The bargaining power of suppliers represents the specific forces stemming from the market of inputs that can affect a business organization and the competitive environment of the industry in which it operates. It is one of Porter’s Five Forces alongside the threat of new entrants, the bargaining power of buyers, the threat of substitutes, and the intensity of competitive rivalry.
Note that the market of inputs or input market provides or supplies the resources needed to make finished products. The ability of a business to have access to this market or built and maintain productive relationships with relevant suppliers can determine not only its profitability but also its competitive advantage versus its competitors.
Defining, Explaining, and Understanding the Bargaining Power of Suppliers
What Are the Effects or Impacts of Supplier Bargaining Power on a Particular Business? How Does this Power Affects Competition?
The bargaining power of suppliers represents the level or degree to which the providers of raw materials can exert influence or pressure in a particular business or an entire industry. A strong bargaining power puts businesses at the helm of suppliers.
However, a weak bargaining power enables a particular business to access less costly raw materials or readily secure needed resources or production inputs that can translate to lower production costs and lower end-use market price.
Note that the supplier bargaining power can be considered as the mirror image of buyer bargaining power. The suppliers are the businesses that sell production inputs while the buyers are the businesses that buy these inputs.
Examples of these suppliers include manufacturers and vendors, livestock and agriculture producers, wholesalers and distributors, importers and exporters, drop shippers, and independent or smaller craftspeople, among others.
The pressure that these suppliers can exert on a particular business depends on the level of their bargaining power, and it can affect pricing decisions, increase or lower the quality of end-use products, and increase or decrease the availability of these products.
With regard to the impact of these suppliers on a particular industry and the overall competitive environment, their bargaining power can determine the level of entry barriers, the dominance of a particular business, and the overall longevity of the industry.
What Are the Factors Influencing the Bargaining Power of Suppliers? What Are Some Specific Real-World Examples?
Several factors influence the bargaining power of suppliers, particularly the level at which they can exert pressure on specific businesses and influence an entire industry, or whether their bargaining power is strong or weak. Take note of the following:
• Suppliers-To-Firm Concentration: One of the factors that determine the bargaining power of suppliers is the actual number of these suppliers relative to the number of buyers. This is called the supplier concentration-to-firm concentration ratio. A few number of suppliers indicate a strong bargaining power because of the limited options to businesses. An abundance of them indicates a weak bargaining power because businesses have more alternatives and even substitutes.
• Costs of Switching to Suppliers and Firms: The supplier switching costs are the costs incurred by a particular supplier if it switches from an existing business client to another. The firm switching costs are the costs incurred by a particular business if its supplier switches from one supplier to another supplier. A low cost to a supplier and a high cost to a business translates to strong bargaining power. A high cost to a supplier and low cost to a business translates to weak bargaining power.
• Degree of Differentiation of Inputs: Another factor influencing the bargaining power of suppliers is the level of differentiation of production inputs or the varieties in the entire market of inputs. The higher the differentiation the weaker the bargaining power because it gives businesses more options to choose from and enables them to innovate and create differentiating end-product themselves. A lower degree of differentiation weakens this bargaining power because of limited options for businesses.
• Existence of Substitute Inputs: Similar to the degree of differentiation within the market of inputs, the presence of substitute product inputs provided businesses with more options and the possibilities for creating more innovative and highly differentiated end-use products with unique selling propositions. An example would be a smartphone manufacturer with access to substitute chipmaking technologies such as processor architecture and process node, or an innovative operating system.
• Possibility of Forward Integration: Some businesses transact directly with suppliers while others have pursued vertical integration as part of their competitive advantages. Regarding the first one, it weakens the bargaining power of certain suppliers such as wholesalers, distributors, and importers. The second one makes a particular business independent, thereby weakening or eliminating the bargaining power of direct suppliers such as input manufacturers and providers.
• Impact of Inputs on Costs and Differentiation: Remember that production inputs can enable a business to manufacture or provide products with unique selling propositions and even lower the costs of production. These businesses are fundamentally dependent on the quality and quantity of inputs. As an example, shortages in the supply of agricultural produces increase the bargaining power of suppliers because food processing manufacturers have limited options while affecting their production volume.
• Sales Dependence of a Particular Supplier: A supplier has a weak bargaining power if bulk of its revenues depends on a particular business client. Examples include chip manufacturers that exclusively supply a particular tech company or an outsourced garment manufacturer that produces products on behalf of a large and established clothing brand. Another example is the main accounts of service-oriented companies such as business process outsourcing firms and marketing firms.
What Can Businesses Do to Mitigate the Impacts of Supplier Bargaining Power? How Can They Leverage this Bargaining Power?
The effects or impacts of bargaining power of suppliers collectively center on the level at which suppliers can exert pressure on a particular business, thereby affecting its pricing decisions, the quality of end-use products, and the quantity of these products.
Nevertheless, there are several ways a business can mitigate the risks or manage the aforementioned impacts. However, doing so depends on the factors affecting the level of the bargaining power of its suppliers, as well as the specifics of the circumstances.
Vertical integration is an example. Take note that Apple has developed in-house capabilities to design desktop-grade and laptop-grade microprocessors to lessen its dependence on the chips manufactured by Intel and the risks associated with this dependency.
Other examples of companies with vertically integrated supply chains are Ikea, which controls and coordinates the acquisition of raw materials, production of its products, and distribution; as well as Target, which has its own manufacturing and distribution facilities.
Larger companies have also employed mergers and acquisitions to strengthen their supply chain. As an example, a food and beverage company may opt to acquire farmlands and livestock facilities to secure its supply of agricultural produces.
A well-written enforceable contract is also a basic approach to managing the impact of supplier buying power while upholding supplier interest. A specific written agreement can provide exclusivity, non-compete clauses, pricing thresholds, and force majeure clauses.
Businesses can also form trade unions to create a collective bargaining power against a dominant industry supplier or a particular trade union of suppliers, thereby leveraging the advantages of solidarity within a particular industry.