Bargaining power of suppliers: Porter’s Five Forces

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The presence of powerful suppliers reduces the profit potential in an industry. Suppliers increase competition by threatening to raise prices or reduce the quality of goods and services. As a result, they reduce profitability in industries where companies cannot recover cost increases in their own prices.

The bargaining power of suppliers is one of the five forces that determine the intensity of competition in an industry. The others are barriers to entry, industry rivalry, the threat of substitutes and the bargaining power of buyers.

Power of supplier group

The following conditions indicate that a supplier group is powerful:

  • It is dominated by a small number of companies and is more concentrated than the industry to which it sells
  • It is not required to contend with substitute products for sale in the industry
  • The industry is not one of the supplier’s important customers
  • Its products are an important part of the buyer’s business
  • Its products are differentiated or there are built-up switching costs
  • It poses a clear threat of forward integration

How to mitigate a strong bargaining power of supplier

Centralize procurement If you have multiple business units that independently procure raw materials from the same vendor, establish a central procurement unit that consolidates all orders while negotiating prices for your business units and dictating your terms; failure to follow these terms will result in the cancellation of all purchases.
Diversify your supply chain By diversifying your supply chain, you can reduce your reliance on a single supplier. This will also enable you to develop long-term competitive advantage and resilience to supply chain disruptions in such situations as war and pandemics.
Use substitutes If you are a manufacturer, look for a raw material substitute that has the same function and quality required by your products. If a substitute is available, use this instead of your original raw materials. As a result, the possibility of your single supplier becoming more dominant is significantly reduced.
Backward integration Examine your company’s ability to integrate backward. If you start producing key supplies for your business/manufacturing, you can eliminate your supplier’s bargaining power. For example, Apple has begun developing its own processors to reduce its reliance on powerful vendors, such as AMD and Intel. This can also help you gain control of your supply chain, enhance product quality and save total costs.
Competing with your supplier This is similar to backward integration, except that you do not cut ties with your supplier. Such companies as Walmart, Costco and other retail players have their private label products that compete with the brands of their suppliers. This maintains control over price hikes and supply chain manipulation by suppliers. This scenario is more relevant in the retail industry, where multiple brands are sold under one roof. Keep in mind that you will need to work on your branding and marketing, since customers will come to you to buy your private label products because of your brand value.
Bring new value to your supplier If you have plans to expand into a new geography or industry where suppliers have tried but failed to penetrate, you can offer them a new market opportunity in exchange for price concessions. If the offer is lucrative enough, you can gain the upper hand in price negotiation.
Strategic partnership agreement If you are a bulk buyer, you can control your suppliers’ bargaining power by negotiating and signing an exclusivity agreement with them. This agreement lowers the risk of them selling the product directly to customers in your area and competing with you. You can also make sure that your supplier is not selling any raw materials to your competitor to reduce your margins. Keep in mind that your supplier may require you to make certain commitments in exchange for signing such an exclusivity agreement.

A careful examination of the cost and value of your supply chain is required to assess your suppliers’ bargaining power in your business, which can be identified and mitigated by considering one or more of the following options:

  • Changing how you buy 
  • Assessing what value you can offer to your supplier 
  • Building a robust supply chain
  • Becoming self-sufficient
  • Conducting strategic negotiations