Even though it impacts them the most, many procurement professionals are not formally aware of the concept of bargaining power of suppliers and how it impacts their businesses. Part of the competitive analysis framework (Porter’s five forces analysis) put forth by the Harvard professor Michael Porter, an analysis of the bargaining power of suppliers can help businesses understand the extent to which they are dependent on their suppliers and how vulnerable they are to any changes in the supplier ecosystem. As one could expect, if an organization’s suppliers enjoy a high bargaining power, it is not very good news for the organization. The supplier could drive up the cost or change delivery terms as he pleases, which will have consequences on business operations.
If taken out of its competitive analysis context and applied to an individual business and its suppliers, a coherent understanding and analysis of their suppliers’ bargaining power could help an organization’s procurement professionals take measures to reduce, or even eliminate it. In this series of posts, we’ll look at what creates this power, how it affects an organization, and how procurement professionals can take necessary steps to tailor their approach to counter this.
How is suppliers’ bargaining power created? For a variety of reasons, some of them being:
Number of suppliers: A very important cause of bargaining power is the number of suppliers who can meet the organization’s demand. When an organization can choose from a high number of suppliers, the suppliers’ bargaining power will be low, and vice versa. In other words, suppliers in a monopoly or oligopoly market structure tend to have high bargaining power while those suppliers in a perfectly competitive environment tend to have low bargaining power.
Over-reliance: Sometimes, in order to reduce supplier risk, organizations tie up long-term contracts with one or very few supplier(s). This approach gives the organization very little flexibility and gives their suppliers a lot of bargaining power.
Switching cost: This refers to the additional cost that’s incurred by the organization if they decided to switch from one supplier to another. These costs include cost of setup and configuration, infrastructure costs, cost of customization, legal costs, etc… High switching costs inhibit organizations from changing their current supplier, which essentially gives the current supplier a lot of bargaining power.
In the next post, we’ll continue looking at bargaining power of suppliers.