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Negotiating the terms of any agreement, formal or not, is a complicated matter. Taking commerce as an example, buyers will always want to negotiate to the lowest prices possible, while sellers will always seek to sell at the highest prices possible. Bargaining power is one of many economic concepts introduced to facilitate the understanding of all of the different factors that can affect how deals are struck and how businesses perform. In this article, we’ll be explaining what bargaining power is, what can affect it, and what significance it has in business.
What Is Bargaining Power?
Bargaining power is a measure of the capacity of one party to influence another. It is an important topic in negotiation because parties with higher bargaining power are able to leverage their circumstances to strike more desirable deals with others.
All of the parties in an agreement have their own bargaining power, however little or great.
What Determines Bargaining Power?
There are a number of different factors that determine or affect how much bargaining power a party has. In the following list, you can see some of these factors along with a short explanation of how they affect a party’s ability to bargain.
Factors that affect bargaining power:
- Having alternatives — If a party does not need to be dealing with some other party, because they have alternatives, then they have more bargaining power. This is because they present a risk in being able to walk away from the deal without causing themselves too much trouble.
If a party does not have any alternatives, then they have little bargaining power as the other negotiators can threaten to walk away from the deal, leaving them in an unfavorable situation.
- Little trouble in switching to an alternative — Similarly, a party has more bargaining power if there is little trouble in them switching to an alternative, and vice versa.
- Lack of necessity/importance — If one of the parties in a negotiation can walk away from the deal without suffering any consequences, either due to a lack of necessity or importance to cut the deal, then they have more bargaining power. Once again, this is because it indirectly threatens the other party with them losing business, so they have to offer a better ‘bargain’.
- Relevant knowledge — Being knowledgeable in relevant fields also provides parties with more bargaining power. This is because they are less susceptible to making unfavorable deals due to being uninformed or misinformed.
Why Is Bargaining Power Important in Business
If you own any sort of business, then it’s logical that you are aiming to make the highest returns you can and strike the best deals you can. Thankfully, bargaining power can be a useful concept in helping you decide how to effectively price products and make agreements.
Consider a business which sells bracelets. Two important bargaining powers here are those of the customers and the business. In order to create the optimal pricing strategy, this business should take into account their own bargaining power as the seller (Do they provide a unique product which has no alternatives? Does their business rely on selling a certain product or can they afford to sell a lower quantity of it at a premium price?) and the bargaining power of the customer/buyer (Is the product essential to the buyer?).
The ‘Bargaining Power of Buyers’ and the ‘Bargaining Power of Suppliers’ are also two of the five ‘forces’ considered in Porter’s Five Forces Analysis, a popular business analysis tool that you should definitely read up about if you haven’t already.
Regardless of what type of business you may own or be associated with, the concept of bargaining power has many different uses that might come in handy.
Bargaining power is an important economic concept that measures the ability of parties in negotiation to influence each other. There are many different factors which can affect how much bargaining power an individual or group has, from the number of alternatives they have to the importance of the deal. Bargaining power has strong ties with Porter’s Five Forces analysis, and is especially useful in all sales-related businesses.
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