What’s it: The bargaining power of suppliers describes how strong a supplier can influence input costs and company operations. Suppliers earn revenue and profit by selling inputs to the company and some players in the industry. They will maximize profits in several ways, primarily through the price and quality of inputs, specifications, and credit policies.
The supplier’s bargaining power is one of Porter’s five forces. Others are buyers’ bargaining power, the threat of substitution, the threat of new entrants (barriers to entry), and rivalry between companies in the industry. These five forces explain why profitability in certain industries is higher than in others.
Why the bargaining power of suppliers matters
With their strong bargaining power, suppliers squeeze the company’s profits and other players in the industry. Suppliers can threaten the company by increasing prices or reducing the quality of goods and services purchased. They can also establish strict credit collection policies. Also, inaccurate delivery of inputs to production facilities can disrupt company operations.
Profitability pressures are more significant, for example, if firms are unable to pass input prices onto their selling prices. Thus, companies have to bear higher operating costs and lower profit margins.
Conversely, if the supplier is weak, the company has the opportunity to negotiate a lower price. Or, the company can ask for higher quality input and more lenient credit terms.
For labor input, companies can ask workers to be more productive. If they can’t, the company can fire them and replace them with another individual.
Furthermore, apart from being dynamic, suppliers’ bargaining power is often outside its control. Therefore, in some industries, companies can only adapt without being able to negotiate with their suppliers.
Factors affecting suppliers’ bargaining power
Like buyers, suppliers’ ability to maximize their profits depends on their strength relative to the firm’s strength. The bargaining power of suppliers is strong if:
First, firms face little or no substitution for inputs. Companies are, therefore, forced to rely on deliveries from their current suppliers.
Conversely, if there are many substitutions available, it is easy for the company to switch from its current supplier. It increases the bargaining power of the company.
Second, the company is not an important customer for the supplier. Suppliers’ revenue and profits do not depend on sales to the company or other industry players; they only make a small contribution. Suppliers sell to various industries.
Conversely, if the company and other industry players are strategic customers, the supplier’s profit will depend on their demand. Say, their demand contributes to 50% of the supplier’s total revenue. In this case, the supplier will maintain current demand by meeting demand specifications, offering discounted prices, or offering more lenient purchase credits. That way, they don’t switch to other suppliers.
Third, the number of suppliers is relatively concentrated. Say, a supplier operates under an oligopoly market with few players. Meanwhile, the company operates under a monopolistic competitive market with many players. In this case, the supplier has a higher negotiating power on price, quality, and sale terms.
Conversely, if the number of suppliers is greater than the number of buyers, the buyers have more substantial bargaining power. Take, for example, a supplier of input for food commodities such as corn or soybeans. They have weak bargaining power because supplies come from many farmers. Meanwhile, requests only come from a few companies.
The bargaining power of farmers may increase when corn and soybeans’ supply shrinks, such as natural disasters.
Fourth, supplier products are essential inputs for the company. It has a higher quality than other suppliers. Its supply dramatically affects the production and quality of the company’s output. That, of course, increases the bargaining power of suppliers.
The supplier’s power is higher if the input cannot be stored for an extended period. Companies cannot build inventory in warehouses to anticipate supply uncertainty.
Fifth, input from suppliers is highly differentiated. That results in high switching costs. The uniqueness of the inputs makes it difficult for companies to switch to suppliers for similar inputs. Or, when switching to alternative suppliers, they have to incur high costs.
Sixth, suppliers have the credibility to threaten the company through a forward vertical integration strategy. In other words, the supplier can stop delivering inputs, enter the industry, and become a direct competitor to the company.
Bargaining power in the labor market
Inputs include not only raw materials or energy but also labor. In the labor market, individuals act as suppliers, while firms act as buyers.
Labor costs have a significant influence on profitability in many industries, especially those that are labor-intensive. They cover most of the company’s operating costs.
In the labor market, another factor affecting is the organization’s level, whether workers are organized. Organized labor through trade unions has higher bargaining power. On the other hand, although employees are highly skilled and professional, their bargaining power will be weak if they are not in a union.