1. David J. Bryce © 2002 Strategies for Responding to Supplier Power MANEC 387 Economics of Strategy MANEC 387 Economics of Strategy David J. Bryce

2. 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 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

3. 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 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

4. 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 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

5. 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 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

6. 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 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

7. 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 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

8. 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 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

9. 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 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

10. 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? GPOs (Group Purchasing Organizations) emerged as purchasing organizations for member hospitals to gain power relative to medical suppliers (gauzes, bandages, other hospital supplies) Others?

11. 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 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

12. 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)

13. 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 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

14. 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)