Strategies for Responding to
Supplier Power
MANEC 387
Economics of Strategy
David J. Bryce
David J. Bryce © 2002
Summary of Last Few Sessions
• Suppliers have power relative to buyers when supply
curves are steep or inelastic
• Supply curves tend to be steep when relatively few
suppliers are in the market or when they offer
differentiated or specialized products. This limits
flexibility in the buying firm’s cost structure—forcing
its own market prices higher.
• A decrease (increase) in the price of inputs (supply)
will lower a firm’s cost leading to enhanced
(decreased) competitiveness for the firm
• Thus, when suppliers wield power over the firm, the
firm may be at a disadvantage in its own markets
David J. Bryce © 2002
What can be done to neutralize the
bargaining power of suppliers?
1. Buy or ally with a supplier, or develop exclusive
sourcing arrangements with them to assure access
to the factor at the lowest possible cost, greatest
value
2. Develop alternative sources of supply
3. Narrow the sell options of the supplier through
market consolidation, merger or alliances
4. Innovate to change the specific nature of inputs and
thus neutralize the power of specific suppliers
5. Diversify product base to diminish dependence of
your business on any particular supplier
David J. Bryce © 2002
1. Buy a supplier or alliance
• The buyer merges with the supplier
– Reduces supply price risk
– Reduces risk that a competitor will tie up
the supply through a similar acquisition
– Also called “vertical integration”
• An alternative approach is to pursue a
“cooperative strategy” of forming a
mutually beneficial alliance
David J. Bryce © 2002
Example: Vertical Integration or
Cooperative Alliance
• IBM launches a semiconductor unit for
memory manufacture to assure supply to its
new IBM PC in the 80s
• Chrysler launches a supplier partnership
program for critical parts
– Chrysler engineers and supplier engineers design
parts for specific car models
– Chrysler promises business for the life of the
automobile model
David J. Bryce © 2002
2. Develop alternative sources
of supply
• When the number of sources of supply
is low, suppliers’ demand curve is
inelastic and they have pricing power
• One response is to actively seek
alternative sources of supply by
investing in new sources, or
• Pay some other firm to enter the supply
market
David J. Bryce © 2002
Example: Alternative Sources
• Nutrasweet
– Had a monopoly in the supply of aspartame, the artificial
sweetener in many cola drinks
– Charged Coca-Cola a premium price of $90 per pound
– Holland Sweetener Company (HSC) contemplated entering
the market
– Coke should have been willing to subsidize HSC’s entry to
effectively create competition in its own supply market
• Cubic Zirconia are an alternative to diamonds for
buyers of jewelry and reduces collective dependence
on the diamond monopoly
David J. Bryce © 2002
3. Narrow the sell options of
supplier
• When a particular buyer accounts for
only a small portion of a supplier’s
business, the supplier has relative
power
• To respond, the buyer can merge with
other buyers, or ally by forming a
purchasing coalition or other joint
arrangement
David J. Bryce © 2002
Example: Narrow Sell Options
• Provider health market:
– Large, self-insured employers and insurance companies are
the “suppliers” of lives who need healthcare; Hospitals are
the buyers
– Employers were extracting price concessions from hospitals
and physicians in regional areas where many health delivery
options existed;
– With large numbers of lives, employers and insurers had the
power
• Solution?
– Merge the hospitals and physicians in a local area into a
health system with a single point of negotiation with
“suppliers”; The employers must negotiate with the health
system or risk having no healthcare for their covered lives
David J. Bryce © 2002
Other Examples
• GPOs (Group Purchasing Organizations)
emerged as purchasing organizations
for member hospitals to gain power
relative to medical suppliers (gauzes,
bandages, other hospital supplies)
• Others?
David J. Bryce © 2002
4. Innovate
• If a powerful supplier controls an
important factor input, the firm may
need to “design-out” its dependence on
that particular factor
• This may be difficult, especially if the
input is a basic material, like fine
chemicals, certain precious ores, etc.—
try one of the other techniques
David J. Bryce © 2002
Example: Innovate
• Many manufacturers reduced
dependence on Intel chip
architecture in the late 80s by
redesigning products compatible
with Motorola, or RISC chips; e.g.
computer controls for automobiles
(Ford)
David J. Bryce © 2002
5. Diversify product base
• Assume a single supplier controls a significant
portion of the input value of a firm’s single
product
• Then by diversifying into additional products,
the firm reduces dependence on that supplier
• This response may be used to achieve a
number of different objectives; it is only
infrequently used to curtail a powerful
supplier—try one of the other techniques first
David J. Bryce © 2002
Example: Product
Diversification
• Citizen Watch company became less
dependent on core suppliers when it
diversified out of watches into printers,
disk drives, liquid crystal displays and
computers. (Leveraged its competency
of manufacturing small, high tech
mechanical parts)
David J. Bryce © 2002