Strategy toward suppliers: Purchasing Strategy

The analysis of suppliers’ power in Chapter 1 coupled with a re-verse application of the principles of buyer selection can help a firm in formulating purchasing strategy. Although there are many aspects of purchasing strategy, procedures, and organization that go well beyond the scope of this book, some issues can be usefully examined by using the industry structure framework. Key issues in purchasing strategy from a structural standpoint are as follows:

  • stability and competitiveness of the supplier pool;
  • optimal degree of vertical integration;
  • allocation of purchases among qualified suppliers;
  • creation of maximum leverage with chosen suppl

The first issue is the stability and competitiveness of suppliers. From a strategic point of view, it is desirable to purchase from sup-pliers who will maintain or improve their competitive position in terms of their products and services. This factor insures that the firm will purchase inputs of adequate or superior quality/cost to insure its own competitiveness. Similarly, selecting suppliers who will con-tinue to be able to meet the firm‘s needs will minimize the costs of changing suppliers. Structural and competitor analysis, discussed throughout this book, can be used to identify how a firm‘s suppliers will fare along these dimensions.

The second issue, vertical integration, will be postponed until Chapter 14, which examines the strategic considerations in decisions to integrate vertically. Here I assume that the firm has decided what items to purchase outside, and the question is how to purchase them so as to create the best structural bargaining position.

In allocating purchases among suppliers and creating bargain-ing power, the third and fourth issues, we can turn to structural anal-ysis. In Chapter 1, the following conditions were identified as lead-ing to powerful suppliers of a particular input:

  • concentration of suppliers;
  • lack of dependence on the customer for a substantial fraction of sales;
  • switching costs facing the customer;
  • a unique or differentiated product (few alternative sources);
  • threat of forward integration.

The analysis of buyer selection earlier in this chapter added a num-ber of other conditions in which the supplier will hold the power vis- à-vis the buyer:

  • buyer lacks a credible threat of backward integration;
  • buyer faces high information, shopping, or negotiating costs.

In purchasing, then, the goal is to find mechanisms to offset or surmount these sources of suppliers’ power. In some cases this power is built into industry economics and is out of the firm‘s con-trol. In many cases, however, it can be mitigated by strategy.

Spread Purchases. Purchases of an item can be spread among alternate suppliers in such a way as to improve the firm‘s bargaining position. The business given to each individual supplier must be large enough to cause the supplier concern over losing it—spreading purchases too widely does not take advantage of structural bargain-ing position. However, purchasing everything from one supplier may yield that supplier too much of an opportunity to exercise power or build switching costs. Cutting across these considerations is the purchaser’s ability to negotiate volume discounts, which is partly a matter of bargaining power and partly a matter of supplier economics. Balancing these factors, the purchaser should seek to create as much supplier dependence on its business as possible and reap the maximum volume discounts without exposing itself to too great a risk of falling prey to switching costs.

Avoid Switching Costs. Good purchasing strategy, from a structural standpoint, involves the avoidance of switching costs. The common sources of switching costs have been identified earlier, and other subtle areas exist as well. Avoiding switching costs means resisting the temptation to become too dependent on a supplier for engineering assistance; insuring that employees are not coopted; avoiding suppliers’ efforts to create a custom-variety or custom-en-gineered application without a clear cost justification that outweighs possible future exercise of leverage; and so on. This policy may in-volve deliberately requiring that an alternate supplier’s product is used some of the time, disapproving investments in ancillary equip-ment that are tied to a particular supplier, and resisting supplier products that involve specialized training procedures for employees, among other things.

Help Qualify Alternate Sources. It may be necessary to en-courage alternate sources to enter the business, through funding de-velopment contracts and contracts for a small part of purchases. Some purchasers have actually helped capitalize new sources or gone overseas to persuade foreign firms to come into the business. It may also be desirable to help new suppliers minimize their costs of be-coming qualified sources. Mechanisms range from extreme atten- tiveness to finding new suppliers by the purchasing staff to subsidiz-ing the cost of testing new suppliers’ products.

Promote Standardization. All firms in an industry may be well served by promoting standardization of specifications in the in-dustries from which they purchase inputs. This policy helps reduce suppliers’ product differentiation and undercuts the erection of switching costs.

Create a Threat of Backward Integration. Whether or not the purchaser actually desires to backward integrate into an item, its bargaining position is helped by the presence of a credible threat. This threat can be created through statements, leaked word of inter-nal studies of the feasibility of integration, creation of contingency plans for integration with consultants or engineering firms, and soon.

Use of Tapered Integration. When the volume of purchases allow it, a great deal of bargaining leverage can be gained through tapered integration, or partial integration into a particular item while buying some or even the majority of it from outside suppliers. This process was briefly discussed in Chapter 1 and will be examined further in Chapter 14.

The objective of all these approaches is obviously to lower the total long-run costs of purchasing. It should be recognized that using some of them may actually raise some aspects of narrowly defined purchasing cost. For example, maintaining alternative sources or fighting against switching costs can involve expenses that could be avoided in the short run. However, the ultimate purpose of such ex-penses is to improve the bargaining position of the firm and hence its long-run input costs.

A number of points emerge. First, it is important to avoid the situation in which too narrow a short-run cost-cutting orientation undermines potentially valuable purchasing strategies like those out-lined above. Second, any additional costs created by such a purchas-ing strategy must be weighed against its long-run benefits in mitigat-ing suppliers’ bargaining power. Finally, since the cost of purchasing from different suppliers can vary, the firm should purchase from low-cost suppliers unless there are offsetting benefits in terms of long-run bargaining power.

Source: Porter Michael E. (1998), Competitive Strategy_ Techniques for Analyzing Industries and Competitors, Free Press; Illustrated edition.

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