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  • Writer's picturePeak Frameworks Team

What is the Bargaining Power of Suppliers? (Strategic Management)

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Five Forces Analysis

In strategic management, Michael Porter's Five Forces Analysis is a framework used to analyze the competitive environment of an industry.

One of the crucial components of this model is the Bargaining Power of Suppliers.

This force determines the extent to which suppliers can influence the terms and conditions of business operations.

Bargaining Power of Suppliers
Source: Power Slides

Understanding the Concept of Bargaining Power of Suppliers

The bargaining power of suppliers refers to the capacity of individual suppliers to increase product prices, reduce product quality, or limit the number of products they sell.

For instance, Apple Inc. is notorious for its dependence on Foxconn, a Chinese electronics manufacturer, for a major part of its device production. This scenario potentially amplifies Foxconn's bargaining power, making Apple vulnerable to its supply terms.


Factors Influencing the Bargaining Power of Suppliers

Porters Five Forces
Source: eCampus Ontario Pressbooks

Several factors influence the bargaining power of suppliers:

Number and Size of Suppliers

A market dominated by a few, large suppliers increases their power. For instance, the commercial aerospace industry is largely dominated by Boeing and Airbus, reducing the bargaining power of airlines.

Uniqueness and Value of the Supplier's Product or Service

The more unique a product or service, the greater the supplier's power. For example, Intel's high-performance chips are unparalleled in the market, increasing their bargaining power.

Cost of Switching Suppliers

High switching costs strengthen the power of suppliers. This is evident in industries where heavy machinery is involved, such as manufacturing or construction.

Availability of Substitute Goods/Services

When suppliers offer products that have few substitutes, their power increases.

Dependence on the Industry by the Suppliers

If a supplier's business heavily depends on the industry, they're less likely to risk their relationship with the buyer, reducing their power.

The Impact of High Supplier Power on Businesses

High supplier power can negatively impact businesses in various ways:

  1. It may lead to increased production costs due to higher input prices.

  2. It can cause supply chain disruptions, as seen in the global semiconductor shortage.

  3. High supplier power may limit business growth and expansion due to constrained resources.

How to Manage and Mitigate the Bargaining Power of Suppliers

In the face of supplier power, businesses must deploy strategic approaches to maintain a balance of power and protect their competitive advantage. Here's how:

Developing Supplier Relationships and Contracts

Long-term relationships with suppliers can cultivate trust and mutual benefits. By maintaining strong relationships, businesses can negotiate favorable contract terms and ensure reliable supply chains.

For example, McDonald's maintains long-term relationships with its suppliers, ensuring consistent product quality across its global outlets.

Moreover, businesses can secure long-term contracts to lock in current prices and protect against future price increases. These contracts may also offer favorable conditions, such as volume discounts or first access to new products.

Diversifying Supply Base

One effective way to mitigate the bargaining power of suppliers is to diversify the supply base. Relying on a single supplier for critical input exposes a business to a significant amount of risk. If that supplier increases prices, the company may be forced to absorb the cost or pass it on to consumers.

By diversifying the supply base, a company can reduce its dependency on a single supplier. This is what Apple did when it began sourcing its OLED screens for iPhones from both Samsung and LG, reducing its reliance on a single supplier and creating a competitive environment that can lead to better pricing and terms.

Investing in In-house Production or Vertical Integration

Vertical integration is another strategy for managing supplier power. It involves the expansion of business operations into stages of production that were previously supplied by businesses up or down the supply chain.

Tesla is a classic example of this, as they built their Gigafactory to produce batteries in-house, significantly reducing their dependence on external battery suppliers.

Negotiation Tactics and Strategies

Strong negotiation skills can also help businesses manage supplier power. Companies can negotiate for lower prices, better payment terms, or improved service levels.

Negotiation
Source: VIA Mediation Centre

Knowledge of the market, understanding the supplier's costs, and demonstrating the value you bring as a customer are all critical aspects of successful negotiation.

For instance, Walmart, known for its strong of the world's largest retailers negotiates favorable terms with its suppliers. negotiation tactics often manage to keep its costs low by leveraging its position as one

Leveraging Technology for Supplier Management

With the rise of digital technology, businesses can now manage suppliers more effectively. Supply chain management software can provide better visibility into supplier performance, streamline communication, and quickly identify and mitigate risks.

Companies can also use data analytics to evaluate supplier performance and make informed decisions.

For instance, companies like Unilever use digital solutions to assess the sustainability practices of their suppliers, ensuring they align with their corporate social responsibility goals.

Effects of Digitalization and Globalization on the Bargaining Power of Suppliers

Digital platforms and e-commerce have made it easier for suppliers to reach consumers directly, potentially increasing their power. On the other hand, globalization has brought more suppliers into the market, often leading to a decrease in supplier power. Thus, businesses need to strategically navigate these shifts to stay competitive.

Conclusion

In a world of constant business dynamics, understanding and managing the bargaining power of suppliers is crucial for maintaining competitive advantage. Engage with us in the comments below and share this article on your social media to help others understand this critical concept.

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