Bargaining power of buyers | Porter’s Five Forces Analysis

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Bargaining power of buyers | Porter’s Five Forces Analysis

Bargaining power of buyers | Porter’s Five Forces Analysis

Introduction

The essence of strategy formulation involves competition. Yet it is easy to view competition too narrowly pessimistically.

 

You might have heard executives complaining that rigorous competition in an industry is neither bad luck nor a coincidence.

 

 

Moreover, within the fight for market share, competition isn’t manifested only within the other players.

 

Instead, competition in an industry is deeply rooted in its competitive forces and economics, that outdoes the established combatants in an organization.

 

The situation of competition depends on five basic forces. These forces are the bargaining power of buyers, bargaining power of suppliers, threats of entrants, threats of substitute products or services, and position among current competitors.

 

The collective strength of the forces presents the profit potential of an industry.

 

It includes industries like metal cans, tires, and steel, where no company earns investment, or returns, to mild industries like oil field services and equipment, toiletries, and soft drinks.

 

This type of industry structure offers the worst prospect for long-run profitability. The weaker the forces collectively, however, the greater the chance for superior performance.

 

Whatever their collective strength, the company strategist’s goal is to seek out an edge within the industry where his or her company can best defend itself against these forces.

 

For example, What determines the bargaining power of suppliers? what makes the industry prone to entry.

 

So, knowledge of these underlying sources of competitive pressure provides the groundwork for a strategic agenda of action.

 

Also, I have written this article that will cover the main aspects with examples of what is bargaining power, how to mitigate buying power of buyers, where it stands in porter’s five forces model when it is high or low.

 

Let’s get started!!

 

Porter’s Five Forces Analysis

This analysis is especially useful when starting a new business or when entering a new industry sector. The framework for the Five Forces Analysis includes these competitive forces:

 

Competitive Rivalry 

It determines the degree of competition among existing firms. How many rivals do you have? Who are they, and the way does the standard of their products and services compare with yours?

 

Where competitive rivalry is intense, companies generally attract customers with high-impact marketing campaigns and aggressive price cuts. 

 

And, then the buyers and suppliers can change their vendors if they feel that they’re not getting a favorable deal from that same vendor.

 

But when competitive rivalry is minimum, and your product or services are unique, then you will probably have tremendous strength and healthy profits.

 

Threats of Substitutes 

This is often associated with your product and services. The availability of substitute products will limit your ability to boost prices.

 

For example, if you supply a singular software package that automates a crucial process. So, people may substitute it by doing the process manually or by outsourcing it.

 

A substitution that’s cheap and easy to make can weaken your position and will threaten your profitability.

 

Bargaining Power of Buyers 

Here, you ask yourself how easy it’s for buyers to drive your prices down. How many buyers are there, and how big are their orders? 

 

How much does it cost them to change from your services and products to those of a rival? Are your buyers strong enough to dictate their terms and conditions to you?

 

This force analyzes to what extent the purchasers are ready to put the corporate struggling, which also affects the customer’s sensitivity to cost changes.

 

The customers have tons of power when there aren’t many of them and when the purchasers have many alternatives to shop for from.

 

Hence, companies can take measures to reduce buyer power by for example implementing loyalty programs or by differentiating their products and services.

 

Bargaining Power of Suppliers 

This is determined by how easy it’s for your suppliers to extend their prices. How many potential suppliers do you have?

 

How unique is that the product or service that they supply, and the way it is expensive wouldn’t it be to modify from one supplier to another?

 

The concentration of suppliers and therefore the availability of substitute suppliers are important factors in determining supplier power.

 

The fewer there are, the more power they need. That can impact your profit.

 

Ins and Outs of Porter’s Five Forces Analysis 

  • Use this model where there is a minimum of three competitors within the market.

 

  • Consider the impact that the government has or may have on the industry.

 

  • Consider the industry life cycle stage – earlier stages will be more turbulent.

 

  • Also, consider the dynamic/changing characteristics of the industry.

 

  • Five forces analysis helps organizations to know the factors affecting profitability during a specific industry.

 

  • This also helps to tell decisions relating to whether to enter a selected industry; whether to extend capacity during a specific industry; and developing competitive strategies.

 

Note –

  • Avoid using the model for a single private firm; it’s designed to be used on an industry basis.

 

Case Study on Porter’s Five Forces

Presented in the June 2010 issue of Financial Management magazine, Srikant Parthasarathy (head of Chakra Ventures Partners) decided to apply the famous “five forces” model, which was designed by Michael Porter (professor of competitiveness and strategy at Harvard University).

 

He applied that model to the emerging Indian business environment in comparison with more developed markets.

 

The analysis found that factors like state protectionism and a scarcity of infrastructure are greater barriers to entry in India than they’re in additional developed nations, where market forces are more powerful.

 

The analysis highlighted many issues affecting competition in emerging economies and compared them to people who are more prevalent in additional developed markets.

 

One factor that would play an important role in India is popular opinion, which exerts a substantial influence on the government.

 

A good example of this is often a campaign by local retailers against Walmart, who feel that the arrival of the US retail giant could put them out of business.

 

Walmart has made huge investments in India but has to seek out ways around stringent regulations that prevent it from doing things as basic as putting its name on stores.

 

What is the bargaining power of buyers?

Buyer’s Bargaining power refers to the pressure consumers can exert on businesses to get them to provide higher quality products, better customer service at lower prices.

 

So, strong buyers can pressure sellers to lower prices, improve product quality, and offer more and better services. All of those things represent costs to the vendor .

 

Let’s just take an example, Two companies A and B are producing substitutes with nearly equal pricing.

 

Now we’ve a situation wherein company A raises its prices because it thinks consumers won’t mind since their product is required.

 

But the consumers shift to company B and therefore the sales of company A thus falls.

 

Company A now wakes up to understand this fact and quickly rolls back the price increase. Thus the buyers have bargained and shifted back to company A. So that’s how it works.

 

How to assess the power of a buyer group

The power of an industry’s important buyer groups depends upon:

 

Factors affecting bargaining power of buyers

Buyer’s Concentration

If the amount of buyers is little relative thereto of suppliers, the buyer’s power are going to be stronger.

 

Conversely, if the buyers are widespread, then their business is additionally smaller and that they are easy to ignore for a producer.

 

Percentage of Sales

Another leverage for a buyer is the amount of business they provide to a producer. If the share of sales from one buyer is critical , then the producer won’t want to risk losing their business.

 

Switching Cost

If switching costs are low for a buyer, then any dissatisfaction with a producer or a product will cause loss of business. This is often because the customers are going to be ready to find an alternative with minimum hassle and inconvenience.

 

Threat of Integration

If the customer can integrate or merge suppliers, the customer has greater bargaining power over the prevailing suppliers.

 

Price Sensitivity

If the buyers are sensitive to changes in prices and may stop the purchase from producers, then it becomes difficult to ignore their demands.

 

Available Substitutes

If there are many substitutes or alternatives within the market, then the buyers will have tons of options to modify and search around.

 

Information

If buyers have full information regarding the producer’s operations and what their actual costs are, then they’ll be able to demand better prices from the producer.

 

Undifferentiated products

If the producer sells a typical or undifferentiated product, then they’ll usually have the potential threat of a buyer switching producers.

 

If many producers are supplying an equivalent sort of product, a buyer will have the choice of exploring possibilities.

 

Bargaining Power is High If

  • Buyers are more concentrated than sellers.

 

  • The switching costs of the buyer are low.

 

  • Also, the threat of backward integration is high.

 

  • The buyer purchases products in bulk (high volume).

 

  • They can get similar products/services from other suppliers.

 

  • The buyer is well-educated regarding the product

 

  • Substitutes are available.

 

  • The product is not differentiated.

 

Bargaining Power is Low if 

  • Buyers are less concentrated than sellers.

 

  • The switching costs of the buyer are high.

 

  • The threat of backward integration is low.

 

  • The buyer is unable to get similar products/services from other suppliers.

 

  • The buyer is uneducated regarding the product.

 

  • Substitutes are not available on the market.

 

  • Buyer purchases comprise a small portion of seller sales.

 

Mitigating Buyer Bargaining Power

Let’s go through some important aspects that help in mitigating bargaining power.

 

Increasing Switching Costs

Focus on creating an environment that your buyers would miss if they switched to a different vendor.

 

For Instance, manufacturers of health monitor bands usually build a companion website to store users’ historical health data in the cloud.

 

Customers would think twice about changing to another vendor and leaving their data behind.

 

Offering Differentiated Value

Customer retention always starts with a good product. In a B2B scenario, you will hit a sweet spot if your products stand out of the box for the quality or performance of buyers’ final products and services.

 

Increasing The Social Presence

Promote your products among influential people within the buyers’ circles, getting key endorsements when appropriate.

 

Use Pricing Strategies

This helps to increase retention. You can opt for implementing pricing strategies through lower prices for current customers or long-term membership deals.

 

Complimentary Services

You can attract customers through your business model by offering after-sale services they find valuable.

 

Personalizing customers’ experience

Personalize your customers’ interaction with the merchandise and therefore the company. The more personalized their use of your product is, the harder it’s for them to modify over to a special solution.

 

Offer Attractive “Upgrades” 

If an agreement is coming to an end, you’ll offer a beautiful upgrade if customers renew. Think about how cell phone companies offer free upgrades or app installations in the latest smartphone every two years.

 

Bargaining power of buyers Example

Bargaining power of buyers within the airline industry

The bargaining power of buyers within the airline industry is high. Customers can check prices of various airline companies fastly through the numerous online price comparison websites like Makemytrip, Goibibo, and Expedia.

 

Moreover, there aren’t any switching costs involved within the process. Customers nowadays are likely to fly with different carriers to and from their destination if that might lower the prices .

 

Some airline companies try and vary this with frequent flyer programs aimed toward rewarding customers that come to them from time to time.

 

Bargaining power of buyers within the retail industry

Walmart Inc. competes against Amazon.com Inc., Whole Foods Market, eBay Inc, and Costco Wholesale.

 

So, the range of competition compels Walmart to develop strategies for the problem that I actually have mentioned in E. Porter’s Five Forces analysis model above.

 

Walmart’s generic strategy and intensive growth strategies establish the essential approaches to grow the business and keep it competitive. Also, they decided to remain aggressive to compete within the market.

 

Walmart faces the weak intensity of the bargaining power of buyers within the retail industry environment. The massive population of buyers makes it difficult for them to impose significant pressure on retail firms.

 

Higher buyer diversity makes it harder for purchasers to impose pressure on the corporate . In effect, the bargaining power of buyers is weak in influencing Walmart and other firms within the industry.

 

Bargaining power of buyers in the pharmaceutical industry

Let’s take the example of Bulk Chemicals. The industrial Buyers of Bulk Chemicals offered downstream customers differentiated products as those Buyers discovered new solutions and opened up new markets. 

 

However, over time, industry practices were standardized and Buyers’ products became increasingly commoditized.

 

As the Buyer’s industry consolidated, and the size of the Buyers increased, the pressure they could exert on the Bulk Chemical Sellers also increased.

 

Buyers who place very similar values on the upstream Bulk Chemicals are those who tend to merge. Their downstream Products increasingly compete on price. This, in turn, puts pressure on those Buyers to decrease their costs.

 

Hence the Profit Maximizing Price of the Sellers of Bulk Chemicals decreases as there’s less and fewer diversity within the Buyers’ value for his or her Bulk Chemical products.

 

Wrapping Up

So, understanding the power of buyers relative to industry players is a critical component of every industry analysis. 

 

Since buyer power is dynamic, it behooves businesses to maintain a strong sense of their own industry’s buyer power evolution especially as they consider the new product/fixed asset investments or business model innovation.

 

You can also use our Business Ideal Pre Screening Assessments to evaluate your business and this will also help you in getting funding for your business in just 5 steps.

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