Chapter 6: Strategy Toward Buyers and Suppliers
Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
Chapter 6: Strategy Toward Buyers and Suppliers p. 108
This chapter is focused on two of the five basic competitive forces that determine the economic structure of the industry in which a firm competes (See Figure 1-1 below). More specifically, the focus is on how a firm can improve its competitive position by paying attention to buyer selection, and by using structural analysis to develop a purchasing strategy to counter the bargaining power of suppliers.
Buyers can differ widely in terms of their volume of purchases, purchasing needs, emphasis on product quality and durability, service, and bargaining power. Because of these differences, buyer selection is an important strategic variable. This section is about finding, and in some cases creating "good" buyers.
A Framework for Buyer Selection and Strategy p. 110
The quality of buyers is determined by four criteria:
1. The buyer's purchasing needs versus company capabilities,
2. The buyer's growth potential,
3. The buyer's structural position including; intrinsic bargaining power, and propensity to exercise it in demanding lower prices,
4. The cost of servicing the buyer.
Since these buyer characteristics do not always move in the same direction, determining the best target buyers frequently involves a weighting and balance of these four factors.
Purchasing Needs Relative to a Firm's Capabilities p. 111
Matching the buyer's purchasing needs with the firm's capabilities will help the firm achieve a higher level of differentiation, and minimize its buyer servicing costs including order processing, shipping, and delivery. The tools described for competitor analysis in Chapter 3 can be used to identify the firm's own relative capabilities.
Buyers Growth Potential
The buyer's growth potential is determined by the growth rate of its industry, the growth rate of its primary market segment, and the buyer's market share in the industry and in its particular market segment. The growth potential for individual household buyers is related to demographics (e.g., income level, education, marital status, age etc.), and quantity of purchases. The quantity of purchases is influenced by many factors, e.g., the existence of substitutes, and social trends. The long run demand for an industry's products is discussed in Chapter 8.
Intrinsic Bargaining Power of Buyers p. 113
The characteristics that enhance the bargaining power of the industry's buyer group were discussed in Chapter 1. This section is focused on "good buyers" from a buyer selection perspective, i.e., buyers that do not have much intrinsic bargaining power. The characteristics of this group include:
Buyers who purchase small quantities relative to the seller's sales,
Buyers who lack qualified alternative sources (e.g., because they require a unique product or service),
Buyers who face high shopping, transaction, or negotiating costs (e.g., buyers in a isolated geographic area),
Buyers who lack a credible threat of backward integration, i.e., merging or acquiring their supplier, and
Buyers who face high fixed cost of switching suppliers, e.g., where switching suppliers would require modifying products, testing the compatibility of the new product, retraining employees, etc.).
Price Sensitivity of Buyers p. 114
Good buyers are those that are not price sensitive, or those who are willing to pay more for a product's performance characteristics. Types of buyers that fit this description include:
Buyers who view the cost of the seller's product as small relative to their product's cost or purchasing budget,
Buyers who face a large penalty if the seller's product fails relative to its cost,
Buyers that can experience major savings or performance improvement from the seller's product,
Buyers where the seller's product contributes to a strategy of competing on the basis of high-quality,
Buyers of a custom designed or differentiated product,
Buyers that are very profitable or those who can pass on the cost of inputs to their customers,
Buyers who are not well informed about the product or substitute products, and
Buyers who's decision is based on something other than the cost of inputs.
Cost of Serving Buyers p. 118
The cost of serving buyers vary for a variety of reasons including: order size, selling direct vs. selling through distributors, required lead time, regularity of order flow, shipping cost, selling cost, and the need for customization or modification.
Buyer Selection and Strategy p. 119
Some firms have a buyer selection option to seek buyers based on the favorable characteristics outlined above. In such cases the choice of the best buyer is one that balances the four criteria against the firm's capabilities.
Other strategic implications of buyer selection include:
Firms with a low-cost position can still be successful by selling to price sensitive buyers because they can meet price cuts by competitors,
Firms without a cost advantage must be more selective in choosing buyers to achieve an above-average return and not get stuck in the middle as described on Chapter 2,
Good buyers can be created or improved, e.g., by persuading the buyer to include the seller's product in the buyer's product design,
The buyers choice can be broadened by increasing the value the firm provides to the buyer (e.g., providing responsive customer service, engineering, rapid delivery, or new features), and by redefining the way the buyer views the product's function (e.g., includes a resale value, provides a reduction in maintenance cost, fuel cost, installation cost etc.),
High cost buyers can be eliminated from the customer base in some cases, although they may be insensitive to price and in some cases needed for a firm to achieve economies of scale,
The factors that determine buyer quality can change over time, and
Switching costs need to be considered when making strategic moves.
Purchasing Strategy p. 122
The characteristics that exist in an industry that lead to powerful suppliers were discussed in Chapter 1, e.g., where the supplier group is dominated by a few companies, and the supplier group's products are differentiated or have switching costs. This section is focused on finding ways to offset these sources of supplier bargaining power.
From a structural standpoint, the key issues in determining a purchasing strategy include:
1. The stability and competitiveness of the supplier pool, i.e., suppliers that will insure that the needs of the firm are met,
2. The optimal degree of vertical integration (discussed in Chapter 14),
3. The allocation of purchases among qualified suppliers, i.e., spreading purchases across alternative suppliers to improve the firm's bargaining position, but making sure the quantity of business to each supplier is large enough to cause the supplier to be concerned, and
4. The creation of maximum leverage with chosen suppliers using tactics such as:
Avoid switching costs by not becoming dependent on a supplier for engineering, custom products etc.,
Help qualify alternative sources or encourage them to enter the business,
Promote standardization of specifications of inputs,
Create a threat of backward integration, and
Use tapered or partial integration (discussed in Chapter 14).
The purpose of the tactics described above is to lower the costs of purchasing from a broad long-run perspective. This is an important point because some of the approaches may raise narrowly defined purchasing costs in the short term. Therefore, additional short run cost created by a purchasing strategy must be weighed against the long run benefits of defending against the bargaining power of suppliers.
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