Competition

The internet has a huge wealth of information if you can find it. In doing research I came across a web site entitled Valuebasedmanagement.net.  The site contains a number of papers on management methods, management models and management theories by experts in their field. In searching about power I came across a few papers that were written by Michael Porter and decided that there is much procurement can learn from his writings on business strategic planning. Professor Porter is a Professor at Harvard Business School and a leading authority on company strategy and competitiveness.

One of the things he created is called the five forces of competitive position. Many companies use his five forces of competitive positioning in strategically determining whether to enter into certain markets. Much of what he describes for companies to understand before entering into a market can be applied to understanding the leverage or power in the relationship between the Buyer and Supplier.

Professor Porter’s five forces are:

• Supplier power (How a company’s Suppliers can affect a company).
• Buyer power (How a company’s  customers can affect a company)
• Product and technology development (alternatives, price and quality)
• New Market Entrants and barriers
• Competitive rivalry within the marketplace

In procurement you deal with the same five forces but from a slightly different perspective.

Competitive Position	Negotiation competitive position
Supplier power	Supplier power
Buyer power	Buyer power includes the potential power of the Buyer and their customers
Product and technology development as a differentiator	Alternatives from the perspective of their features and cost and quality and their use in applying competitive pressure
New Market Entrants	Ease of movement to another Supplier (for the threat of switching suppliers)
Competitive rivalry in the market	Competition between suppliers and demand from competitors and other industries

In negotiation the last three forces impact either the Buyer’s or Supplier’s power.  If there are substantial alternatives that meet the Buyer’s needs, the Buyer will have more power because of the power of competition.  If it’s difficult or costly to change Suppliers, that can provide the Supplier more power in follow on negotiations. If it’s easy for new companies to enter the market, Buyers will seldom want to make long term commitments as the competitive position of the market will most likely change.

In the past many times you derived power by your place in your industry. Now you need to be concerned with competition from all industries. For example, for years tantalum capacitors were almost exclusively used by the computer industry.  Leader in the industry would get the best deals from the Suppliers. Along came cell phones that also used them and the demand from the Cell phone industry was higher than the computer industry. This change not only increased demand, but the dynamics and requirements between the industries were different.  When that happens, the Buyer’s position and leverage is no longer measured against the one market, they are measured against the total market. Suppliers will also look at the costs and risks of each industry and that can impact what they are willing to agree upon. When it was only the computer market a leader could ask for and get extremely favorable terms. Once the market broadened, Suppliers could compare the costs and risks in both markets and respond accordingly.

In a separate article Professor Porter also created a simple classification of industries:

1.     Fragmented

2.     Emerging

3.     Mature

4.     Declining

5.     Global

Once again the same terms can be used in procurement to describe commodities, but more frequently we may think of them not from the perspective of the market or industry as much as we think about product life cycle.

·       Instead of thinking of things as fragmented, we think of products or services being niche market products or having volumes so small they aren’t leveraged.

·       Instead of thinking about emerging markets, we think of new products or new versions of a product being at the beginning of a new product life cycle.

·       Our concept of a mature market is one that has maximum amount of competition where the Buyer may have the most leverage.

·       Instead of thinking about declining markets, we think about when companies begin to exit that individual product’s market to move on to the next product reducing the competition.

·       Instead of thinking about global markets, we think about landed costs and whether a product can legally be imported, used, services and supported and whether that is financially practical.

Irrespective of how the industry would be classified on its own, while that can have some impact on the procurement strategy or leverage, we are usually more concerned about individual product life cycles and where you are in the product life cycle as that can impact a number of things such as the costs and risks of doing business with a supplier and relying upon that supplier to meet your needs.

In another article Professor Porter also published a competitive advantage model and describes three different focus or approaches to competitive advantage.

1.     Cost leadership

2.     Differentiation

3.     Focus

Once again we see these focuses in procurement. Many times a market will be made up of all three types of Suppliers.

You can have technology leaders whose goal is to come out with leading products that differentiate themselves in the market where their goal is either to get designed into the Buyer’s product, or to win most of the business until there are other entrants in the market. They want to make high profit margins until competition drive the price of the product down. You can have suppliers whose focus is trying to differentiate them from the competition by offering unique product features and services. Both of these are differentiators as Professor Porter would describe them.

Many markets also have technology followers and they are usually focused on cost leadership. They will enter the market at some point and usually drive the price of the product or service down through price competition.  At some point the technology leader may exit the market to move to a new market, so the cost leader may get the benefit of their exit from the market by the supply / demand imbalance created by the exit of the technology leader(s).

The third type of approach that Professor Porter describes is focus. Focus companies want to be the best in a segment either based on cost or differentiation. In procurement in addition to having companies that focus on a segment (what we would call niche suppliers), there are also suppliers that I refer to as bottom fishers. Bottom fishers are one that will buy into or enter a market after the technology leaders have left and after the cost leaders have decided that the reduced volume of the market doesn’t warrant being there. They are Suppliers that can be profitable because there will be on-going demand because customers for whatever reason have not migrated to the new technology and because at the volume the cost leaders aren’t interested.

A typical product price curve reflects the different entry point and effect that each has on the market.

• The Technology leaders will set the initial price of the product high.
• As cost leadership suppliers enter the market, the price will be drive down (unless there is excess demand against capacity)
• The price will bottom out when the market reaches saturation and that will usually drive out technology leaders.
• As volumes fall with companies migrating to newer product, the cost leaders may exit the market and drive the price up for bottom feeders
• Companies with a market segment focus (niche players) will usually not be impacted by other suppliers wanting to enter the market, unless the volumes become significant enough, Where niche players will get impacted is when customers do a form of value equivalence evaluation and determine that the differentiation isn’t worth the price premium.