Buyer Power: Understanding its Impact on Businesses | [Your Brand/Website]

The Bargaining Power of Buyers, one of the forces in Porter’s Five Forces Industry Analysis framework, refers to the pressure that customers/consumers can put on businesses to get them to provide higher quality products, better customer service, and/or lower pricesFiscal PolicyFiscal Policy refers to the budgetary policy of the government, which involves the government controlling its level of spending and tax rates.

It is important to keep in mind that the bargaining power of buyers analysis is conducted from the perspective of the seller (the company). The bargaining power of buyers would refer to customers/consumers who use the products/services of the company.

Determining Factors: Bargaining Power of Buyers

Buyer power gives customers/consumers (buyers) the ability to squeeze industry marginsOperating MarginOperating margin is equal to operating income divided by revenue.  It is a profitability ratio measuring revenue after covering operating and by pressuring firms (the suppliers) to reduce prices or increase the quality of services or products offered.

There are four major factors to consider when determining the bargaining power of buyers:

1. Number of buyers relative to suppliers: If the number of buyers is small relative to that of suppliers, the buyer’s power will be stronger.
2. Dependence of a buyer’s purchase on a particular supplier: If a buyer is able to get similar products/services from other suppliers, buyers depend less on a particular supplier. Therefore, the power of the buyer would be greater.
3. Switching costs: If there are not many alternative suppliers available, the cost of switching is high. Therefore, buyer power would be low.
4. Backward Integration: If the buyer is able to integrate or merge suppliers, the buyer has greater bargaining power over the existing suppliers.

When is Bargaining Power of Buyers High/Strong?

• There are fewer buyers relative to that of suppliers
• The switching costs of the buyer are low
• If the buyer is able to backward integrate
• The buyer purchases product in bulk (high volume)
• The buyer is able to get similar product/services from other suppliers
• The buyer purchases the majority of the seller’s products
• Several substitutes are available on the market
• Product is not differentiated

When is Bargaining Power of Buyers Low/Weak?

• There are a significant amount of buyers relative to that of suppliers
• The switching costs of the buyer are high
• If the buyer is not able to backward integrate effectively
• The buyer is unable to get similar product/services from other suppliers
• Substitutes are not available on the market
• Product is heavily differentiated

Purpose of Buyer Power Industry Analysis

The bargaining power of buyers, used in conjunction with the other forces (threat of new entrants, rivalry among existing competitors, bargaining power of suppliers, and threat of substitute products or services), provides an external analysis of an industry and allows companies to:

1. Determine threats and opportunities in the industry
2. Determine if above-average profitsReturn on Invested CapitalReturn on Invested Capital - ROIC - is a profitability or performance measure of the return earned by those who provide capital, namely, the firm’s bondholders and stockholders. A company's ROIC is often compared to its WACC to determine whether the company is creating or destroying value. are attainable in an industry
3. Understand the competition in the industry
4. Make more informed strategic decisionsCompetitive AdvantageA competitive advantage is an attribute that enables a company to outperform its competitors. It allows a company to achieve superior margins

Buyer power is important in an external analysis of an industry, as it provides an understanding of the profit potential in an industry. High buyer power diminishes the industry’s profitability and lowers the attractiveness of an industry. This may deter new entrants or cause existing firms to make more strategic decisions to improve the profitability of their business.

Bargaining Buyer Power in the Airline Industry

To determine whether buyers face high or low bargaining power in the airline industry, consider the following:

1. The number of buyers relative to suppliers: There are a significant number of buyers (customers) relative to suppliers (airlines). However, customers can look at several options when choosing an airline. Therefore, buyer power is medium.
2. Dependence of a buyer’s purchase on a particular supplier: Although the seat itself is not more comfortable across airlines, it is important to note that some airlines focus on providing better services, as compared to other airlines. Some airlines offer horrible customer service, while other airlines go above and beyond to provide extraordinary customer service. Therefore, service level differs throughout different airlines (differentiated service). Buyer power is medium.
3. Switching costs: There are several airlines available to choose from with a low switching cost – buyer power is medium/high.
4. Backward Integration: Buyers are not able to backward integrate. Therefore, buyer power is low.

Taking into consideration the four factors that affect buyer power, you can tell that the buyer power in the airline industry is overall high/medium. Therefore, the profit potential in the airline industry is not that high.

However, buyer power alone does not determine the overall attractiveness of an industry. Other forces (threat of new entrants, rivalry among existing competitors, bargaining power of suppliers, the threat of substitute products or services) must be taken into consideration to determine an industry’s overall attractiveness.

Other Resources

To learn more and continue advancing your career, see the following CFI resources:

• Market EconomyMarket EconomyMarket economy is defined as a system where the production of goods and services are set according to the changing desires and abilities of
• Law of SupplyLaw of SupplyThe law of supply is a basic principle in economics that asserts that, assuming all else being constant, an increase in the price of goods
• Invisible HandInvisible HandThe concept of the "invisible hand" was invented by the Scottish Enlightenment thinker, Adam Smith. It refers to the invisible market force
• Inelastic DemandInelastic DemandInelastic demand is when the buyer’s demand does not change as much as the price changes. When price increases by 20% and demand decreases by