What is Bargaining Power?
Bargaining power is the relative power of two or more parties used for influencing each other in a specific situation to get better and favourable deals. The bargaining power of the suppliers, customers, and the labour force are some of the crucial factors that influence the flow of profits and cash in an organization.
The concept of bargaining power is used in so many fields such as labour economics, game theory, collective bargaining arrangements, and settlement of litigation along with the price of insurance, diplomatic negotiations as well as negotiations in general life and business instances.
The bargaining power of buyers refers to the pressure and influence buyers can place on sellers to avail products and services of their desired quality and quantity at a lower price.
At the same time, the bargaining power of suppliers is associated with the pressure that suppliers can put on companies by raising their prices or reducing products’ accessibility, or decreasing product quality.
In this way, the buyers’ and suppliers’ bargaining powers stand to be the pillars that shape the profit potential, competition, and attractiveness of a particular industry.
Importance Of Bargaining Power
The bargaining power of a business party is often studied in conjecture with the other four forces from the Michael E. Porter’s Five Forces Industry Analysis Framework’s theory.
These five forces are the threat of new entrants, competition among existing competitors, buyers’ bargaining power, suppliers’ bargaining power, and the threat of substitute products or services. Some of the common benefits of bargaining power that deserve your attention here are-
- It helps determine the competition in a particular industry as it shows the availability of alternative products and services, which could be cheaper or of better quality.
- It offers an understanding of an industry’s profit margins and its potential to change, as higher bargaining power would mean a lower profit margin and vice versa. This would aid in offering a realistic picture to companies about their profits, what can be done to improve it or if they need to dissolve their company altogether.
- It also gives an idea of threats that a company must be prepared to face and how to manage such situations to prevent negative PR and maintain consistent sales.
- This force is helpful in the planning of realistic goals and strategic decision-making of a business. As there are constraints put forth by buyers’ needs and buying budgets along with a suppliers’ income and supplying ability of products, the bargaining power proves to be vital in setting goals that are in touch with industry standards and market conditions.
Factors determining Bargaining Power
There are four factors upon which the bargaining power of a certain group of people depends on:
In terms of barging power, the lesser the number of people, the more bargaining power they hold.
If a buyer is heavily dependent on a particular supplier or a supplier is heavily dependent on the particular brand, they will have lesser bargaining power. If alternatives are available, the bargaining power also increases.
3. Switching costs
This refers to the cost of changing preferences from one supply chain to another or from one manufacturing company to another. If the cost is low, the bargaining power would be high.
4. Backward or forward integration
Backward integration is a business strategy when a company has the power to own the supply chain for its products and services. If the buyer has integration potential, then bargaining power is higher. This works the same way for suppliers who can employ forward integration.
Example Of Bargaining Power of Buyers
One simple example of the bargaining power of buyers would be the clothing industry. To evaluate their bargaining power, let’s evaluate all the determining factors:
- Since there are many buyers from a particular supplier, the buyers have low bargaining power.
- Since clothes are available in local malls and online websites with worldwide shipping, the supplier is highly dependent on its buyer’s purchase. So, the buyer has high bargaining power.
- Unless there is customer loyalty to a brand, choices for one clothing product are easily available elsewhere. Hence, buyers have low switching costs and high bargaining power.
- Buyers would not be able to backwards integrate or merge suppliers, so buyers’ bargaining power tanks.
Hence, buyers’ bargaining powers in the clothing industry would be medium to high, which results in a medium profit margin for companies in the clothing industry.
Example of Bargaining Power of Suppliers
The bargaining power of suppliers could be demonstrated through the example of the food industry. For the supplier of a small-town vegan brand, let’s analyze the following:
- Assuming that only 2 or 3 suppliers supply vegan products, the supplier’s bargaining power would be high.
- If it is assumed that the supplier has other large-scale vegan brands to supply from, it will result in the supplier’s high bargaining power.
- Since switching costs would be high for the supplier, the bargaining power would below.
- The threat of forwarding integration can be assumed as possible since the brand is a small one, so bargaining power is high for the supplier.
Therefore, in the case of a supplier for small food brands, suppliers’ bargaining power hypothetically seems to be on the higher side. Profit for these brands would be low and would result in less attractiveness of the industry.
On the concluding note, we hope that you would have understood that bargaining power is the power/influence that someone has in discussions with someone else for reaching an agreement of their favour.
In the successful channelization of businesses, the bargaining power of buyers and suppliers is of great significance, and adept use of this helps businesses in converting more favourable deals.