Suppliers provide inputs for the company. For example, they supply raw materials to a manufacturing company. Or they sell components, other intermediate goods, or capital goods.
On the one hand, the owner is critical for the company because it affects its competitiveness. On the other hand, they are also interested in the company to make money.
In a broad definition, input suppliers include those who provide financial capital (such as banks), financial services (such as insurance), and even labor. In a narrower definition, it only includes those who provide inputs used in the production process, such as raw materials, semi-finished materials, components, and capital goods. And this article focuses on the last definition.
Suppliers may be individuals or companies. Individual suppliers are usually for small businesses. Meanwhile, corporate suppliers are more relevant to big business. They can come from local, national, or overseas.
Why is the supplier a critical stakeholder?
Suppliers are primary stakeholders besides employees and customers. Building a healthy long-term relationship with them is in the company’s best interest. As well as contributing to improving operations, they are also crucial in a company’s efforts to reduce costs and improve customer service.
We consider suppliers to be critical stakeholders for several reasons.
First, they directly affect the selling price. For example, higher prices for raw materials and components increase production costs. The company will usually pass on the increase to the selling price. Therefore, it is in the company’s interest to get lower input prices, for example, by buying on a large scale to get a discount.
Second, suppliers affect quality. Quality products require quality materials. For example, quality leather shoes come with high-quality leather but are also influenced by design factors. Thus, companies must be selective in choosing suppliers.
Third, delivery affects the production schedule. Suppose suppliers are on time in bringing raw materials and components to factories on time. In that case, production activities and schedules can be smooth. Problems can get bigger if the company does not have stock when adopting a just-in-time (JIT) inventory system.
JIT requires reliable suppliers to deliver raw materials and components on time. Companies adopt this system to increase efficiency and reduce inventory costs by receiving goods only when needed for production.
Fourth, suppliers can become potential competitors in the future. They may go into the downstream business where the company operates. Their goal is to reap added value in the downstream industry.
For example, you are a leather shoe manufacturer. If the shoe market seems profitable, your supplier may start producing leather shoes and compete with you. They may do so by making themselves, establishing subsidiaries, or acquiring your competitors.
What is the supplier’s interest in the business?
Suppliers are happy when companies perform well because they can continue generating revenue. For suppliers, companies are their customers. So, when companies make a lot of money, so do they.
It is in the supplier’s interest to get regular orders, keeping them in business. Purchasing in bulk is also crucial for them because it can save costs such as warehousing. So, they usually give discounts to encourage companies to buy in bulk.
Discounts are also a way to attract companies to continue to be loyal. Suppliers want to build long-term relationships with companies. If successful, they will get regular orders.
Prompt payment is another supplier’s interest in the company. If they receive money faster, they can use it for working capital, repaying debt, or investing. On the other hand, late payments can disrupt their cash flow.
What is the supplier’s role and influence on the business?
Suppliers are essential for businesses to remain competitive and successful. Companies must maintain good relations with them because they affect operations and output.
We can see how suppliers affect business from the following aspects:
- Input quality. It affects the output quality.
- Input prices. Lower prices mean lower production costs and, therefore, higher profit margins.
- On-time delivery. This affects production schedules and processes, as well as inventory costs.
- Specification accuracy. If the inputs sent are out of specification or damaged, it can become a big problem for the company.
- Reputation. Working with highly reputable and reliable suppliers influences the company’s image.
- Shared values. For example, a sustainable business requires support from suppliers with similar values who are socially and environmentally responsible.
- Credit facilities offered. Looser credit eases cash flow cycles because companies can temporarily use the money for other purposes without incurring penalties.
The above factors are the primary considerations in selecting a supplier. The accuracy of the selection affects the company’s competitive advantage because it impacts the cost structure, output quality, production process, image, and company profits.
What makes a supplier critical?
Suppliers are critical if they have a material impact on the business. For example, they may provide essential inputs for which there are no close alternatives. Or they are the only supplier.
Then, when suppliers have strong bargaining power over the company, they can squeeze profits. They exert their market power to increase prices or reduce the quality of inputs.
Porter’s Five Forces help us to answer what makes a supplier critical.
- Suppliers are critical if their numbers are few. Thus, the company faces fewer alternative suppliers to choose from.
- Their inputs are unique or differentiated. Thus, the company has no substitutes. Or, if anything, the company has to incur significant switching costs.
- Your company is not a critical customer for the supplier. They can make money even if they don’t sell inputs to you.
Credible supplier to threaten by going into downstream business. They can be potential competitors to your business and have power over your company because they have secured inputs.
Due to critical reasons, some companies enter the upstream business by acquiring suppliers. They want to secure input supplies. This is what we call backward vertical integration.
There are several examples of backward vertical integration. For example, a steel producer acquires an iron ore mining company. Or in a real example, Apple Inc. purchased semiconductor supplier Dialog Semiconductor Plc in a $600 million deal in 2018.
Backward integration is vital for increasing control over inputs, including their quality and supply. In addition, this strategy contributes to cutting costs and increasing efficiency.
Some companies also use strategies to create barriers to entry. For example, a company acquires a supplier with the largest market share in its industry. This strategy forces new players to operate at a large scale and look for alternative, credible suppliers.
