Customers can capture your profit by exercising their buyer bargaining power and suppliers can do the same.
Introduction to Buyer Bargaining Power and Supplier Bargaining Power
This is the third article focused on Michael Porter's Five Forces model for Industry Analysis (Michael Porter Five Forces Model (the introduction) and the Threat of New Entrants and we now turn our attention to two similar but opposing threats:
- The bargaining power of customers
- The bargaining power of suppliers
Is Negotiation On The Basis Of Win Win or Win Lose?
It is always best to go into any negotiations on the basis of looking for win-win arrangements where you and your customer or supplier can agree to strip out any unwanted or unnecessary extras that increase cost but add little or no value to the transaction.
But it is essential to recognise that when it comes to price, any reduction you negotiate with a supplier transfers profit from them to you and the opposite happens if a customer wins an extra discount.
How well each party to the negotiations will perform will depend on individual negotiation skills and the industry structure which usually biases the negotiating power one way or another.
Two Major Factors Determine Relative Power Between Buyers and Suppliers
- The price sensitivity of the customer to paying a high or low price.
- The relative bargaining power that comes from a readiness to walk away from any deal and go elsewhere.
Price Sensitivity of the Buyer
Buyers will be more willing to switch to get a lower price if:
- The product being bought is important to the buyer in terms of the high proportion of costs spent on the items but there is little difference in the products from the suppliers. The buyer knows that the product can be sourced from somewhere but doesn't really care where, provided the price is the lowest.
- The buyer will also become much more sensitive to price if the buyer and its industry is under pressure and is having to scramble for every drop of profit. Good times may protect suppliers at the moment but as the expected recession bites, pressure to reduce prices will increase because the buyer is trying to compensate for profit lost in its market.
Relative Bargaining Power - Who Can Walk Away The Easiest?
The second factor that determines whether buyers or sellers capture the majority of the profit from a transaction is the bargaining power that comes from having the knowledge that you can walk away from any deal you don't like.
It's a wonderful position to be in and if you are a seller, it is great to keep reminding yourself that you always have a choice and you don't have to accept any deal the supplier proposes.
Industry analysis and Michael Porter's Five Forces model says that the buyer has the advantage if:
- The buyer is large and the supplier is small which means that the deal is likely to be much more important to the supplier.
- There are few buyers and many suppliers. The buyer has the choice of many different suppliers to play off against each other but the supplier knows that to achieve good sales, at least one of the small number of large accounts need to be captured.
- The buyer knows the product very well and has no problem comparing goods and prices from different suppliers. Buying apples v apples and dominating the price negotiation is easy but it gets much more difficult to compare apples with oranges and feel confident that the deal is right for you.
- The buyer does not incur any penalties or other switching costs from moving its purchases from one supplier to another.
- The buyer can make a credible threat to enter the suppliers industry and provide its own supplies of the product unless the price is very low while the supplier cannot move into their customers market safely. This issue of vertical integration forward and back is a big topic which I will be covering in future business strategy articles.
Can you see how some of these factors apply to your relationships with your customers and help or hinder your negotiations while others apply to your suppliers?
The Worst Of All Worlds - Being Squeezed by Customers & Suppliers
If business was fair, some industries would be able to pass on pressure from suppliers to customers or vice versa but the worst situation is when you are stuck in the middle, sandwiched between very powerful buyers and sellers.
I have seen this in the metals processing industries where the big steel and copper mills control supply and can even ration it during times of peak cyclical demand while the customer chain is dominated by the big vehicle companies who force price reductions down the line.
While there is little that can be done about the basic industry structure, any business competing in this market has the chance to try to re-position itself to more protected areas by developing specialist capabilities and market niches. The stronger the differentiation and the bigger the gap from competitive products, the more the company is able to think of itself as the unique or sole supplier.
It May Not Just Be Price Pressure
It is easy to fall into the trap of thinking that buyer and seller power is just about price and often that is where the pressure is exerted but sometimes a strong buyer will insist on extra service requirements (next day delivery at no cost) or a favourable financial arrangement (extended credit terms or consignment stock).
Conclusion on Buyer Supplier, Supplier Power & the Respective Bargaining Strengths
So far we have looked at three of the five forces in Michael Porter's industry analysis model so in the next two articles on strategy we will examine the threat of substitute products and the threat of competitive rivalry from firms in the same industry.
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