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Note: Michael Porter developed a technique to
help leaders to analyze the nature of competition in their
industry. Discover how this technique can assist you to
improve your business performance. To read an overview of this Model click here
"How do you know if
your customer is bluffing?" Find out who has the
negotiating power in your industry, before it costs you
money?
We can use Porters Five forces,
the section on "the bargaining power of customers" to identify the
extent to which your customers can play you off
against your competitors.
Often customers will ask for
higher quality or improved service at the same price or a
better price, using this analysis technique you can
determine how much you need to give
or if you can simply call their bluff.
Porter, Bargaining Power of
customers example:
Imagine someone who provides contract cleaning services to a
major shopping center and they only have this one contract.
Every time their contract is ready for renewal the
shopping center can get three of four quotes to compare prices.
This is a very powerful customer
and is likely to place a lot of commercial pressure on the cleaner.
How to Guide
Using the Porter Model, to complete an
analysis of the bargaining power of customers you will need to
consider the following factors, click on each for more details and ignore
those not relevant to your industry.
What makes a
good leader has provided strategic planning
templates for all five forces in the Porter Model.
The Bargaining Power of Customers (buyers) template is at
the bottom of this page, take me
there
Differentiation of outputs
Are products/services in your
industry similar or are
you able to easily differentiate your products and
services from those of your competitors?
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.
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Switching
Costs
Does your customer incur any costs to switch to one of your competitors
products?
These
costs could be legal review of new contracts,
change in spare parts and change in ordering systems. These maybe intangible costs such as
risk.
One Example: 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.
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Index
Presence of
Substitutes
Are there alternatives or substitutes for
your product/service?
Substitutes are typically products/services that are not in your industry,
however a customer may chose a substitute product/service over
your product/service.
An Example: 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 can substitute buying a DVD instead
of renting.
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Index
Industry concentration relative to
buyer concentration
What is the ratio of customers to
suppliers? Imagine if you have 20 competitors competing for
100 customers then there will be more competition
than if they were competing for 1,000 customers.
The more suppliers your customer can
choose between the greater the likelihood of price
competition and the more customers your competitors have
to chase the less likelihood of price competition.
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Importance of volume to buyers
The more frequent your customer purchases and the more
they purchase each time the more they are likely to
negotiate.
i.e. If your customer is looking for small volumes
infrequently then they are less likely to bargain on price
than if they are looking for regular supply of high
volumes.
One Example: If a hospital is looking to purchase medical
supplies they will put more effort into the negotiation
than if they need a glazier to repair a broken
window.
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Cost relative to total buyer purchases
How expensive is your product compared with the total
purchases of your customer?
If your product/service is a relatively small expense to
your customer then you are likely to be able to increase
prices, though if your product/service represents a major
cost to your customer then you should expect your customer
to pay more attention to your
price/service/quality.
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Impact of outputs on the cost of differentiation
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 customers
product then your customer will have less bargaining power,
whereas if your product is less than significant
to your customers product or service then your customer will
have more power.
An Example: If you supply the nuts that hold the
engine in the engine bay of a car the your customer will
have more power to bargain than if you supplied design
consulting for the interior of the car.
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Buyer information about supplier products
How easy is it for your customers to
understand your product? or your competitors products?
If products in your industry are hard to understand, say
your product is business insurance, customers are less
likely to invest time to understand the differences between
your product and those of your competitors. The harder the
product is to understand the less the bargaining power
of customers.
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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.
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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Index
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.
Porter Model
Templates from What Makes a Good
Leader
Back to Index
Porter
Model 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
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