Porters Five Forces - Competitive Analysis

Porter Strategy & The Bargaining Power of Your Customers

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“Find out how to use porter strategy to find out who has the bargaining power in your industry”

 

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The bargaining power of your customers

When developing your 3 to 5 year strategy you should consider the relative bargaining or negotiating power of the different players in your industry, once you understand where the negotiating power resides you can plan how you might respond.  

 

In your analysis the question you seek to answer  

"Is the bargaining power in your industry held by the suppliers to the industry, the customers of the industry or by the industry itself?"

You will find that powerful customers will often ask for higher quality or improved service at the same price or simply for a better price. In general terms the more powerful your customers are the less profitable your industry will be.

However, you cannot determine the likely profitability of your industry by looking at this one factor alone, you will also need to consider your suppliers, competitors, new entrants and substitute products.

 

Porter Strategy & the Bargaining Power of Customers example:

Imagine a small business consisting on one owner operator who is a cleaning contractor, they have only one customer, this customer is a major shopping center.

Every time their cleaning contract is ready for renewal the shopping center can get three of four quotes to compare prices and can request the contractor to match the best price. If the contractor does not match the best price they could loose their only source of income. 

This is a very powerful customer and is likely to place a lot of commercial pressure on the cleaner. It is unlikely that the cleaner will ever improve their profit margin from this customer.

 

This is a simplified example, so how will you determine the bargaining power of your customers?

 

Bargaining Power of Customers, Your How to Guide

To analyze the Bargaining Power of your Customers you will need to review your industry by considering the following generic criteria.

• The differentiation of outputs
• Switching costs
• Presence of Substitutes
• Industry concentration relative to buyer concentration
• Importance of volume to buyers
• Cost relative to total buyer purchases
• Impact of outputs on the cost of differentiation
• Buyer information about supplier products
• Buyer profitability
• Decision makers incentives
• Threat of backward integration

 

Now, lets explain and illustrate each of these points

 

The Differentiation of Outputs

You will find that most marketing is aimed at trying to differentiate your brand or your products from those of your competitors. This can be seen in the insurance industry in Australia where all brands are essentially the same however each brand consumes considerable resources to position their brand or product as somehow different.

When considering the differentiation of outputs, you need to determine if the products or services in your industry are similar or are you able to easily differentiate your products and services from those of your competitors?

You need to answer this from your customer’s perspective, quite often an organization will be able to differentiate their product or service however, the difference is not important to their customers.

If your customers perceive that your products or services are different to your competitors and your customer values that difference then you will have some protection during negotiations, however, if your customer perceives that your products/services are essentially the same as your competitors then they will have more bargaining power.

 

Example Porter Strategy & The Differentiation of Outputs:

I remember listening to an engineer telling me with great passion that the copper in their electrical switches was thicker than the copper in their competitors lower cost imported switches, hence the products were differentiated.

This did not strike me as a differentiation that the average consumer would consider important, as the average consumer would have no idea why the thickness of copper is an issue.

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Switching Costs

A switching cost is a cost that your customer would incur if they ceased buying from you and commenced buying from one of your competitors.
These costs could be anything from

• The cost for legal to prepare and review of new contracts,
• The cost of stocking spare parts specific to your competitors products
• The cost of adopting a new ordering systems
• The cost of retraining your employees, or  
• These maybe intangible costs such as increased risk (the unknown).

 

Example 1, Porter Strategy and Switching Costs:

If you have ever bought a nail gun you will know that to change the brand of nail you use, you will also have to buy a new nail gun as nails and guns are not typically interchangeable – the cost to switch brand of nails is the cost of a new nail gun.

Example 2, Porter Strategy and Switching Costs:

To change your banking from one bank to another will cost you a lot of time and in some countries there is a fee to close out your old loans and credit cards and a new fee to take out new loans and set up new credit cards.

Example 3, Porter Strategy and Switching Costs:

In aged care there are several suppliers of beds, these beds need to lower close t the floor to allow help the elderly to get out of be, and raise high enough for a nurse to care for the patient without bending over.

If an aged care facility has one make of bed they will also have a stock of spare parts and special tools to maintain these beds. If they wanted to change supplier for all new purchases they would also have to stock spare parts and special tools for the beds from the new supplier, they tend not to be interchangeable.

The duplicate stock of spares represents a switching cost for the organization.

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Presence of Substitutes

A substitute is a different product or service that can be used instead of your industries products or services. A substitute is not a competitor’s version of your product. Substitutes are typically products/services that are not in your industry.

 

Example, Porter Strategy and the Presence of Substitutes:

If you own a DVD hire shop you will have competition from other DVD hire shops however your customers may also choose to substitute cable TV for renting a DVD or they can substitute buying a DVD instead of renting one.

Some common everyday substitutes  

• Electricity for petrol as a fuels in cars
• Hiring a gardener instead of buying a lawnmower
• Hiring a cleaner instead of buying a vacuum cleaner
• Using glue instead of nails
• Using wood look plastic instead of wood in furniture
• Building a house with a steel frame instead of a timber frame
• Putting a tin roof on your house instead of a tiled roof
• Shopping on the internet instead of going to the shopping center

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Industry concentration relative to buyer concentration

By measuring the ratio of the number of competitors to the number of buyers you can get an idea of the likelihood that buyers can shop around and place you under commercial pressure.

As the number of buyers increases relative to the number of competitors the negotiating power of anyone buyer deceases.

Conversely as the number of buyers reduces relative to the number of competitors the power of the buyer increases.
 

Example 1, Porter Strategy & Industry concentration relative to buyer concentration

Microsoft for all intended purposes was the only home and office PC software available during much of the 1990’s so they had considerable power to set price.

Now there are a number of competing suppliers emerging so Microsoft’s ability to set price has been significantly eroded. (In the early days each upgrade offered significant benefits, now there is a resistance to regular upgrades, as any version since 2000 will be suitable for most consumers)

Example 2, Porter Strategy & Industry concentration relative to buyer concentration

When DVD’s were first released you could only get them in a few specialty shops who could set DVD prices, now, DVD’s are stocked in supermarkets, record shops, service stations, news agents this has significantly reduced the ability of any one stockist to set price.

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Importance of volume to buyers

Buyers who buy only a few of your products each year are less likely to shop around for price on those items.

 

Example, Porter Strategy & Importance of Volume to buyers

Imagine a small doctor’s surgery that uses only one ream of paper each quarter they may just pop over to the local news agent to buy that ream of paper and not worry too much about how much it costs.

Whereas a finance company who uses 50 reams of paper each week is more likely to want to get a good deal on their paper.

If you were to buy a filing cabinet you may get a few prices then place your order, however if you were to order 200 filing cabinets you are more likely to ask “What can you do for me?”

In general terms the more frequent your customer purchases and the more they purchase each time the more they are likely to negotiate on price, quality and service.

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Cost relative to total buyer purchases

Buyers tend to prioritize their negotiation efforts in the areas where they spend the most money. If your product or service is a large expense for your customer, then you are more likely to be the focus of their negotiations.

However, if your product or service is insignificant to your customers overall purchasing you are less likely to be the focus of their negotiations.

 

Example, Porter Strategy & cost relative to total buyer purchases

A hospital would be expected to spend more time in negotiation with medical suppliers than with the glazier who was called to repair a cracked window, or the plumber who was called to clean a blocked drain.

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Impact of outputs on the cost of differentiation

This is an interesting area for consideration, and it boils down to a simple question
“Does a unique quality of your product or service help your customer to differentiate their product or service?”  

If your product is a key component of your customer’s product then your customer will have less bargaining power.

 

For example:

Consumers are becoming increasingly aware that their computer has an “Intel inside” as this awareness increases, some consumers may be wary of computers that don’t have an “Intel inside”.

Computer manufacturers will seek to ensure that they have an “Intel Inside” which will give some negotiating power back to Intel.

Whereas if your product is less than significant to your customer’s product or service then your customer will have more negotiating power.

For example:

Your business supplies generic paper to the printing industry, you will find that your product does not contribute to the printer’s ability to differentiate their product or service in the market.

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Buyer information about supplier products

This tends to relate to technical products, where the technology in the product is different to the technology of the industry. You are trying to answer the question

“How easy is it for your customers to understand your product? or your competitors products?”

 

For example:

A medium manufacturing plant with a industrial boiler on site, which is maintained by the company who supplied it. No one in your business really understands the boiler, all you know is that it works and does the job.

You are not likely to negotiate on the price of the annual maintenance contract, unless a significant increase is asked for.

You are restricted in asking for a price from a competitor as you probably don’t really know what the maintenance involves.

Whereas if you sell paper for to the printing industry, you may find your buyers are well aware of their specific requirements.

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Buyer profitability

Buyer profitability – are your customers profitable and likely to remain profitable?

The more profitable your customers are the less likely they are to be concerned with the amount you charge.

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Decision makers incentives

The decision maker within your customers business may be receiving incentives from your competitors such as free tickets. However they are equally likely to be given incentives, to negotiate, by their employer.

The presence of incentives influences the decision, with part of the decision based on something other than merit.

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Threat of backward integration

Could your customer set up and provide your product or service, eliminating the need for you? 

It is more likely that your customer will enter into your industry if their business is large compared with the average size of a business in your industry.

If your customers tend to be smaller than you or your competitors then they are unlikely to start doing what you do.

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Porters Five Forces and the Bargaining Power of Customers - Template

The following free strategic planning template can be used to determine if each of the factors that affect the bargaining power of your customers has a positive or negative impact on their bargaining power.

You can then give an overall rating for this force.

The bargaining Power of customers (Buyers)	Comments on the degree of customer power	Rating +/-
Differentiation of outputs
Switching costs
Presence of Substitutes
Industry concentration relative to buyer concentration
Importance of volume to buyers
Cost relative to total buyer purchases
Impact of outputs on the cost of differentiation
Buyer information about supplier products
Buyer profitability
Decision makers incentives
Threat of backward integration
The bargaining Power of customers (Buyers) Overall Rating

 

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Porter Strategy Links

The Bargaining Power of Customers is one of the five forces in the Porter Model, read up on each of the five forces and become a skilled strategic leader.

Each page includes a free strategic planning template, listing the common factors to consider.

• The Threat of New Entrants into your Industry

• The Bargaining Power of Suppliers

• Threat of Substitute Products

• Industry Rivalry

Follow each link for even more porter strategy examples