Understanding the Bargaining Power of Suppliers
If you have powerful suppliers (or vendors as some call them), they will always try to keep a bigger piece of the action on their side of the table.
If they are well-positioned in their industry, they may leverage their position to raise prices and enforce changes in the quality and volume of their supplies, limiting the profitability you are able to extract from your businesses.
For that reason, a good business strategy must always prevent vendors from becoming too powerful
In general, vendors tend to be powerful if:
- The vendor has a dominant position in its market, for example through exclusive access to key components and resources, or if there is a very limited number of equivalent vendors, leaving your company without many options.
- The quality of the vendor’s offering is critical for the final performance of your products and services.
- There’s a credible threat that vendors can integrate forward. That is, if vendors can leverage their privileged position to set up their own shop and compete with you for the same consumer segments.
- Your business faces high switching costs to move to a different vendor. For example, if you would have to invest in expensive software or new equipment if you wanted to buy from a different source, it may give you tangible reasons to stick to a vendor.
You must find ways to prevent the rise of powerful vendors and mitigate their ability to dictate the rules of the game.
Netflix’s aggressive plan to produce its own content is a move to reduce their business’s dependency on powerful content networks.
If they hadn’t done that, they would have been in deep trouble when Disney (who later bought all of Fox’s content including Marvel Universe and other franchises) decided to pull their content to build their own streaming service.
Mitigating Supplier Bargaining Power
The power of vendors can be mitigated through a combination of the following:
- Incentivizing competition between vendors: A company is always in a better negotiation position when it has multiple vendors to choose from. For an online retailer like Amazon, for example, it would be in their best interest to help the US Postal Service to become a competitive player against FedEx. At the end of the day, the customer (in this case us) always benefits from rivalry among vendors.
- Integrating backwards: Some companies may be well-positioned to start producing key inputs themselves as a way to reduce reliance on another company’s strategy. Apple, for example, has started creating its own processor chips to avoid being choked by powerful vendors like AMD and Intel.
- Competing with vendors: A variation of the previous point is what Walmart, Aldi, Target, Costco and other retail players are doing: having their own in-house brands compete with vendors’. That move will keep vendors at bay, minimizing any threat of price increase or scarcity.
You must always see the relationship with your vendors as a strategic negotiation where you carefully plan and brainstorm the best ways to do business with them.
To rephrase a popular negotiation approach, in planning your negotiation with vendors you must make sure to “involve the right parties, in the right sequence, to deal with the right set of issues, each facing the right consequences of walking away if there’s no deal”.
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.
Lax, David A; Sebenius, James K. 3-D Negotiation: Powerful Tools to Change the Game in Your Most Important Deals. Harvard Business Review Press. Kindle Edition.