Buyers compete with the industry by forcing down prices, bar-gaining for higher quality or more services, and playing competitors against each other—all at the expense of industry profitability. The power of each of the industry’s important buyer groups depends on a number of characteristics of its market situation and on the rel-ative importance of its purchases from the industry compared with its overall business. A buyer group is powerful if the following cir-cumstances hold true:
It is concentrated or purchases large volumes relative to seller sales. If a large portion of sales is purchased by a given buyer this raises the importance of the buyer’s business in results. Large– volume buyers are particularly potent forces if heavy fixed costs characterize the industry—as they do in corn refining and bulk chemicals, for example—and raise the stakes to keep capacity filled.
The products it purchases from the industry represent a signifi-cant fraction of the buyer’s costs or purchases. Here buyers are prone to expend the resources necessary to shop for a favorable price and purchase selectively. When the product sold by the industry in question is a small fraction of buyers’ costs, buyers are usually much less price sensitive.
The products it purchases from the industry are standard or undifferentiated. Buyers, sure that they can always find alternative suppliers, may play one company against another, as they do in aluminum extrusion.
It faces few switching costs. Switching costs, defined earlier, lock the buyer to particular sellers. Conversely, the buyer’s power is enhanced if the seller faces switching costs.
// earns low profits. Low profits create great incentives to lower purchasing costs. Suppliers to Chrysler, for example, are complain-ing that they are being pressured for superior terms. Highly profit-able buyers, however, are generally less price sensitive (that is, of course, if the item does not represent a large fraction of their costs) and may take a longer run view toward preserving the health of their suppliers.
Buyers pose a credible threat of backward integration. If buyers either are partially integrated or pose a credible threat of backward integration, they are in a position to demand bargaining conces-sions.9 The major automobile producers, General Motors and Ford, are well known for using the threat of self-manufacture as a bargain-ing lever. They engage in the practice of tapered integration, that is, producing some of their needs for a given component in-house and purchasing the rest from outside suppliers. Not only is their threat of further integration particularly credible, but also partial manufac-ture in-house gives them a detailed knowledge of costs which is a great aid in negotiation. Buyer power can be partially neutralized when firms in the industry offer a threat of forward integration into the buyers’ industry.
The industry’s product is unimportant to the quality of the buyers’ products or services. When the quality of the buyers’ prod-ucts is very much affected by the industry’s product, buyers are gen-erally less price sensitive. Industries in which this situation exists in-elude oil-field equipment, where a malfunction can lead to large losses (witness the enormous cost of the recent failure of a blowout preventor in a Mexican offshore oil well), and enclosures for elec-tronic medical and test instruments, where the quality of the en-closure can greatly influence the user’s impression about the quality of the equipment inside.
The buyer has full information. Where the buyer has full in-formation about demand, actual market prices, and even supplier costs, this usually yields the buyer greater bargaining leverage than when information is poor. With full information, the buyer is in a greater position to insure that it receives the most favorable prices offered to others and can counter suppliers’ claims that their viabil-ity is threatened.
Most of these sources of buyer power can be attributed to con-sumers as well as to industrial and commercial buyers; only a modifi-cation of the frame of reference is necessary. For example, consumers tend to be more price sensitive if they are purchasing products that are undifferentiated, expensive relative to their incomes, or of a sort where quality is not particularly important to them.
The buyer power of wholesalers and retailers is determined by the same rules, with one important addition. Retailers can gain signi-ficant bargaining power over manufacturers when they can influence consumers’ purchasing decisions, as they do in audio components, jewelry, appliances, sporting goods, and other products. Whole-salers can gain bargaining power, similarly, if they can influence the purchase decisions of the retailers or other firms to which they sell.
ALTERING BUYER POWER
As the factors described above change with time or as a result of a company’s strategic decisions, naturally the power of buyers rises or falls. In the ready-to-wear clothing industry, for example, as the buyers (department stores and clothing stores) have become more concentrated and control has passed to large chains, the industry has come under increasing pressure and has suffered falling margins. The industry has been unable to differentiate its product or engender switching costs that lock in its buyers enough to neutralize these trends, and the influx of imports has not helped.
A company’s choice of buyer groups to sell to should be viewed as a crucial strategic decision. A company can improve its strategic posture by finding buyers who possess the least power to influence it adversely—in other words, buyer selection. Rarely do all the buyer groups a company sells to enjoy equal power. Even if a company sells to a single industry, segments usually exist within that industry which exercise less power (and that are therefore less price sensitive) than others. For example, the replacement market for most products is less price sensitive than the OEM market. (I will explore buyer selection as a strategy more fully in Chapter 6.)
Source: Porter Michael E. (1998), Competitive Strategy_ Techniques for Analyzing Industries and Competitors, Free Press; Illustrated edition.