A powerful supplier can become a force within markets extracting profits for themselves.
A powerful supplier is one who captures more value for themselves by charging higher prices, limiting the quality of service or shifting costs to distributors.
A powerful supplier can squeeze the profitability out of an industry that is unable to raise prices on its own.
Microsoft milks the personal computer industry of its profits by charging for the windows operating system. The many PC makers cannot afford to raise prices as there is too much competition. If you buy a windows based computer do you really care if it is made by HP, Toshiba or Dell?
Here are 6 ways a supplier can become powerful.
1. There are fewer suppliers than distributors.
A supplier will become powerful if there are many more distributors than suppliers. Microsoft is a great example here. Over 76% of desktop computers run on Windows and there are dozens of companies that make computers that run on Windows. Microsoft can essentially charge whatever it likes as the computer manufacturers have nowhere else to go.
2. The supplier does not depend on a single industry for its revenues
If a supplier serves many different industries it can afford to extract as much profit as possible from each one. If a supplier is limited to a single industry it cannot afford to do this as it will risk causing harm to the industry and sour relationships.
3. Distributors face switching costs when changing suppliers
If the distributor faces significant switching costs when changing suppliers they will be at a disadvantage. For example, if a distributor has invested significant capital in one supplier of equipment it may be difficult to change. It is also possible that a distributor has built facilities close to a particular supplier to limit transport costs. It would be costly to move their operations to a new location closer to a different supplier.
4. The supplier offers a differentiated product
If a supplier’s product is significantly different from its competition it will become powerful. Pharmaceutical companies for example can have patents on their drugs that the competition can not copy. When the patent expires customers trust and prefer these name-brand products over generic medication. The distributor may be forced to stock the brand-name product or risk customers going elsewhere.
5. There is no substitute
If there is no substitute for the supplier’s product then the distributor will have little leverage. A pilot union is an example here. Airlines are hamstrung by the pilot union as there is no substitute for a trained pilot.
6. The supplier can sell straight to customers
The supplier will hold power if it can bypass the middlemen and sell straight to the consumer. If the distributors are making too much money compared to the supplier the supplier may decide to become a distributor. The supplier doesn’t actually need to do this, merely the threat is enough to gain power.
If a supplier can become powerful it will gain hold significant pricing power often to the detriment of the distributor. Would you like to learn more about how a supplier can be a force within an industry? Read more at The Five Competitive Forces That Shape Strategy by Michael E. Porter.