Warren Buffet once said that “anything that can’t go on forever will end”. This is true for businesses that over time face the economic reality of buyer and supplier forces that are external and exert pressure on the firm’s ability to sustain profits.
We have been following closely the debacle at the firms ZNFU and Mopani. On the famer’s union end, the national food reserve agency (FRA) is at the brink of suing the Zambia national farmers union for coercing farmers not sell their maize to the agency. This is due to a conflict of price of the staple maize brand (source: Daily Mail 25 Aug 2017). On the mining end, Mopani and Copperbelt Energy (CEC) are in a Mexican standoff regarding new energy tariffs that the latter has argued will not budge in terms of its position on the new rates.
At TFHZPC, we wondered and asked the question “How did we get here?”. Michael Porter provides some answers in his “Competitive Strategy” book of 1990. Buyers and suppliers can exert external pressure on a firm’s ability to create value. According to Porter, a firm becomes power when it is concentrated or purchases in large volumes. Mopani fits the description of this by the scale of business it runs. Furthermore, as a large volume buyer, they are a particularly potent forces due to the heavy ﬁxed costs characterize the mining industry.
Like any union, ZNFU in a bid to protect the profitability of the farming industry argues that the price of the maize bag is unprofitable. According to Porter, their power comes from the production of the maize product forming a significant fraction of the costs incurred. Therefore, farmers are likely to shop for a favorable price and make sales selectively. Despite, FRA being a not for profit entity, they still require to breakeven and bring parity to food supply in Zambia. Therefore, they too need to understand the forces that can prevent them from breaking even.
It is clear from these two examples that firms in Zambia require strategies for buyers and suppliers. Too often, policies towards them are narrow and only focus on operational issues. Porter argues that the company’s choice of suppliers to buy from or buyer groups to sell to should be viewed as a crucial strategic decision. A company’s such as CEC can improve their strategic posture by ﬁnding suppliers or buyers who possess the least power to inﬂuence it adversely. However, the argument can be made that when dealing with contracts that are of scale, the options may not be that many. What this demands for is prudence in the structuring of power supply agreements over agreed tenures.
In addition, Porter proposes an inward approach when a firm has no options but to deal with a strong buyer. It is clear that in CEC’s case, an inward approach of ensuring that operational costs are kept low could help in achieving margins in the event that their bargaining power is threatened. However, we do not that in the energy business, the fix costs do pose a challenge in achieving operational efficiencies.
Both industries (mining and agriculture) are poles apart when it comes to switching costs. On the one hand, switching costs in the mining industry tend to be high due to the sunk costs associated with setting up power connections. On the other hand, switching costs are low for maize suppliers hence the allure of the brief case business men and women who become an attractive option for small scale farmers.
Overtime, the power of buyers and suppliers changes over time. This is largely due to the conditions in the micro-environment. In addition, the strategic direction of the affected firm also impacts on the power of buyers and suppliers. On the buyer end, over time the choice of buyer groups that CEC can sell power to should be viewed as a strategic decision. This may require employing buyer selection where only buyers who wield the least power are engaged. On the supplier end, FRA can consider backward integration as it seeks to eliminate switching costs. This would require FRA positioning itself deeper into the agricultural value chain. We are not proposing that FRA starts buying maize growing farms. However, positioning of FRA in the agriculture industry will inevitably become crucial to its survival.