Your Buyers Have Power: Maybe More Than You Think!

38309393 - group of different families together of all racesIn 1979, Michael Porter, an associate professor at Harvard Business School, developed what would become known as Porter’s Five Forces, a framework intended as a tool for determining the attractiveness of certain industries based on the level of competition within those industries. The five forces — threat of new entrants, threat of substitutes, supplier power, buyer power and competitive rivalry — collectively determine the degree of competitiveness within an industry. We’ve written about the framework as a whole. Now we’re looking at each force in depth. Today, we look at buyer power.

Forces Impacting Businesses

We’ve already 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, in the pizza restaurant example we used in the threat of substitutes post, potential competition can come from existing restaurants of the same type, new restaurants of the same type, or new or existing close alternatives, like hamburger restaurants or frozen pizza producers.

However, there are also forces coming from the bottom up and the top down. From the bottom up are the pressures caused by the power of buyers.

Contributing Factors

Just as with supplier power, concentration here is key. How many buyers are there relative to suppliers? If you’re in a B2C industry, such as an automobile manufacturer, there are a handful of major suppliers and millions of potential buyers, meaning buyer power is low. However, if you’re a contractor for defense aircraft like Lockheed Martin, your customers are governments, and primarily the United States government. Such an industry has very strong buyer power, as recently demonstrated by Lockheed Martin slashing the cost of its F-35 aircraft in the face of pressure from President Trump acting as the representative of the buyer, the U.S. government.

There are a number of other factors that influence buyer power as well:

  • Buyer Information: The more informed a customer is, the more they will demand in terms of price and quality, because they can better compare what you have to offer relative to your competition.
  • Availability of Substitutes: Related to the threat of substitutes, if buyers can meet their needs by buying something other than what you’re offering, they will have added leverage. For example, if the price of orange juice goes up, I can drink sports drinks instead.
  • Product Differentiation: If I sell grain, my grain is probably not much different than anyone else’s, so I have to keep my prices in check or my customers will go elsewhere. However, if I have just written an incredible book that everyone wants to read, that covers content not available anywhere else, I have more flexibility in what I charge.

Backward Integration

Backward integration refers to the ability of the buyer to vertically integrate that portion of the supply chain currently held by its suppliers. Consider, for example, one of the giants of industry around the turn of the 20th century. Steel is produced by smelting iron from iron ore to remove the impurities and then adding carbon. A key input, therefore, is obviously iron ore. If you were a supplier of iron ore to Carnegie Steel, there was a very real chance that your customer would buy you out or buy so many iron mines that they didn’t need your product anymore.

Buyer power isn’t typically a concern for most B2C companies. There’s little risk that I’m going to develop my own smartphone, for example, or strong arm Apple or Samsung into giving me a great deal. But for B2B companies, the bargaining power of its customers is an important factor in determining how competitive their industry is.

Who are your buyers and what forces are they exerting—or could they exert—on your business? Porter’s Five Forces provides a framework to think differently, and more strategically, about the forces around you.

Next up: a look at competitive rivalry.

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