Bargaining Power of Suppliers

The influence the Supplier can exert on the prices, quality, and movement of goods from one place to another.

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 yield good profits for the company. 

The bargaining power of suppliers enables the Supplier to exert control on pricing and quality of goods which ultimately affects the value chain process and the end goods and services the customers would receive. 

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 in benefiting 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 yield good profits. 

To understand the power the suppliers hold, let us first understand the different types of suppliers existing in a market and their role in providing goods and services as raw materials to businesses. 

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 Supplier that exists in a typical market: 

types of suppliers

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. 

For example, A farmer grows sugarcane, the raw material for making sugar. A manufacturer making lithium car batteries provides the battery component for manufacturing electric vehicles. 

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. 

For example, A wholesaler buys clothes from the manufacturer in huge quantities and sells them to retail stores at higher prices. 

A Distributor also stores goods of all types in its warehouses and supplies them as required. This helps the company save storage space. 

3. Independent Suppliers

Independent suppliers usually produce small quantities of their products due to the absence of infrastructure. They sell their products through representatives, agents, and trade shows. 

For example, an artisan weaving jute baskets exclusively can sell its product by participating in trade shows or seeking contracts from sustainable companies for eco-friendly packaging. 

4. Importers and Exporters

When there is demand for certain goods and services, importers purchase goods from other countries by acting as a retailer.

On the other hand, exporters send their surplus production to international retailers.

For example, importing technologically advanced operational equipment in hospitals is purchased from international countries. 

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.

For example, while placing an order on AliExpress, the company will directly contact the Supplier, who will then ship to the end customer. 

Porter's Five Force Model

porter's five force model

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: 

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. We will read about this in the coming sections. 

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 are also factors contributing to the bargaining power. 

The Threat of New Entrants in the Industry 

Porter determines the threat of new entrants as the company tries to reap the benefits of 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. 

Threat of Substitutes

When there is more than one product to satisfy the consumer's needs, the industry offers more choices. 

Depending on the consumer's preference relating to price sensitivity, relative quality performance, and switching costs, the threat of substitutes can affect a company's profits. 

Competitive Rivalry

An industry with cut-throat competition offers low profitability for existing companies. Competitive rivalry, on the other hand, forces companies to market their products uniquely to differentiate themselves from their competitors and attract potential buyers. 

The Bargaining Power of Suppliers is one of the forces that sways a company's decision to cost and price its product or service. 

Let us now look at the factors that contribute to determining the bargaining power:

Factors that help determine how much bargaining power the Supplier holds (according to Porter's Five Force Model)

Porter's Five Force Models help businesses evaluate their market standing. By studying these forces, they make better decisions relating to the supply chain and contribute to market demand. 

Evaluating the Supplier's power in an industry can help a firm make sound decisions on the supply of raw materials and labor. Following are the factors which can help decide so: 

1. 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, it has to increase the focus on maintaining good supplier relations for the timely delivery of quality products.

2. Dependency of the Buyer on the Supplier

When the company is too dependent on its Supplier, it loses out on 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. 

3. 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. 

4. Strength of distribution channels 

Mega tech e-commerce giants like Amazon and Walmart have ease of distribution channels which they use as leverage over suppliers. This makes the suppliers hold less power and provide goods at a lower cost. 

5. 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, ores iron mining company is more likely to acquire the steel industry due to its hold on the key raw material. 

6. 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 gives the Supplier added benefit. 

For example, Drop shippers are now a common form of Supplier. As a result, the company no longer needs an inventory storage warehouse, and goods can directly be delivered from the Supplier's place, and the company can save costs. 

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When is the bargaining power of the Supplier considered vital?

  • A limited number of suppliers.
  • 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, and
  • Substitutes of supplies are limited.

When is the bargaining power of the Supplier considered weak?

  • The abundant number of suppliers
  • 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?

supplies

Suppliers play a crucial role in determining the efficiency and effectiveness of a company's operations. In addition, their power determines a company's further decisions to launch its product in the market. 

When the company maintains a good supplier relationship, it helps streamline the production process and ensures quality goods enter the market. Supplier management is one of the few essentials of a business that helps meet the needs of a company. 

The bargaining power of suppliers fluctuates in the market due to the abovementioned factors. Therefore, the company has to make multiple decisions due to disruption in prices, quality, and movement influenced by the Supplier. 

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 at times, the absorption gets off-limits, higher prices persist in the market. If the target is not receptive to change, 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, i.e., 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 could 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 he finds that the price he 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 exchanges, complaints, etc., hampers the brand's reputation and gradually moves the business out of the competition.

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.  

Strategies to Manage Suppliers 

Suppliers play a crucial role in making the supply chain efficient and effective. Maintaining good supplier relations ensures timely delivery and quality goods at reasonable prices. 

Maintaining good supplier relations ensures that both parties are growing their business, and there's scope to optimize operations that will result in maximum utility for the end customer. 

A company can benefit from timely delivery, agreements to contract in the future, and enjoying discounts for making larger purchases. It also leads to higher quality products and services and helps reduce the risk of disruptions to operations.

strategies to manage suppliers

Following are some of the strategies that can foster better supplier relationships:

1. Evaluate the cost and value of the supply chain and ascertain the value of the Supplier in it.

2. Companies should build an honest and fruitful working relationship with their suppliers to ensure timely payments and delivery of quality goods. 

3. Both parties should expect performance metrics defined in the service level agreements. 

4. Establishing open communication channels for faster resolution of queries. 

5. Confidentiality about trade secrets should be honored by both parties. 

6. Contingency plans should be implemented in case of an emergency or when the value chain gets disrupted. 

7. Timely monitoring of the supply chain to look for areas of improvement.

Key Takeaways

  • The bargaining power of suppliers helps the Supplier exert influence on the prices of products and services, the quality offered, and the movement of goods from one place to another.
  • There are five market suppliers: Manufacturers and Vendors, Distributors and Wholesalers, Independent Suppliers, Importers and Exporters, and Drop Shippers. 
  • 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. 
  • Factors that affect the bargaining power of suppliers include: 
    • The number of suppliers that exists in the market.
    • Dependency of the Buyer on particular sellers.
    • Switching costs of the Buyer when choosing from one Supplier to another.
    • Strength of distribution channel of the company.
    • Possibility of forwarding integration by the Supplier by its clients.
    • Product differentiation is offered that makes it unique and unsubstitutable. 
  • The bargaining power of the Supplier affects the company in its pricing decision, meeting demand with supply, quality issues, and market dynamics. 
  • Some strategies to improve supplier relationships are to evaluate your value chain and the importance of the Supplier in it, create contingency plans in case of emergencies, and have agreements signed with open communication channels to solve grievances. 
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Researched and authored by Samridhi Singh | LinkedIn

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