent on a single, volatile commodity are walking a tightrope.

• High Input Costs: Companies like airlines are extremely sensitive to the price of jet fuel. A sustained period of high oil prices can destroy demand for air travel as ticket prices soar, pushing customers towards alternatives like trains or video conferencing. An investor must ask: can this business survive and thrive if its most critical cost doubles and stays there?
• Inflexible Business Models: Look for companies whose products become obsolete or uneconomical when a key commodity price changes. For example, a manufacturer of inefficient but cheap-to-run machinery is at risk if energy prices rise permanently.

Every crisis creates winners. Demand destruction in one area is often a catalyst for a boom in another.

• The Problem Solvers: Look for the companies that provide the solutions. If high oil prices are the problem, companies involved in renewable energy, battery technology, home insulation, and energy-efficient software are the solution. These are the businesses that will benefit from a permanent shift in consumer and industrial behavior.
• Durable Moats: These shifts can create powerful new economic moats. A company that develops a patented, cheaper substitute for a critical industrial material can lock in customers for decades. A value investor's job is to spot these emerging long-term winners before they become household names.

The textbook case of demand destruction happened during the oil crises of the 1970s.

• The Trigger: In 1973, the OPEC oil embargo caused the price of crude oil to quadruple. The shock was severe and global.
• The Reaction: Panic set in, but it was followed by innovation and adaptation. Governments and consumers were forced to change.
• The Permanent Changes:
  1. The U.S. government mandated vehicle fuel efficiency through CAFE standards (Corporate Average Fuel Economy), forcing automakers to innovate.
  2. American consumers, once in love with giant “gas-guzzlers,” began buying smaller, more efficient cars from Japanese and European manufacturers. This permanently altered the landscape of the global auto industry.
  3. Homeowners invested in insulation, and industries poured money into energy-saving processes.

Even after oil prices fell in the 1980s, U.S. oil consumption per person never returned to its pre-1973 peak. The technological and behavioral changes were permanent. The demand had been structurally broken.