Tweaking the ecosphere for business success

BY Jayashantha Jayawardhana 

In 1900, North America was home to 35 suppliers of cast rail wheels and railway builders had plenty to choose from. A century later, there were only two suppliers remaining; and today, there’s only one left. So railway builders are at the mercy of the monopolist that can raise the price on a whim.

Suppliers in any industry may become too powerful for several reasons: in some cases, they succeed in eliminating the competition by achieving substantial cost advantages or developing disruptive technologies.

In others, the rapid growth in demand exceeds supply and suppliers can charge what they want. And in still others, buyers have consolidated demand and bargained so hard that the few suppliers left in the market enjoy too much clout.

This is why a business that finds itself in a weak position with its suppliers must learn to deal with them strategically. In their article titled ‘How to Negotiate with Powerful Suppliers’  – published in the Harvard Business Review (HBR) – Petros Paranikas, Grace Puma Whiteford, Bob Tevelson and Dan Belz talk about an analytical framework for strategic reappraisal of suppliers.

They say they’ve developed it with practical insights drawn from the business world. It must be noted that between Approach #1 and Approach #4, the degree of risk involved increases.

APPROACH #1 Bring new value to your supplier. This approach has practically zero risk. You can negotiate with the supplier in two ways: one is to open a gateway for him or her to enter a new market by offering the supplier an opportunity that’s too good to pass up in exchange for a price concession.

A beverage company was facing annual price hikes from a packaging supplier. It looked like there was no way out since the supplier held a patent for the manufacturing process and its price was lower than others. But there was an opening: the beverage company was about to penetrate two developing markets, which the packaging supplier had not been able to enter.

The procurement manager in consultation with the marketing team dangled the right carrot before them: “In exchange for a 10 percent price reduction globally, the company would use the supplier’s cans in the new markets.”

Another way to negotiate with a supplier is to help him or her to reduce price risks.

APPROACH #2 Change how you buy. This approach is riskier than the first; but if there aren’t any opportunities for you to create new value for your supplier, it’s the next least risky option before you. Pick one of these three courses of action: consolidate your purchase orders, rethink purchasing bundles or decrease purchase volume.

An aircraft manufacturer whose various departments were sourcing parts independently from the same supplier was facing price hikes and unsatisfactory service standards. The company consolidated the purchase orders and went to the supplier’s top executive, who agreed to bring the margin down to 10 percent and improve service standards.

Where a company can’t create large purchasing bundles within product categories or geographies, it should rethink its purchasing bundles and consider buying across them. The mere mention of decreasing the purchase volume can motivate negotiation. But you must stand behind your decision if the supplier refuses to budge.

APPROACH #3 Create a new supplier. In case the first and second approaches fail, you will have to create a new source of supply. Researchers observe that this is “most likely to be necessary in industries where price negotiations have gone so far as to drive most suppliers out of business, effectively giving the survivors a monopoly.”

“Of course, such drastic action risks alienating your supplier completely and may change your company’s business model,” they add. Then you have to either bring in a supplier from an adjacent market or become your own supplier through vertical integration.

APPROACH #4 Play hardball. This is the riskiest approach in the entire framework. If nothing else works, calling off all your orders, excluding the supplier from future business or threatening to sue – or a combination of these actions – may be the only solution, short of going out of business.

Since these are the tactics of last resort, think long and hard before you jump in.

A global financial services firm was forced to cut its costs by US$ 3 billion. To cut its IT costs, the firm asked its main hardware supplier for a 10 percent price reduction, which was refused. The firm’s CIO immediately informed the supplier’s CEO that all the supplier’s projects in the company were suspended with immediate effect.

He didn’t stop there but went on to make good on the threat. Fearing the gloomy prospect of losing all existing and upcoming projects, the supplier promptly agreed to the price cut.