Retail Dogma

Bargaining Power of Suppliers: How to Reduce it?

When I first started out as a small e-commerce retailer I had no clue what bargaining power of suppliers is. I thought all I have to do is to find good reliable suppliers to get my products when I need them and make sure they will continue to do so over time.

Little did I know that the relationship between a buyer (like me) and his suppliers is very complicated and requires a lot of in depth knowledge of how the industry works, and what the different forces here are.

So let’s talk some Strategic Management!

What is Bargaining Power of Suppliers?

In 1980 Michael E. Porter published his strategic management classic ” Competitive Strategy: Techniques for Analyzing Industries & Competitors

The book included the Five Forces Model (figure below), which is used to assess the competitiveness, attractiveness and profitability of an industry (e.g retail).

Bargaining Power of Suppliers
Image by Denis Fadeev / CC BY-SA

The bargaining power of suppliers is one of those five forces in an industry that dictates its attractiveness & profitability.

Example:

In an industry where suppliers have high bargaining power, they will be able to dictate prices on the buyers. This will mean lower margins for the buyers, as opposed to another industry where suppliers have lower bargaining power. Not only can suppliers here increase prices, but they can also lower quality without much pushback from buyers, just because the bargaining power of suppliers is so high in this industry.

What Determines The Balance of Power ?

There are many factors that dictate the relationship between suppliers and buyers and determines the level of power for each one.

Supply & Demand

If the industry has too many suppliers and few buyers, then the power of buyers will be higher than that of suppliers. This will reduce end prices and make the buyers more profitable.

Industries that are monopolized on the other hand, where only few (or only one) suppliers exist, will give a huge bargaining power to suppliers over buyers. That’s why there are laws to protect competitiveness and fight monopolies, because when suppliers have high power the end product will become unaffordable to the final consumer. Basically, everyone in the value chain tries to push the higher costs to the next player, and it almost always lands in the consumer’s lap.

But because buyers (here companies) can only pass so much costs to the final consumer before it affects demand for the product, this high power of suppliers will reduce the buyers’ profitability, as they will absorb some of the cost increase themselves.

Read Also: Pricing Strategies: 4 Important Things to Consider

Switching Costs

If switching from one supplier to another one will require a costly investment on the buyer’s side, then the power of supplier will increase.

For example if suppliers in some industries require buyers to pay an initial sign up fee or purchase a certain equipment or software to be able to deal with them in the future, this would mean that if the buyer ever wanted to switch suppliers, they would have to pay all those fees all over again. This constitutes a barrier to switching and plays in the supplier’s favor.

On the other hand if switching between suppliers is as easy as exchanging some mails and cancelling contracts without any penalties, then the bargaining power of suppliers here will be very low and it plays in buyer’s favor.

Threat of Forward Integration

Forward integration is when one player in the value chain starts assuming the role of the next player.

For example if a retail supplier starts bypassing a retailer (buyer) and sells directly to customers. A good example of this is when Nike launched its Nike Direct program, which lets it bypass a lot of retail partners and sell directly to consumers. By doing this, Nike has reduced their retail partners from 30,000 to only 40, and started keeping more of the profits to itself.

Of course this gives more power to the supplier and directly affects the buyer because now the buyer is in direct competition with the supplier.

How to Reduce Bargaining Power of Suppliers in Retail?

Here I am going to mention a few things that I have done myself to make sure the relationship between me as a buyer and my suppliers stays healthy but at the same time beneficial for my business.

I have already mentioned in our guide to Starting a Retail Business that suppliers are your most important business partners. This dictates a high level of care when it comes to dealing with your suppliers and at the same time a high level of shrewdness to ensure you are acting for the best interests of your business.

Having good, reliable suppliers can make or break your retail business, so it is very important to treat the subject of supplier relationships with absolute care and attention.

1. Supplier Diversification

The first rule for making sure your suppliers don’t have much of a bargaining power over you is by having multiple suppliers.

Having multiple suppliers might seem like a daunting task. After all, you have to maintain all those suppliers relationships, traveling to meet them, communicating regularly with them and making sure they are receiving adequate amount of business from you. However; doing so will give you the high bargaining power that you will need to keep prices down and increase your profitability.

You will be surprised at how fast suppliers will increase their prices on you the minute that they feel they actually could do so without you leaving them. It’s a clever thing to do from their side and I don’t blame them. This is a business relationship after all.

2. Exclusivity

This one will depend on the size of your business, but if you are buying and selling a lot of merchandise for a particular product category you can negotiate an exclusivity agreement with your suppliers over the market you are operating in (e.g certain country or state).

This will serve you in two ways: You will use it to make sure no other buyers will be selling the same product as you do and compete with you and thereby reducing your margins. At the same time it will ensure that your supplier doesn’t start selling the product directly to customers in your area and compete with you.

You might find that after you have spent a lot of time and marketing dollars on introducing a certain product to your market, that other people (including your suppliers) will want to capitalize on this success and take a bigger share of the pie. This could be in the form of directly selling to customers or finding more buyers to carry the product in your area. So this is something you want to keep in mind from the start and act on it at an advanced stage.

Basically if you have implemented rule no. 1 and have enough suppliers for your products you will probably be able to implement rule no. 2 and demand exclusivity, because you have enough power.

This exclusivity agreement could be drafted for a certain period of time and be subject to renewal. In return for such an agreement the supplier might ask for a certain volume or % of your buying budget over a year. If the numbers work out for you and you believe it will increase your margins, and hence also your profits, it could be beneficial to have such and agreement in place.

3. Your Brand Over Your Supplier’s Brand

This is especially important for people running a boutique store or department stores that carry different brands under their umbrella, rather than doing private label.

Always make sure to maintain the power over your channel, including your branding and marketing efforts. Make sure that customers come to buy from YOU, because they trust that you are sourcing the best products for them.

When I was implementing rule no.1 (Diversification) for my stores and introducing new suppliers/brands into my collections, it felt like a risky thing to do.

However; because I have kept the branding for my stores clear in my communications and throughout the entire customer experience, putting emphasis on my brand name rather than any of the brands I carry, it didn’t affect my sales at all.

On the contrary, I started making more sales out of this particular product category because now I was carrying more variety and customers had more options to choose from.

Read more on Category Management

This will put you in a very strong position as a buyer and will give you more bargaining power. Because when you have a powerful brand, suppliers will be more keen to do business with you and you will be able to get more concessions and better terms.

As a retailer, always keep absolute control over your sales channel

Having a High Bargaining Power as a Buyer

Once you establish a strong position as a buyer, you will see this reflect on your financial results. Not only will you be able to negotiate lower product prices, but you will also negotiate better shipping terms and payment terms. This in return will improve your margins as well as your cash flow.

Further Readings on Dealing With Suppliers