Bargaining Power of Customers

Your organization should also assess the extent to which its customers or buyers have bargaining power. In a situation where customers have a strong position they can bring considerable pressure to the market and demand improved quality and/or lower prices.

There are several key factors that increase the bargaining power of customers:
• Customers are more concentrated than sellers
• Switching costs for customers are low
• Customer is well educated regarding the product
• Customer is price sensitive
• A large portion of a seller’s sales is made up of customer purchases
• The customer’s own product or service is affected
• There is little differentiation between products
• The threat of backward integration is high.

The extent to which customers can influence the market depends on their level of concentration or how well organized they are. Many small farmers produce fruit and vegetables, which they are contracted to sell to their customers, the supermarkets. The smallholder has to meet the strict quality control imposed on them by the supermarkets or risk losing the contract. This enables the supermarkets, as the customers, to exert pressure on these small suppliers.

The degree to which customers are able to manipulate market forces is swayed by the how significant their purchases are in terms of the supplier’s revenue.

Bargaining Power of Customers

Customers also have significant bargaining power in markets where it is easy for them to transfer between different products without suffering any transfer costs. A good example of this is the washing powder market, which without brand loyalty has no financial impact if you swap between products. This power decreases if the customer has to spend more time or effort in switching between products or services.

In situations where the customer’s purchase represents a substantial proportion of their total costs they will be more price sensitive and the buying process will be more protracted. This results in the bargaining power being greater for the customer, and the seller will have to be more persuasive during the sales process.

Also, the more knowledge the customer has about the product the greater their bargaining power will be, as they will be aware of the product’s benefits and features. They may also be aware of how your product compares to that of your competitors, and in many instances may be familiar with your costing structure and prepared to use this intelligence to bargain.

This occurred in the automotive industry in the 1980s when manufacturers seconded their own staff to component makers on the understanding that the component makers would become the manufacturers’ ‘preferred’ supplier. This gave the manufacturers extensive inside knowledge about the costing structure of the components, which eventually enabled them to dictate prices and margins to the producers.

In markets where the products have little to differentiate them, brand loyalty is low or non-existent, and the product is available from multiple suppliers, customers are usually motivated to purchase based on price rather than any concept of loyalty. This gives the customers greater bargaining powers than suppliers, who may only win new customers temporarily because their offer is better at that particular point in time.

Another example of this shift in bargaining power is that of the component-type market. Your product in this case may have a well-known brand but as this product is only one of many items in the end product that has no perceived benefit over any other component then customers will buy on price. A commonly cited example is that of Duracell batteries. Although their batteries last longer, manufacturers who supply batteries in their products don’t use them because this aspect does not affect the sale of their product.

Customers may also decide to set up their own production of your product as part of a strategy of integrating backwards down the supply chain. This threat of satisfying their need for your product internally keeps prices competitive.

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Key Points

  • There are several key factors that increase the bargaining power of customers:
    o Customers are more concentrated than sellers
    o Switching costs for customers are low
    o Customer is well educated regarding the product
    o Customer is price sensitive
    o A large portion of a seller’s sales is made up of customer purchases
    o The customer’s own product or service is affected
    o There is little differentiation between products
    o The threat of backward integration is high.

 

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