Wednesday, April 5, 2017

The Power of Buyers - A Brief Case Study

In evaluating Michael E. Porter’s Five Forces framework, I struggled to connect the power of buyers with this week’s Cola Wars case. What I could connect it with, however, was my own experience in the contact lens industry. While the contact lens industry is about as stolid as they come, the way in which major distributors – buyers – display significant negotiating power makes it a great case study for the power of buyers.

The contact lens industry is made up of four major manufacturers with roughly equal market share, all of which are able to exercise some degree of supplier power. Within that, however, most business-to-business (B2B) transactions are conducted between channel distributors and optical practices. This market structure allows for distributors to exercise significant leverage over their manufacturer partners; if a manufacturer fails to provide a friendly pricing scheme, the distributor can promote a competing product via marketing channels and rebate schemes. As Porter notes, buyers possess significant power when they can “influence the purchasing decisions of customers downstream.” With field sales teams that in many territories dwarf those of their manufacturer partners, optical distributors are well-positioned to influence their customers in a way that can be potentially harmful to their upstream vendors, thus giving the buyer unique power.

Porter writes that purchasers have greater leverage if they generally own low margins. This is another area wherein buyer power applies in the contact lens industry, as distributors typically earn margins between 3-5%. Producers are able to apply some supplier power by way of a rebate system that only allows distributor partners to achieve that 5% margin if they meet certain sales thresholds. While the emphasis on rebates does push distributors to focus on certain products at certain times so as to meet rebate thresholds, it also means that suppliers end up in de facto price competition with one another. Ultimately, suppliers lower their own margins in exchange for market share, a situation that Porter identifies as being destructive to industry profitability.

There is another factor contributing to buyer power that is strong in the contact lens market: the quality off the buyers’ products being unaffected by the suppliers’ products. While one might assume that the product contact lens distributors are selling is contact lenses, this is not really the case. In reality, contact lens distributors are selling their services: fast and inexpensive shipping; the luxury of placing an order with a single vendor rather than half a dozen; consolidation of glasses, contact lenses, and ophthalmic products; and a single bill at the end of the month. An optical distributor is judged on its ability to deliver on service, rather than its ability to deliver new or better contact lenses. As outlined by Porter, this makes for a situation wherein distributors have significant leverage.

Overall, the structure of the contact lens industry – and the optical industry at large – is a great example of the power of buyers as it applies to B2B channel sales. The industry has evolved in such a way that these B2B partners have significant leverage over their supplier partners, while also providing additional value to end-users in the form of superior services and – generally – lower costs. 

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