The presence of powerful buyers reduces the profit potential in an industry. Buyers increase competition within an industry by forcing down prices, bargaining for improved quality or more services, and playing competitors against each other. The result is diminished industry profitability.

Porter’s five forces analysis

The bargaining power of buyers comprises one of Porter’s five forces that determine the intensity of in an industry. The others are barriers to entryindustry rivalry, the threat of substitutes and the bargaining power of suppliers.

The power of an industry’s important buyer groups depends upon:

  • Characteristics related to its market situation
  • The relative importance of its purchases from the industry as compared with its overall business

How to assess the power of a buyer group

The following conditions indicate that a buyer group is powerful:

  • The buyer group is concentrated, or purchases large volumes relative to the seller’s sales
  • Products purchased from the industry represent a significant percentage of the buyer’s costs or purchases
  • Products purchased from the industry are standard or undifferentiated—alternative suppliers are easy to find and competitors are played against each other
  • Few switching costs exist (little penalty for moving to another supplier)
  • Profits earned are low (greater incentive to reduce purchasing costs)
  • Buyers pose a significant threat of backward integration—buyers demand concessions, and may engage in tapered integration (producing some components in-house and purchasing the rest from outside suppliers)
  • The industry’s product is not important to the quality of the buyer’s products or services
  • The buyer has full information (their knowledge of demand, market prices and supplier costs provides them with leverage)

References

Porter, M. (1998). Competitive Strategy. New York: Free Press, pp. 24-27.