Bargaining Power of Buyers

Understanding Buyers’ Bargaining Power

Powerful buyers, especially rational ones like those found in B2B transactions, will do everything they can to pay less for your products and services.

In fact, just like you do with your vendors, their strategy may be to prevent YOU from becoming a powerful vendor to them and erode your ability to raise prices. You would do the same to them, right?

Powerful buyers will always try to pay less and get more, threatening your ability to produce sustainable profits and maximize growth.

This is one of the most feared factors in Porter’s Five Forces model and one that must be well thought-out as part of your business strategy.

In general, the bargaining power of your buyers is higher if:

• There are not many buyers in the market or if they represent an important portion of your company’s sales.
• The buyer has multiple alternatives to source the solution, or if your product is not critical to their business. For example, if they can get what you offer from ten other businesses under similar terms, they will have the final word on who they choose.
• The cost of switching to another vendor is low. If a buyer can switch vendors and buy from another seller without incurring costs or hurdles, they will be able to switch vendors back and forward, picking the one that offers them the best terms each time.
• There’s no credible threat of that you may integrate “forward”. If company A sells a critical supply to company B, and company B uses that supply to sell products to company C, a credible threat that company A could set up its own shop and sell directly to company C will keep company B in check and limit its bargaining power.

You must understand the influence that powerful buyers may have in limiting your profitability and find ways to mitigate it. For example, by offering highly differentiated products, or embedding proprietary components into them.

Mitigating Buyer Bargaining Power

Here are some recommendations that can help:

• Offering differentiated value: Of course, customer retention always starts with a good product. If well-developed, your product should be responsible for a good part of sales and retention. In a B2B context you may hit a sweet spot if your products stand out with qualities that are critical for the quality or performance of buyers’ final products and services.
• Increasing switching costs: Creating an environment that your buyers would miss if they switched to a different vendor. Manufacturers of health monitor bands, for example, usually build a companion website to store users’ historical health data in the cloud. Users would think twice about switching to another vendor and leaving their data behind.
• Increasing the social costs of using other solutions: Promote your products among influential people in the buyers’ circles, getting key endorsements when appropriate.
• Using pricing strategies to increase retention: For example, lower prices for current customers or long-term membership deals.
• Offering complementary services: You can trap customers into your business model by offering after-sale services they find valuable.
• Personalizing customers’ experience: An extension of the previous point is to personalize your customers’ interaction with the product and the company. The more personalized their use of your product is, the harder it is for them to switch over to a different solution.
• Offering attractive “upgrades” at the end of contracts: If an agreement is coming to an end, you may offer an attractive upgrade if customers renew. Think about how phone companies offer free upgrades to the latest smartphone every two years.

You must mitigate powerful buyers even if your relationships with them are in good standing. Remember that the real threat is them being able to use their power, not whether they use it at the moment or not.

The worst position to be at in any given market, however, is being “sandwiched” between powerful buyers and vendors, so you better prevent that at all costs.

References:

This article has been extracted from Sun Wu’s book Strategy for Executives which can now be downloaded for free here.

Porter, Michael E. Competitive Strategy: Techniques for Analyzing Industries and Competitors. Free Press. Kindle Edition.

Magretta, Joan. Understanding Michael Porter: The Essential Guide to Competition and Strategy. Harvard Business Review Press. Kindle Edition.