Friday, August 3, 2007

Gain bargaining power by reducing capacity

To gain bargaining power, some firms reduce capacity to increase competition among their suppliers. For example, health insurers restrict the number of drugs on their formularies or the number of hospitals in their network to to increase competition among health care providers to get onto the formulary or into the network. Similarly, grocery stores limit shelf space to extract bigger payments from the brands they do carry; and airports limit the availability of gates or runways to encourage competition among airlines for gates or landing slots.

Theory tells us that one excluded supplier allows a firm to extract all the bargaining surplus from its suppliers, but recent research by Mike Shor testing this proposition found that firms have to exclude at least 30% of their suppliers to maximize profitability.

Since this result comes from bargaining experiments (using MBA's and the executives of two big companies), I would like to hear from readers if this corresponds with their experience.

1 comment:

  1. If Shor's findings are right, then it seems to follow that disclosure is required in order to extract all bargaining power. It's the supplier who knows when he's given all he can; so the supplier would need to know how many potential suppliers exist and how many would be excluded (so he can know the 30% mark is reached).
    This would appear to have the form of a transaction: as a supplier i am effectively paying for (in concessions) the intelligence received through the buyer's disclosure.