The Power of Suppliers: Are You At Risk?

Michael Porter’s Five Forces framework uses industrial organization economics to evaluate the attractiveness of an industry based on the overall level of competition within that industry. The more competitive an industry, the lower profits will be. Conversely, an industry with little competition is likely to be more profitable and, therefore, more attractive. We’ve already written on the Porter’s Five Forces generally. Now we’re looking at each of the forces individually and in greater detail. Today we’re taking a closer look at the supplier power.

The Impact of Supplier Power

Previously, we’ve looked at what are often considered the horizontal forces that influence the competitiveness of an industry: industry rivalry, threat of new entrants and threat of substitutes. These are considered horizontal forces, because they represent pressures within the industry looking at the same market.

For example, a seller of televisions needs to keep an eye on pressure from existing competitors selling TVs, potential new entrants that might start selling TVs and substitutes like tablets and computers used for watching video. Supplier and buyer power, on the other hand, are forces along the vertical access. A supplier of the computer chips within a television set, for example, isn’t likely to start competing directly with the television manufacturer (although this is a possibility).

So, if the supplier isn’t competing directly with the primary industry participants, how can they make the market more competitive? Well, depending on the power of the buyer, they can squeeze profit margin from their customers. For example, in the television example, if there is only one supplier of the computer chips within television sets, they can increase their prices to the point that the manufacturers are barely able to stay in business, thereby shifting the profit vertically up the supply chain.

Types of Suppliers

Suppliers of raw materials and intermediate parts aren’t the only type of suppliers. The site Cleverism covers several more:

Distributors and Wholesalers

Distributors and wholesalers are the sources of products for retailers. They’re the middle people between those producing the goods and those ultimately offering them for sale. They take a mark-up from what the manufacturers might sell the products for, but the benefit to retailers is that they are able to buy the products in smaller quantities.

Independent Suppliers/Craftspeople

Etsy is probably the best most recent example of independent suppliers and craftspeople. The site has allowed these individuals a ready-made showcase for their goods. Other sources of these types of supplies include trade shows.

Importers

Importers are somewhat similar to distributors and wholesalers. In their case they purchase goods from international sources and sell them to retailers and others.

How Suppliers Become Dominant

Perhaps the single biggest determinant of supplier power is the concentration of suppliers relative to buyers. If there are relatively many suppliers, buyers have greater leverage because they can take their business elsewhere if they aren’t being treated fairly. Obviously, the converse is true if there are relatively few suppliers.

Relatedly, the differentiation of inputs and the availability of substitute inputs are important. If inputs are generic, or there are many options for what inputs to use, there are effectively more suppliers, even if they aren’t offering the exact same input.

Forward Integration

We alluded to this earlier, but another important factor to consider is the threat of what’s called forward integration: the risk that the supplier can compete directly with the buyer. Consider, for example, an orange producer supplier and an orange juice manufacturer. If the orange supplier decides it can capture more of the overall profit margin in the value chain by producing orange juice itself, rather than supplying oranges to another company, it could steal market share from its customers.

Managing supplier power can be tricky for businesses. On the one hand, they need partnerships with their suppliers to keep their businesses going. On the other hand, those suppliers are always running businesses themselves and are always looking to gain more profit, often at the expense of their customers.

What risks do you face from your current suppliers? What could you be doing to help minimize those risks?

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