Bargaining Power of Suppliers

Any organization needs raw materials and this creates buyer-seller relationships between the market and the suppliers. The distribution of power within such relationships varies, but if it lies with the supplier then they can use this influence to dictate prices and availability. You need to assess the balance of power within your own market as part of using Porter's model.

Suppliers may work together to increase bargaining power, although this is usually against the law in developed countries where legal redress is available if such actions are discovered.

Porters Five Forces - Bargaining Power of Suppliers

There are several characteristics that indicate the extent of a supplier's power and one is that they are able to increase their prices without this having a detrimental effect on the volume of sales. Another is the ability to create informal or even formal agreements that control pricing and supply. Most developed countries have extensive anti-trust laws and regulations in place to deter and penalize suppliers caught in this type of activity, but recent anti-trust court cases involving software, finance, healthcare, utility, and oil companies suggest that supplier collusion is still widespread.

Rather than raise prices, suppliers in a strong bargaining position can choose to reduce the quantity of the product available, something that is most effective if there are few substitutes buyers can switch to. Suppliers are also in a strong position if the product or service they supply is an essential component of the end product.

Other ways in which suppliers can dominate include imposing costs or penalties on their customers if they decide to change to another supplier. In addition, a supplier may decide that their best strategy for growth and profitability is to purchase or create agreements with other organizations further down the supply chain in order to increase control of distribution channels.

Well-known examples of strong suppliers are:
• DeBeers - dominates the diamond market.
• Microsoft - practically dominates the market for personal computer operating systems.
• Intel & AMD - dominate the market for processor chips.
• Cargill & Monsanto - dominate the agricultural seed production market.

Whilst some industries do have dominant suppliers this is not the case for all. In industries where the product is standardized you are likely to find a large number of competitive suppliers. The food processing industry is a good example of this because agricultural produce can be bought from a variety of suppliers, both large and small. This is the same for any market involving commodity products.

A high concentration of purchasers is an indication that suppliers in that market have a weaker bargaining position. This is one of the characteristics of the music industry, where there are a limited number of powerful record companies (buyers) and an almost unlimited number of hopeful musicians (suppliers). The mismatch between these groups means that supply far outstrips demand, and consequently most musicians are prepared to work for a pittance, or for free, in the hope getting their product into the market.

Suppliers are also in a weak position if a purchaser could relatively easily adopt a policy of backward integration. This factor, combined with global access to numerous suppliers, is a key characteristic of the automotive components market, where there is only a handful of customers. To be excluded from supplying a particular car manufacturer could be disastrous for the supplier who often has to work on very low profit margins.

Key Points

  • Supplier bargaining power is high where:
    o There are few suppliers and many buyers
    o The cost of switching from one supplier's product to another supplier's product is high
    o Suppliers can begin to produce the buyer's product themselves
    o The buyer is not price sensitive and is uneducated regarding the product
    o The supplier's product is highly differentiated
    o The buyer does not represent a large portion of the supplier's sales
    o Substitute products are unavailable in the marketplace
  • If the opposite is true for any of these factors, supplier power is low.
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You may also be interested in: Introduction to Porter's Five Forces Analysis, Competitive Rivalry, Threat of New Entrants, Threat of Substitutes, Bargaining Power of Suppliers, Bargaining Power of Customers and Advantages and Disadvantages of Porter's Five Forces Analysis.

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