Bargaining Power Of Buyers | Porter’s Five Forces Model
Buyers have bargaining power when they are strong enough to be able to put collective pressure on the companies producing a product or a service. This power is highest when buyers are able to gather together and amount for a large percentage of the producer’s sales revenue or when there is a number of suppliers providing the same type of product.In this article, we will look at 1) types of buyers, 2) bargaining power of buyers, 3) factors that determine the strength of buyers, 4) managing the bargaining power of buyers, and 4) an example of Walmart.
TYPES OF BUYERS
Before a company can create strategies to handle different types of buyers and their potential power, it is pertinent to understand the different types of buyers. There are always different types of buyers and each needs to be treated in consideration of their unique behavior. Inside each market segment, there may be five different groups of buyers:
- Innovators: Innovators are a small group of early purchasers. These people stay updated on the industry and what the current and upcoming trends and technologies are. They are confident and look forward to experiment with new things. If a product sounds exciting to them, they will use it and influence other possible innovators to use the product as well. However, the acceptance and usage of a product by this group may not lead to a widespread trend.
- Adopters: The second type of buyers are the early adopters. These people set an example for others and are opinion leaders of a particular market segment. They will try a new product out if it offers them significant benefit. Being change agents, they will understand the product before they adopt it and this leads credibility to their references.
- Early Majority: The early majority is relatively slower in trying out a new product offering. They will usually embrace a new product after acceptance by their peers and following strong references from them. This is a more practical group of people who are not necessarily excited by the new or innovative.
- Late Majority: This group will become consumers of a product much later in the product’s life cycle, when stronger buyers may have already discovered the next new product. Their motivation is to wait for prices to fall and the product to become established and known in the market with proof of reliability and longevity.
- Excessive Traditionalists: This is the last group to come onboard regarding the product. These people wait till the prices have reached their lowest point, competitors have entered the market and established themselves and the product has turned into a necessary purchase or a need. The product may have become close to obsolete by this time.
Each of these buyer groups has a different potential power over the supplier or producer and need to be understood and managed accordingly.
Within buyer groups, there may be different buyer behaviors. Most of these end up corresponding to the various buyer group characteristics, but there may be more than one behavior within a group. Some of these are:
- The Highly Motivated Buyer: Highly motivated buyers are ready to make an immediate purchase. They are usually informed and have conducted their own extensive research. They are knowledgeable, willing and able to make the purchase.
- The Serious Buyer: Though these buyers are serious about the need to make a purchase, they are not in any hurry to do so. Often first time buyers, they will want to consider all their alternatives and options and then evaluate the benefits of each of these.
- The Bargain Hunter: The bargain hunter is looking to make a purchase but needs to find a good deal to convince them to actually go ahead and buy. It is not always clear whether they have the means needed to make a full priced purchase or if they just like a bargain.
- The Casual Looker: Often, these people are in the perpetual habit of browsing or looking. They may not be able to afford to make a purchase or do not want to at this point. They may however want to keep considering their options.
Types of Business Buyers
Buyer behavior may be different for businesses buying from businesses. Since these buyers have the task of procuring materials or products for their own businesses, decisions are made seriously and after a lot of consideration. These buyers may often make a large chunk of profits for a company and can wield their influence to assert control. Some of the types of business buyers may be:
- The Number-Cruncher: Basing their decisions on facts and figures, these buyers collect information and create a model for the market. Using this model, they will decide when to buy which product at what price. They may also use their data to exert pressure at a later time as and when needed.
- The Intimidator: Using their position of power, these buyers may force their way into a good deal from a company. They may be hostile or loud during negotiations and threats may be used extensively. The goal is to secure a good deal through whatever means are needed.
- The Engineer: Usually from a technical or research background, this buyer will be primarily interested in how a product works. Technical details and product features will figure heavily in their discussions and decisions.
- The Talker: This buyer will believe that they know everything about the market and how it works. They will want to share this knowledge extensively. Often these people have strong backgrounds in their fields so cannot be dismissed at all. But it becomes necessary to understand what excites them and help channel any conversations or decisions.
BARGAINING POWER OF BUYERS
When a strong group of buyers is present in the market, it can significantly impact a company’s product and selling decisions. The strongest power that buyers can exert is to lower prices, which in turn impacts the profit potential. Buyers can also demand higher quality of services or products, and increase competitiveness by forcing different companies into price wars. All of these factors end up decreasing the attractiveness of the industry by lowering its profitability.
Bargaining power of buyers will be strong and powerful depending on:
- Characteristics of a market and its conditions
- The percentage of sales revenue they provides
FACTORS THAT DETERMINE STRENGTH OF BUYERS
There are several different market conditions that determine whether the buyers will have power or not. Some of these factors are:
- Buyer Concentration: When buyers are fewer in number and more concentrated, they have a higher power over the producer. The producer’s sales revenue will be dependent on these few customers and they will not be able to ignore any demands. Conversely, if the buyers are widespread, then their business is also smaller and they are easy to ignore for a producer.
- Percentage of Sales: Another bargaining chip for a buyer or buyer group is the amount of business they give to a producer. If the percentage of sales from one buyer is significant, then the producer will not want to risk losing their business.
- Undifferentiated products: If the producer sells a standard or undifferentiated product, then they will usually have the potential threat of a buyer switching producers. If there are many producers supplying the same type of product, a buyer will have the option of exploring possibilities.
- Switching Cost: If switching costs are low for a buyer, then any dissatisfaction with a producer or a product will lead to loss of business as the buyer will be able to find an alternate with minimum hassle and inconvenience.
- Threat of Integration: If there are possible threats of a buyer integrating backwards, then the producer will have less power. This means that they may begin producing what they buy in-house, or actually acquire the producer.
- Information: If buyers have full information regarding the producers operations and what their actual costs are, then they will be able to demand better prices from the producer.
- Price Sensitivity: If the buyers are sensitive to changes in prices and may stop purchase, the producer will not be able to ignore their demands.
- Available Substitutes: If there are many substitutes or alternatives in the market, then the buyers will have a lot of options to switch and shop around, making their power over the producers substantial.
Analyzing Bargaining Power of Buyers
When entering a market, launching a new product or in response to a change in market trends, a company can ask the following questions to understand and analyze the power of its buyers:
- Who are the potential buyers?
- How many are they?
- What is their level of knowledge regarding the value chain?
- What if their access to data and research?
- How sensitive are they to price considerations?
- Are they likely to value brand loyalty?
- Can we create brand loyalty and product differentiation?
- Are they likely to switch to an alternate product or company?
- Are they likely to move to a substitute in another industry?
- Are they likely to buy in bulk?
- Are they likely to buy often?
- Are there any possible switching costs that may make changing producers difficult?
MANAGING BARGAINING POWER OF BUYERS
It is clear that in certain situations and markets, buyers may have significant power over producers. But producers can take steps to manage this power and mitigate the risks associated with strong buyers. This will help maintain or even increase industry profitability.
Protecting Business from Strong Buyers
Though not always easy, there are steps a company can take to counter the rise of a strong buyers. These steps may include:
- Differentiate the Product: The key here is to build a unique selling proposition for the product so that this becomes vital to a buyer. This may be a feature or a benefit that is not available in competing products or possible substitutes. This will help equalize standing of both buyer and seller in the negotiating process. The seller wants the business and the buyer wants the benefit that is unique to a product.
- Low Cost Leadership: Another possible strategy for a business is to decrease its own cost of production and business in order to offer the lowest possible price to the buyer. The danger here is to go too low and damage one’s own business in the long term. Though this level of commitment to the low cost model may win business in the short term, in the long term the business may not be able to survive.
- Chose Easy to Serve Customers: If the base of customers are expensive to serve, a producer will not be able to offer competitive prices. In this case, it is better to serve a smaller customer base that is easy to access and less costly to service.
- Establish Walk Away Prices: Though not always possible, it may be a good idea for a business to establish a minimum price level that will not be crossed no matter what the buyer demand. This will not allow the buyer to keep making demands as they will understand that a certain level will not be crossed. Though there is a danger of losing customers here if the product is generic, but if the buyer wants to keep the relationship going, an agreement may be reached to the benefit of both parties.
- Offer Only Desired Benefits: Often a company may spend resources in developing and offering features and benefits that a customer may not need, may not know about, or is indifferent to. In these cases, the costs may be reduced and only those benefits and features offered that translate into sales and satisfied customers. Additional benefits can be offered at additional costs to discerning clients only.
- Forward Integration: If a buyer or a group of buyers is becoming difficult to manage, then it may be in the interest if the supplier to integrate forward and consolidate the value chain. This will change the buyer seller dynamic and put them in direct competition with each other.
Choosing the Right Buyers
Often producers can make the decision to choose who to do business with. In these cases, the company may select those customers who will become partners rather than demanding clients. Some instances where this can happen include:
- Select buyers who value the quality and reliability of the product and its delivery above the price. These people will not push on costs and prices and instead work on ensuring that the product provided is top of the line
- Select buyers for whom the product plays a vital part in the assembly of their final offering. Or, where the item provided makes up an important part of their own product portfolio.
- Select buyers whose own end users demand the producer’s product. This could be the necessity for Intel processers within laptops for example. The end user pressure will ensure that the company in the middle does not become too demanding towards the producer.
- Select buyers who require customization that only the producer can provide.
- Select buyers whose customers will also be willing to pay a higher price. This means that the entire value chain will easily absorb cost increases.
- Select a buyer who does not have the technical expertise to understand the details of manufacturing. This may be an unethical practice as there may be the opportunity to trick a buyer into believing that a product costs more than it actually does.
EXAMPLE OF BARGAINING POWER OF BUYERS – WALMART
An American multinational retail store, Walmart operates large discount departmental and warehouse stores. The company was founded in 1963 and have over 11,000 stores in 27 countries operating under as many as 55 different brand names. Some of these other brand names are Asda in the UK, Seiyu in Japan and Best Price in India.
There are two aspect to be considered when assessing the bargaining power of buyers in the context of Walmart. The company itself is a massive buyer of a large and diverse number of products from many different manufacturers and suppliers. In addition it sells to thousands of individual end consumers of these products. In this regard, we can discuss both the power of Walmart as a buyer and the power of customers over Walmart.
Walmart’s Power as a Buyer
Walmart is an extremely powerful as a buyer. It has enormous reach and reaches thousands of end users. It also buys in large quantities and controls how a customer accesses the brands and products that it stocks. This means that Walmart can dictate prices, delivery times and product quality from its suppliers. Suppliers cater to this pressure by basing their operations close to Walmart headquarters and allowing easy access to the company’s purchasing departments to test products and negotiate terms. Walmart can easily switch suppliers which gives the company additional power to dictate terms. In certain cases, Walmart can also integrate vertically.
There are instances when Walmart will have less power and this usually happens in interactions with sellers large enough to wield significant influence of their own. Companies such as Coca Cola, Procter and Gamble and Unilever have products that are directly demanded by end users and cannot be easily substituted.
The Power of Walmart’s Buyers
In comparison, Walmart buyers have moderate influence over the company’s decisions. The convenience and lower costs offered by the store means that buyers will not easily switch to an alternate. This means that pricing techniques are decided by the company with little input from the final consumer. Consumers may demand certain popular brands or products which will reduce Walmart’s power over those suppliers.
Within the five forces model, the factor of Threat of New Entrants analyzes how likely it is for a …