Income School Blog

Five Forces—Bargaining Power

How much power do you have in negotiating with your suppliers and customers?

The first and fifth of the Five Forces described by Michael Porter are Buyer Bargaining Power and Supplier Bargaining Power.  If this is the first time you’ve heard about Porter’s Five Forces, check out my previous article here.

So bargaining power… What is it?

Bargaining power is the strength you have in a negotiation.  It’s based on your position relative to your suppliers or customers.  If your suppliers have high bargaining power, then it means that they have more power than you do when it comes to setting the terms of your supply agreements.  On the other side, if a customer has high bargaining power then it means they have more power to set the terms of your sales agreements.

Bargaining power is determined by lots of things, but it’s primarily determined by how important the relationship is to you, and to them.

Let me give you an example.

If you have a website that makes money through affiliate advertising, then the companies that you market for would be considered suppliers.

To be more specific, let’s suppose you do affiliate marketing for Amazon.

In this relationship, Amazon supplies you with products to market, or rather, with links to those products.  You post those links on your site, and if those links lead to sales for Amazon, you get a commission off those sales.  Now, imagine that this is your primary source of income on your site, and that it’s doing really well for you.

But now let’s say that Amazon decides to change how they structure their Associates program.  And under their new structure, you’ll only make half as much off each sale.  Well, now your revenue is cut in half.  That has a HUGE impact on your business!  But how much power do you think you’d have in that relationship with Amazon?  How successful do you think you would be if you tried to negotiate a higher commission?

Not very…

And the reason is, your relationship with Amazon is extremely important for your business.  But it’s not all that important to Amazon.  Your referrals make up only a tiny portion of the income that Amazon earns.  Whereas the commission that Amazon gives you makes up a huge portion of your income.  So in this case, Amazon has virtually all the power.

Now let’s look at the relationship between Amazon and their suppliers.  Amazon has a ton of suppliers.  They have suppliers for their retail goods.  They have suppliers for their servers.  They have suppliers for their devices.  They have suppliers for everything.  How much power do you think Amazon has in each of those relationships.  Well, in most of them, I’d say that Amazon still has a ton of power.  The reason being that Amazon his huge, and they don’t rely on really any one supplier to keep their business running.

If you sell a product on Amazon, and you decide that you don’t like the arrangement anymore and decide to stop selling through them, how much do you think that impacts their business?

But Amazon may have some suppliers who hold a lot more power.  Let’s say that Amazon’s cloud storage service is running up to its maximum capacity.  This means that they’re going to need more servers to handle their customers’ needs.  Now, let’s say that servers are really scarce right now.  Nobody can make them fast enough to keep up with industry demand.  Well, now Amazon’s supplier or servers may hold a lot of power.  In this case, they can probably charge just about anything they want for their servers.  And it’s because those servers are Really important to Amazon.

Now, Amazon is a pretty extreme example.  They hold a lot of power in most of their relationships because they have become so huge.  And not only that, their suppliers and customers are extremely fragmented.  By that, I mean that they have so many of them in so many different areas that no one supplier and no one customer has much power in their relationship with Amazon.

Another company like this is WalMart.  They hold the power in pretty much all of their supplier and customer relationships.  This is because if you don’t like WalMart’s service, then you can stop shopping there and it won’t hardly impact WalMart’s earnings at all.  On the other side, WalMart can afford to lose a supplier.  They have hundreds, if not thousands of suppliers just dying to supply them with goods.

So now to your business.  Who holds the power, you or your suppliers?  If you’re small, then it’s probably almost always your suppliers.  And there may not be much  you can do about that.  But it’s important to know and understand.  Look for ways you can structure your supply sources and your agreements with them.  You might be able to find ways to increase your power.  One way to do this is to have multiple suppliers for anything you buy.  This gives you alternatives which is a must if you want any power in a negotiation.

Now let’s look at the customer side.  With customers it works just like it does with suppliers.  If you have a website with lots of traffic, then how much does it impact you if one customer decides to leave?

Not much.

So if some customers don’t like the price you charge for whatever it is you sell, then they can leave, as long as other customers are willing to pay it.  That’s okay.  That’s totally normal.  In fact, everyone out there has a different price that they would be willing to pay for a given good or service.  There will always be someone who thinks that your products are overpriced.  But there will be others who think your products are a bargain.

But it’s important to understand where your business fits in.  If you supply a good or service to other companies, and you only have a few customers, then your customers’ bargaining power is often significantly higher.  But again, that depends on how many suppliers your customers have.  If you have only three customers, but all three need the item you sell, and you are their only supplier, then you may still have a lot of bargaining power.

So what do you do about it?

Well, first you need to understand it.  If you know where you have power and where you don’t, you can be more prepared for negotiations.  If you know you have power with a supplier, then maybe you can be more assertive when you negotiate pricing.  Or maybe you can get more service for the price you pay.  If you know you have more power with customers, then maybe you look at pricing and decide if you’re really charging the right price.

If you know where you stand on bargaining power, then you can start to look at how to improve your situation.  I know that how I’ve said it here it sounds like your bargaining power is sort of set.  But it’s not.  Bargaining power, like all of the Five Forces, is constantly changing.  Your competitive environment will rarely be the same two years in a row.

So look at your situation.

If you only have one supplier for each good or service that you buy then you may consider adding other suppliers.  If you only have a few customers, maybe you need to reach out to other potential customers to build your customer base.  If you only have one way to make income, and your suppliers or customer have a lot of power, then you are at high risk of losing your source of income if anything changes.  And I assure you, eventually something will change.  So if you’re in that situation, start considering how to earn money in more ways.

Think about your bargaining power.  How can you increase it?

And most importantly, go do something about it!

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