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Porter’s 5 Forces and Supplier Power

With the advent of groups such as the Chinese-owned Alibaba group, a diverse business which facilitates B2B and sources production and logistics solutions for companies around the globe, the buyer has gained the ascendency.

This notion of where the balance of power resides (between the buyer and seller) is no better evidenced than in the resources sector where Chinese buyers have been able to gain strategic advantage (in some cases) over giant corporations such as BHP Billiton and Rio Tinto, who despite their vast resources and highly efficient operations, are nevertheless vulnerable to the whims of a Chinese economy and it’s powerful buyers.

It a salient lesson for CFOs who would have additional pressure placed on them to contain cost pressures both from within the supply chain as well as rising utility and labour costs.

In the art/science of M&A, the leadership team may be encountering a relatively unfamiliar industry domain when taking on an acquisition or merger. Some idea of the threats and opportunities would be in order. As far as competitive pressures, the ability to extract economies of scale and synergies will often depend to a large extent on the relative balance between suppliers and buyers. The idea is that the bargaining power of the supplier in an industry affects the competitive environment for the buyer and influences the buyer’s ability to achieve profitability. Strong suppliers can pressure buyers by raising prices, lowering product quality, and reducing product availability.

As far as the CFO and his company is concerned, all of these things represent costs to his company. A strong supplier can make an industry more competitive and decrease profit potential for the buyer. On the other hand, a weak supplier, one who is at the mercy of the buyer in terms of quality and price, makes an industry less competitive and increases profit potential for the buyer.

These tensions and imbalances were well articulated by Michael Porter in his eponymous 5 Forces. Porter's 5 Forces is a framework for the industry analysis and business strategy development developed by Porter of the Harvard Business School in 1979. He refers to supplier power as the pressure suppliers can exert on businesses by raising prices, lowering quality, or reducing availability of their products.

Each business has the opportunity to do its own industry-specific, five forces analysis. Diversified businesses will compete in more than one – possibly a dozen or more industries (lines of business). In some industries, for example mobile telecommunications, there is clear evidence that suppliers have moderately low bargaining power where suppliers (for example, of smart phones or business plans) can be easily replaced with little transaction costs. Other suppliers (application software, information management systems, research databases, etc.) can be difficult not to rely on.

That said, there are alternative and sometimes free sources which can be used as a substitute to those suppliers. Supplier power examples include markets for new products or those protected by IP.

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