Bargaining power of Buyers & Suppliers

Buyers can put forth a lot of pressure and utter prices, if there are a large number of sellers with similar products/services.

On the differing, they may not be such a big influencer in case there are few sellers for a product/service.

To Summarise, it is the purpose of number of buyers and sellers and discrimination in their products/services, which may establish buyers’ bargaining power in an industry. The size and profile of the buyer, for instance, the government as a buyer of the product or service, can pressure the bargaining power they have.

Buyers’ bargaining power can be implicit from following simple industry features.

It would be high when:

1. Competitive intensity in the industry is strong (continuous pricing pressure would exist on industry participants).

2. There is small or no differentiation with standardized between products and services.

3. Close substitutes of the products/services exist and switching cost for customers is low or nil.

Bargaining Power of Suppliers

A consumer will seldom bargain over the fees charged by hospitals or schools. But, the same consumer will bargain with the vegetable or fruits seller all the time. In the first case, the bargaining power of suppliers is fixed and in the second case, bargaining power of suppliers is nil (until he/she is the only vendor and close alternative is quiet far).

The sugar industry, particularly in the Indian context, is completely dependent upon the price which is decided by the government after bearing in mind the views of the sugarcane farmers.

Hence, the input cost of the raw material is based upon the price which the suppliers demand.

In this case, suppliers have a tough bargaining power. Likewise, supplies of the necessary commodity, crude oil arealmostforced by a few Organization of the Petroleum Experting Countries (OPEC) through alteration of the production to maintain the price levels, they wish. In a way, we may say OPEC has pricing power on oil.

Suppliers’ bargaining power can be implicit from following simple industry features.

It would be high when:

1. The number of suppliers are inadequate and buyers are many

2. Suppliers supply some significant inputs to buyers

3. Competitive intensity in the industry is low with differentiation in products and services.

4. Products/services do not have threat of substitutes

5. Switching cost for the customers is high

Barriers to entry (Threat of new entrants)

Any industry which does not face the threat of new competitors coming in would be astriking industry for investors/owners. There could be several barriers to entry for new entrants in a business - licensing, required competence/skills (IT products), capital (oil and gas), distribution reach (banking and finance), brand loyalty of customers with the active participants (toothpaste, coffee markets) etc. This is what Warren Buffet calls as ‘the moat’; he says “In business, I look for economic castles protected by unreachable ‘moats’". This fundamentally means he looks for businesses with high entry barriers. Such businesses will have pricing power viz. can sell the products at a premium without fright of losing customers.

Entry barriers in an industry can be understood from following simple industry features.

They would be high when:

1. There are lots of licensing required in the business

2. Patents and copyrights prevent new entrants

3. Huge investments in specialized assets pose a threat

4. Strong Brands, strong distribution network, specialized execution capabilities, customers loyalty with existing products/services exist in the business

Based on the above talk, attractive Industry from shareholders’ viewpoint is one that has one or more the following prominentcharacteristics that create a profitable atmosphere for the business:

1. Low competition

2. High barriers to entry

3. Weak suppliers’ bargaining power

4. Weak buyers’ bargaining power

5. Few substitutes

If an industry is having these characteristics, it would have sturdy pricing power and high profit margins and attract investors.

For example, Education is an industry in India where there is ample demand (and continuously increasing) and very little bargaining power of the students (buyers of the service).

The industry isconfined from recession. Starting an educational institute requires multiple permissions (high entry barriers) and quality institutions are a few (low competition). Teaching staff is hired at salaries resulted by the management of the institute (weak suppliers’ bargaining power). Challenging courses though may be available, but do not create enough self-assurance amongst students (few substitutes). Hence, education industry can be supposed to be a model of an attractive industry