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Porter’s five forces is considered by academics and business people as the established standard framework for analysing the competitive forces that are driving the levels of profitability of your industry.
One of these five forces is the bargaining power of your suppliers. You will find that strong suppliers can reduce the level of profitability in your industry.
In this article you will learn how you can analyse the bargaining power of suppliers in your industry.
Why analyse the Bargaining Power of Your Suppliers?
An analysis of the bargaining power of suppliers is completed to identify how much power your suppliers have in your business relationship.
If you have a powerful supplier you will find that they have a lot of influence over your profitability, as they may choose to raise prices, reduce quality or reduce service without fear of consequence.
As the bargaining power of your suppliers increases the profitability in your industry tends to decrease. However, supplier power can vary from season to season and at different stages of the economic cycle.
How do you Analyse the Bargaining Power of your Suppliers?
You can complete this stage of your analysis relatively easily, by answering a number of generic analysis questions about the nature of your relationship with your suppliers. The common analysis questions that you are likely to ask are as follows
- Are your supplier’s products generic commodity items or are they able to differentiate their products? To answer this question you need to consider if there are any valued, unique and tangible product differences that exist only in your supplier’s products. A supplier whose product or service is unique or has special attributes that you desire restricts your ability to switch to another supplier.
- Will you incur any costs to switch to another supplier? When answering this question consider maintenance spares, unique tools required and the costs of drawing up a new contract incurred by you to switch to another or a new supplier. You should also consider your time investment and the risk of the unknown that comes with a new supplier. You will find that any cost associated with changing supplier generally reduces the frequency that the businesses will change suppliers.
- Can you substitute your supplier’s products for an alternative product that your supplier does not provide? When answering this question also consider the switching costs of the alternative product.
- How many suppliers are there compared to the number of buyers? When answering this question you can normally consider the market share of the top four suppliers to your industry. The greater the market share of the top four suppliers, the greater their power. However, you also need to consider how many suppliers there are in total compared to buyers. If there are far more buyers than suppliers then your supplier has the marketing power, as the ratio approaches 1:1 the buyer power increases. If you have more suppliers than buyers then the buyer has the power.
- How important is the volume of sales to your supplier? When answering this question consider the importance of your purchases to the supplier, can they scale back production if you shift your purchases to another supplier. If demand for a product is less than the suppliers to your industries total capacity and it is hard to scale back production then the higher volume buyers will have the bargaining power. If demand exceeds production capacity then the suppliers to your industry will have an increased bargaining power. Note: Watch for economic changes that will shift the bargaining power between supplier and buyer.
- What percentage of your annual expenses do you spend with each supplier? When answering this question consider the value to be derived from entering into price negotiations with each supplier. You will find that the greatest value comes from directing your negotiation effort towards the suppliers who represent the largest spend for your industry. Some companies insist on entering into competitive tender for any category of product over a set value, say $100,000.
- How important is your supplier’s product to your product or service? When answering this question consider the role of your suppliers product on the cost of your product (or service) and the role of your suppliers product in the market differentiation of your product. When answering this question consider if your business is successful because of a quality that is inherent in your supplier’s product, if so your supplier will have the negotiating power.
- Is there a threat of forward integration? When answering this question consider if there is a risk that one of the suppliers to your industry will choose to become a competitor of yours, either by establishing a business like yours or buying one of your competitors. Now, you will have all of the information that you need to complete an analysis of the bargaining power of the suppliers to your industry.