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Bargaining power of customers
In order to evaluate the attractiveness and profitability of an industry, a third force we need to look at is the bargaining power of customers. Let’s consider Porter’s five forces model, well-explained in his article ‘The five competitive forces that shape strategy’ published by Harvard Business Review in 2008. The stronger this force is the more it erodes profitability in the sense that customers may force down prices. The weaker it is, the more profitability stays within the industry. A customer group has a strong bargaining power when:
- the customer group is more concentrated than the industry it buys from or each customer purchases in large volumes
- the industry products are standardised or undifferentiated
- the customer group faces low switching costs in changing suppliers
- the buyers may start producing the industry’s products themselves if the sellers of these products are too profitable
Moreover, it is necessary to consider that the buyer group is price sensitive if:
- the products they buy from the industry players are a significant part of their cost structure or procurement budget (e.g. buying a house)
- the buyer group’s activity is not profitable or the buyers are under pressure (highly profitable customers tend to be less price sensitive, if that product does not constitute a significant part of their cost structure)
- the quality of the buyer group’s products/services is not affected by the industry’s products, while customers tend to be price sensitive when the quality of their products is significantly affected by the industry’s products
Last but not least, intermediate customers increase their bargaining power when they can influence the purchasing decisions of their own customers.
All in all, it is important to consider how strong this force is and to what extent it may erode profitability within the industry.
