Soft Market

What Is a Soft Market?

A soft market is a market that has more potential sellers than buyers. The term soft market is most frequently applied to the insurance industry, where it can also be contrasted to a hard market. The term can also be applied to other markets where a lack of buyers relative to sellers puts downward pressure on prices. A soft market can describe an entire industry, such as the retail market, or a specific asset, such as lumber. This is often referred to as a buyer's market, as the purchasers hold much of the power in negotiations.

Understanding a Soft Market

A soft market is a market where demand is decreasing or buyers are exiting the market. This creates a temporary state of disequilibrium where sellers compete more for buyers and buyers have relatively more bargaining power. This puts downward pressure on prices and can lead to rapid drops in prices as sellers compete to find buyers.

The soft market will persist until supply and demand are brought into a new balance, or equilibrium, once prices fall sufficiently. A soft market involves a temporary market surplus until prices adjust. Once buyers and sellers adjust their price offers and expectations lower, some suppliers may leave the market, and more buyers will be willing to buy, thus eliminating the surplus and ending the soft market.

For example, assume that 20 houses are put up for sale and 15 possible buyers enter the market. Five of these houses will not be sold, a surplus, assuming each buyer purchases one house. This forces the 20 house sellers to compete on price to attract a buyer. These sellers will either lower their asking prices or decide to exit the market by waiting to sell their house at a later date.

As prices fall, more buyers may enter the market. Some suppliers could even switch roles from seller to buyer if prices fall sufficiently. Once this process plays out, the number of homes offered for sale will once again just meet the number of homes buyers want to purchase, with no surplus left over, and the market price will stabilize at a new equilibrium, ending the soft market.

Implications of a Soft Market

Different industries may experience distinct effects from their respective soft markets. If the insurance industry faces a soft market, for instance, insurers may have to offer lower premium rates, make underwriting easier by diminishing the criteria, and offer expanded coverage to attract customers who are shopping around.

The opposite of a soft market in the insurance industry is a hard market. The latter is characterized by competition among buyers and low fund availability among insurance companies. Thus, insurance companies tend to be selective about who they will provide insurance to and generally avoid high-risk cases.

If a soft market occurs among auto dealers, prices for cars may drop, along with the requirements needed to qualify for financing. Dealers may try to make up the difference on their narrower margins through higher volume sales. Lower prices due to soft markets means more customers might go shopping for a vehicle.

In almost every case or type of soft market, the seller must look for ways to remain competitive among their peers. Prolonged soft markets can lead to numerous negative effects on sellers in an industry. Products and services may be drastically discounted due to plummeting demand, which, in turn, can affect commissions and salaries and have a ripple effect on related markets.

Industries can also suffer long-term effects if soft markets last for extended periods. Businesses may face lost earnings that force them to lay off staff or close operations because of unsustainable revenue and earnings rates. Scaling back a business or exiting a market may bring the market back toward equilibrium, but it can be painful for the business that has to make the cuts.

On the other hand, soft markets for some goods, businesses, and industries are beneficial to the buyers, who may be consumers or other businesses. The seller's loss is the buyer's gain.

A soft market in one industry may even be offset by a hard market somewhere else, as buyers' preferences over which goods to spend their money on shift from one market to another. If multiple industries are struck simultaneously with soft markets, there may be broader issues about the fundamentals of the economy. A widespread downturn could be developing that leads to stalled activity or a recession.