Monday, November 20, 2006

Bargaining Power

One of the important things that I look for in a company or even industry is bargaining power. In a free market, prices are generally set by the action of bargaining between players. The player that benefits the most is the one with the most bargaining power. For example, I believe that Walmart has enormous bargaining power. It's size allows it to get the lowest prices on products that it buys. When Walmart says no to one of its suppliers, you see a huge drop in that suppliers revenues. Walmart can simply buy that product from some other manufacturer. This is why Walmarts loves to introduce new products of a more generic nature. As long as Walmart shoppers are willing to buy the lowest price item, Walmart holds a powerful hand.

Brand name suppliers like Procter and Gamble, resist the tyranny of Walmart by offering strong brands. No other supplier can sell Walmart Tide detergent, Tampax tampons or Gillette razors. But generic suppliers hold little bargaining power with Walmart and there are so many of them thoughout Asia and the world.

Another example is banking. I just read a book by Ron Chernow called "The Death of the Banker". He suggest that one can make a bar chart with three bars. In the middle is banking which is the intermediary of the other two: the providers of capital and the consumers of capital. More on this in my blog on "The Death of the Banker". His thesis is that today the banker is much weaker than in the previous times of the Rothschilds and J.P. Morgan when they virtually controlled world finance.

One could also consider a similar chart with the retailers like Walmart and Target in the middle with the suppliers on one side and the consumers on the other. I would argue that the retailers are rising in power and hold considerable sway over the two other sides. If you won't pay Walmart prices, you are unlikely to get the products you want. Who can profitably, sell them cheaper? Similarly, if you're a supplier, you are unlikely to get many of your products to the market if you refuse to sell to Walmart under their terms. In many ways Walmart looks like this century's Monster of Morgan.

I think it is fruitful to look at many industries in this same way. Buiild a graph of bar charts showing who in the chain has the most bargaining power. Often there are more than three players. For example consider the Pharmaceutical industry. There is the branded pharmaceutical maker, the generic drug maker, the insurance company, the goverment, the hospital, the patients etc. Big pharma has held considerable bargaining power for years. Much of that has to do with the patentability of drugs and the high barriers to entry. Will this remain the case? Many argue that the recently elected Democrats wish to put an end to this. I wish them luck but I am putting my money with Big Pharma.

picks: Pfizer (PFE), Bristol Myers Squib (BMY), Johnson and Johnson (JNJ)