Bargaining Power of Suppliers: How Porter’s Five Forces Work

The bargaining power of suppliers is a competitive advantage enjoyed by vendors, wholesalers, and distributors when an industry structure channels the majority of customers to a small number of businesses. When the overall number of suppliers decreases, the bargaining power—and the profitability—of existing businesses increases.

Through the lens of Michael Porter’s Five Forces analysis, the bargaining power of suppliers directly competes with four other market forces: the bargaining power of buyers, the threat of new entrants, the threat of substitute products, and the overall competition within the industry. Within a competitive environment, each of these competitive forces has its own effect on industry analyses and business strategies.

To understand how competitive forces shape strategy in the supply chain, you must start by understanding the types of suppliers typically found in a market economy.

1. 1. Manufacturers: These vendors turn raw materials into usable goods. A supplier’s product quality typically traces back to its source manufacturer.
2. 2. Wholesalers and distributors: These companies purchase goods directly from manufacturers and sell them to customer-facing retail businesses.
3. 3. Independent suppliers: These professionals skip wholesalers and distributors. They sell their goods directly to end users. As they aim for greater market share, they may ramp up production and begin using distributors and wholesalers.
4. 4. Importers and exporters: An import/export specialist will purchase products in one country and sell them in another country.
5. 5. Drop shippers: Some businesses do not keep products in stock; instead they order them as soon as a client places an order. When these vendors receive such an order, they pay a third party called a drop shipper, who actually fulfills the order. Certain e-commerce merchandise, including furniture, is sold via drop shippers.

Certain conditions boost the bargaining power of suppliers and keep their profit margins high.

• High barriers to entry: When startup companies face obstacles to joining the marketplace, the existing vendors can charge higher prices while maintaining their market share.
• Strong product differentiation: If a vendor sells a product that is highly differentiated from anything else on the market, it boosts its profit potential and its place within the market.
• Large economies of scale: Many competitive rivalries are won by businesses that can produce the most goods for the lowest per-unit cost. Big businesses, which enjoy strong buyer power and economies of scale in their manufacturing, tend to win these rivalries and exert a lot of leverage within the marketplace.
• High switching costs for buyers: Sometimes it is very difficult for a customer to change from one supplier to another. For example, if an airline’s pilots are trained to fly aircraft from one supplier, a shift to aircraft from another supplier comes at the expense of partially retraining an existing workforce and bringing on new employees (particularly specialist mechanics). This is one example of the high switching costs that benefit certain vendors as they negotiate with customers.
• Threat of forward integration. The threat of forward integration exists in business-to-business (B2B) relationships. It occurs when a manufacturer threatens to sell directly to a consumer or retailer, and thus cut out the wholesaler or distributor acting as a middleman. This looming threat gives bargaining leverage to the manufacturer.

Under the principles of Porter’s Five Forces model, even the most powerful suppliers can experience diminished bargaining power under certain conditions.

• The entrance of new competitors: When new competitors enter a marketplace, it can trigger an industry rivalry. Companies compete to offer lower prices to price-sensitive consumers, which transfers leverage to those very consumers.
• An expansion of raw goods: Sometimes supplier power gets upended by changes farther up the supply chain. For instance, when the fracking revolution changed the economy of oil and gas extraction, many traditional oil drillers lost a good deal of their bargaining power. Oil companies and refineries had more ways to source their raw materials, and their own negotiating powers increased at the expense of their old oil providers.
• Undifferentiated products: If a supplier sells a product that can easily be replaced with something similar, many customers will migrate toward that replacement product, thus denting the supplier’s bargaining power. Meanwhile, the bargaining power of customers goes up.
• Minimal threat of forward integration: If a wholesaler or supplier lacks the conduits to cut out middlemen and sell directly to end users, they lack any real threat of forward integration. This lowers their overall leverage as a supplier.

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