Bargaining Power of Suppliers

What Is Bargaining Power of Suppliers?

The bargaining power of suppliers refers to the influence the supplier can exert on the prices, quality, and movement of goods from one place to another. This influence shapes the market dynamics and the competitive landscape for products and services. 

As raw materials are crucial to all types of business, strengthening supplier relationships can help increase profits for the company.

The bargaining power of suppliers allows them to control pricing and quality, influencing the value chain process and the final goods and services received by customers.

In Porter's Five Forces competitive analysis framework, Porter determines how suppliers determine the attractiveness of the industry and the ability to generate profit through these forces. A collective effort yields benefits for all parties involved in the market. 

A supplier is an entity or a person who provides necessary goods and services as raw materials to the business for further processing. Though they are a crucial factor in regulating the demand and supply in the market, managing healthy relationships yields good profits.

Types of Suppliers

Thousands of vendors and suppliers exist in an industry that forms part of the supply chain process. Differentiating among them helps identify their needs and classifies them according to their contribution, making it easier to study economic supply and demand patterns. 

Let us now look at a broader classification of the types of suppliers that exist in a typical market: 

1. Manufacturers and Vendors: Manufacturers produce raw materials and components for production companies producing the final product. They exist at the bottom of the supply chain and sell their products to distributors and wholesalers.
2. Distributors and Wholesalers: Distributors and wholesalers purchase large quantities of goods at low prices and sell them to retailers at a higher price and in fewer quantities.
3. Independent Suppliers: Independent suppliers usually produce small quantities of their products due to insufficient infrastructure. They sell their products through representatives, agents, and trade shows.
4. Importers and Exporters: Importers purchase specific goods from other countries to meet the demand for certain products and services. On the other hand, exporters send their surplus production to international retailers.
5. Drop Shippers: A drop shipper is a third party that acts as a warehouse of inventory and provides all kinds of products to a business. The company doesn't stock inventory but directly asks the drop shippers to deliver the product.

Importance of Porter's Five Forces

Porter's Five Force Model is an essential tool for determining the feasibility of the business to continue and grow with the competition. It lays down the five forces which will help the company assess its position in the market. 

The five forces are as follows: 

1. Bargaining Power of Suppliers: The power exerted over the inputs of raw materials, services, labor, and components is in the control of the supplier and the factors attributed to it.
2. Bargaining Power of Buyers: The buyers are the end-users who ultimately decide the fate of products by determining their demand. Therefore, the more they have choices, the more power they will have in determining the prices. Buyers' price sensitivity and switching costs also contribute to the bargaining power. 
3. The Threat of New Entrants in the Industry: Porter assesses the threat of new entrants when a company aims for higher profits. However, the industry's barriers to entry and retaliation prevent this threat. However, when the threat intensifies, it influences prices, costs, and investment rates to sustain oneself. 
4. Threat of Substitutes: When there is more than one product to satisfy the consumer's needs, the industry offers more choices. The threat of substitutes can impact a company's profits based on consumer preferences for price sensitivity, quality performance, and switching costs. 
5. Competitive Rivalry: An industry with cut-throat competition offers low profitability for existing companies. Competitive rivalry, on the other hand, forces companies for marketing their products uniquely to differentiate themselves from their competitors and attract potential buyers. 

The Bargaining Power of Suppliers is one of the forces influencing a company's decisions regarding the cost and pricing of its products or services.

Factors Determining Bargaining Power Of Suppliers

Evaluating the supplier's power in an industry can help a firm make sound decisions on the supply of raw materials and labor. The following are the factors that can help decide. 

The number of suppliers existing in a market

If there are more suppliers in the market, the power of suppliers reduces as the company can have multiple suppliers to source their raw materials. In addition, the raw material price would be competitive as it is easily replaceable by others who provide better quality at lower prices.  

At the same time, fewer suppliers of raw materials control the price. This makes it difficult for the company to procure materials at reduced costs. Therefore, the company has to increase its focus on maintaining good supplier relations for the timely delivery of quality products.

Dependency of the Buyer on the Supplier

When the company is too dependent on its supplier, it loses control it can establish to monitor the movement and price of the supplies. The supplier can further lose motivation to improve its product due to guaranteed sales, and the company has to rely on the supplier's IP and know-how.

Therefore, it is recommended for the company to have alternative suppliers to have the opportunity to select better quality and better-priced raw materials and hence have more control. 

Switching costs of the Buyer

When the company switches from one supplier to another, it incurs switching costs. This cost includes the penalty for the breach of contract or the deposit for signing a new contract. Non-economically, it could cost the company convenience and quality. 

The more suppliers, the lesser the switching cost would be for the company and the lesser the power of suppliers. 

Strength of distribution channels 

Major e-commerce giants like Amazon and Walmart have established distribution channels, which they leverage over suppliers. This makes the suppliers hold less power and provide goods at a lower cost. 

Possible Forward Integration

When suppliers supply a significant component in the production of the final product, there are higher chances of forwarding integration in the value chain. This makes the bargaining power of the suppliers strong as they can produce the products themselves. 

For example, an ore iron mining company is more likely to acquire the steel industry due to its hold on the key raw material. 

Product/Service Differentiation

Suppliers with a unique advantage in terms of technology and expertise enjoy differentiation in the service or product they offer. These cannot be replicated and give the supplier added benefit.

Bargaining Power of Suppliers High/Strong or Low/Weak?

Now, let us understand when the bargaining power is considered strong/high:

• A limited number of suppliers are available
• Lower dependence of suppliers on one specific buyer
• Major dependence of a buyer on the sales of a supplier
• When the buyer experiences higher switching costs
• High threat of 'forward integration' by the supplier in specific industries
• Substitutes of supplies are limited

Contrastly, when do we consider it to be low/weak? The determining factors are:

• The abundant number of suppliers is there
• Lower dependence of buyers on one specific seller
• Major dependence of a seller on the buyer to buy its goods
• When the buyer experiences low switching costs
• Low threat of forwarding integration by the supplier
• Substitutes of supplies are considerable

How Does the Bargaining Power of Suppliers Affect a Business?

Let us look at some of the areas where the company is affected due to the power of suppliers:

Pricing Pressure

The more bargaining power a supplier holds, the more it costs to purchase raw materials. This, in turn, increases the cost of the final product, which either the company absorbs to maintain the market share or passes on to the end customer. 

When the absorption becomes unsustainable, higher prices persist in the market. If consumers are not receptive to price changes, the company can lose its customers to the competition. 

Product Demand and Supply Problems

If the demand for a product increases, the supply of its components or raw materials also increases. It is easier for the company to source raw materials when the bargaining power of the supplier is low, meaning more suppliers are available to compensate for the order.

Companies have to agree with the supplier for the timely availability of the raw material so it can fulfill their demand for the season or could lead to loss of customers. 

Quality Issues

Low-quality goods are often low-cost. When a company decides to buy goods of low quality, it can severely impact the user experience of the end customer. A customer can feel cheated if they find that the price they paid does not match the quality offered.

This makes the product replaceable to competition as better and more affordable substitutes are available in the market. 

It also opens the possibility of increased exchange complaints, which hampers the brand's reputation and gradually moves the business out of competition.

Market Dynamics

If the bargaining power of suppliers is something the company can't control, there are always other dynamics in the market that can help a company achieve a competitive advantage. A company can mold itself to look for alternatives that challenge its power.

If the demand is high, other players will enter the industry to serve the target market, eventually correcting the market dynamics. The company can start producing the supply or integrate backward to reduce the bargaining hold.  

How to mitigate a strong bargaining power of supplier

But what if there is a strong bargaining power of suppliers already existing? How should we mitigate it? For that, there are a few strategies that can be adopted. Look at the table below:

Researched and authored by Samridhi Singh | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Backward Integration
• Business Operations
• External Analysis
• Supply Chain
• Vertical Integration