Retail Dogma

Bargaining Power of Suppliers: How to Reduce it?

Bargaining power is the relative ability of each of the negotiating parties to reach an agreement that works to their own advantage.

In any industry, a business will be facing two types of bargaining power:

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  1. Bargaining Power of Suppliers
  2. Bargaining Power of Buyers

The higher those powers, the less profitable will be the company, because suppliers will want to sell at higher prices and buyers (customers) will demand low prices, so the company’s margins will be squeezed in the middle.

Porter’s Five Forces

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.

Porter's Five Forces

An industry will have the following 5 forces, that can affect its profitability & attractiveness:

  1. Bargaining Power of Suppliers
  2. Bargaining Power of Buyers
  3. Threat of New Entrants
  4. Threat of Substitutes
  5. Rivalry Among Competitors

The higher those forces, the more competitive, and less profitable is the industry.

In retail, suppliers are the manufacturers and wholesalers that sell to the retail business, and buyers are the end customers that buy from the stores.

In this article, we are going to explain the bargaining power of suppliers, i.e wholesalers and manufacturers, and how retail businesses can deal with it and reduce it.

What is Bargaining Power of Suppliers?

The bargaining power of suppliers is their ability to sell their products at the prices and terms that are favorable to them.

In an industry where suppliers have high bargaining power, they will be able to increase their prices without much pushback. They can also lower the quality of the products, to reduce its cost of production, and they can dictate payment and shipping terms that are in their favor.

On the other hand, if suppliers have lower bargaining power, they will tend to reduce their prices, improve their quality, or give concessions for payments and shipping to attract more customers to them.

What Determines The Balance of Power ?

There are many factors that dictate the relationship between suppliers and buyers and determines the level of power of 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 prices and make the buyers (here: retailers) 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. 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. Every player across the value chain tries to push the higher costs to the next player, and it almost always ends up being taken by the end consumer.

But because retailers 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 retailers’ profitability, as they will absorb some of the cost increase themselves.

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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 business 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.

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 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 retailers because now the retailers are in direct competition with their supplier.

How to Reduce Bargaining Power of Suppliers in Retail?

Here we are going to mention a few strategies that can be applied to make sure the relationship between the retailer and his/her suppliers stays healthy, while also ensuring the retailer’s profitability at the end.

We 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.

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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, when they feel they can actually do so without you leaving them. So having a few different suppliers, especially for your biggest product categories, is smart.

The Case of Footlocker

Over the years, Footlocker has depended too much on Nike as a supplier. Nike products were selling very well, and Footlocker was buying a lot of them, to the extent that Nike was contributing more than 70% of Footlocker’s purchasing.

When Nike started to reduce their presence at different retail chains, in favor of their own direct channel, Footlocker got caught in the middle. They suddenly realized that they have been too concentrated, and now have to start looking for other brands that can replace Nike’s reduced business, or their sales will suffer. Of course, finding such replacement will take time and would probably affect sales & profitability for a while.

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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.

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. In this case it’s a win win for both of you.

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 you have a power to influence the buying decisions of the final consumer, you have a higher bargaining power over suppliers.

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.

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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 and wholesale vendors will be more keen to do business with you and you will be able to get more concessions and better terms.

4. Backward Integration

We mentioned earlier that threat of forward integration (i.e. supplier selling directly to customers and bypassing retailers) increases the supplier bargaining power. Similarly, a retailer’s ability to backward integrate (i.e manufacture their own private label products) will increase their bargaining power as buyers, because now they can bypass suppliers and wholesalers.

When you have the option and ability to create your own brands, your suppliers will want to make sure that you get good margins out of their products, so you don’t opt for manufacturing them yourself. It’s always easier for the multi-brand retailer to source and sell ready-made products, rather than private labeling them.

However; when retailers find that they can get much higher margins through private labels, and they already have their distribution channels (their stores) for those products, they opt for private labeling certain types of products.

Having a High Bargaining Power as a Buyer

To suppliers and manufacturers, the retailer is a buyer.

Once you establish a strong position as a buyer, by applying some of the tactics mentioned here, 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