Supplier power is one of Porter’s Five Forces and can have a big impact on industry profitability. When suppliers are powerful, they can capture a large proportion of industry profitability, pushing up your input costs, and squeezing your margins. This article explores some of the key reasons why suppliers can be powerful.
Reason 1: The supplier industry is concentrated with few alternatives
One of the most important influences of whether a supplier industry will be powerful is how concentrated it is. At the extreme, if you are buying from a monopoly, and are dependent on that one company, then it is much easier for them to increase the costs of the inputs. Unique features that mean you have to use that particular firm, all contribute to an increased power position of the supplier.
Reason 2: High switching costs
Connected to the above, high switching costs can make it difficult for you to change suppliers. A high cost of training to move to a new supplier, or substantial changes to your operations that would be needed to change who you work with, all increase the power of the supplier. Even if there are technically other firms that could provided a similar service, if you are essentially locked into your current supplier, then this increases their power position.
Reason 3: Your industry is not that important to the supplier
This reason may not sound intuitive, but if you are not a particularly important industry to your supplier – possibly only representing a small proportion of your suppliers’ sales – then your power is reduced. You need them more than they need you, and this makes it hard to negotiate down prices.
Reason 4: The inputs represent only a small proportion of your costs
Suppliers can also be more powerful when they know that their costs are only a small proportion of the total costs. Companies tend to negotiate hard on the high-value input costs – and justifiably so, small percentage reductions in cost can make a big difference. For less significant costs, there are greater opportunities for suppliers to gradually increase their prices without it being noticed or cared about by you. In effect, they can push up the prices because it is not a priority for you to push back and get a better price.
Reason 5: No realistic possibility of backward integrating
Having a realistic possibility of being able to backward integrate puts a cap on how much suppliers can inflate their prices. If they know that you could realistically backward vertically integrate into their sector, then this limits the likelihood that they will be able to charge high prices. It in effect acts as a deterrent – should prices rise, then you have the ability to backward vertically integrate, removing them completely from your supply chain.