Supplier power can erode profits when suppliers are concentrated or when customers are locked into relationships due to relationship-specific investments.
Example: App Developers and Apple Store.
Market Power: Derives not only from supplier shortages but also from customer lock-ins (e.g., app developers needing to distribute via the App Store).
Innovation and Collaboration: In tight relationships, firms should consider collaboration over competition.
Key Questions on Supplier Power
To evaluate supplier power, ask:
Is the supplier industry more concentrated than the industry it sells to?
Is a typical firm's purchase volume small relative to the sales of a typical supplier?
Are there any substitute inputs available?
Do firms make relationship-specific investments with suppliers?
Does the supplier's product represent a significant fraction of revenue?
Point 1: Supplier Industry Concentration
Example: Dairy Farms vs. Processing Facilities.
Observation: There are more dairy farmers than processing facilities, giving farmers less market power despite their important role as suppliers.
Fixed Costs: Processing facilities have high fixed costs requiring scale, leading to increased market power for processors.
Point 2: Purchase Volume
Example: Restaurant Purchasing from Costco.
Restaurants purchasing in small volumes from large suppliers (e.g., Costco) have less market power, as suppliers can dictate prices.
Point 3: Substitute Inputs
Trickier Analysis: Only one input for dairy processing—milk from dairy cows.
Although the substitute status of input is weak (one main source), processors may still have low supplier power due to a large number of suppliers.
Point 4: Relationship-Specific Investments
Importance of relationships can shift power dynamics.
Supplier buyer power can arise from investments requiring specific relationships, increasing potential influence and negotiation dynamics.
Point 5: Revenue Significance
If a firm's product is crucial for a supplier's revenue, it may enhance the firm's negotiation ability.
Monopsony Power
Definition of Monopsony: A monopsonist is the only buyer of a good, possessing significant market power unlike a monopoly (which has singular control over supply).
Example from Dairy Industry:
Dairy processors often hold monopsony power over local dairy farmers; farmers can't easily switch to other processors due to distance and associated costs.
Historical Context: Joan Robinson
Introduced the concept of monopsony in economic studies.
Worked on monopsony power, particularly in labor markets where employers can exploit high switching costs faced by employees.
Example: Labor unions and factory towns often experience monopsonistic conditions due to limited job mobility for workers.
Assessing Buyer Power
Firepower is analogous to how we assess supplier power from the buyer's perspective:
Buyer Questions:
Is the buyer industry more concentrated than the industry it purchases from?
Does the buyer purchase on large volumes?
Does the buyer's volume represent a significant fraction of seller's revenue?
Can buyers find substitutes for the products?
Do firms make relationship-specific investments?
Applications in the Milk Industry
Example of cooperative Model: Dairy farmers formed cooperatives (e.g., Land O'Lakes) to own processing plants to reduce monopsony power exerted by processors.
Conclusion on Power Dynamics in Market Structures
Both monopsony and monopoly power impact price negotiations and profit distribution.
The balance of power affects how costs are divided in the supply chain.
Case Study Reference: In 2019, app developers sued Apple citing monopsony power, highlighting regulatory attention to such market dynamics.
Reminders for Students
Next week's topics: Polo wars.
Group project outlines are due Friday.
Quiz scheduled for Wednesday; prepare adequately for assessments.