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Caution: Do Customers Have Too Much Power Over Your Vested Company?

Porter’s Five Forces is a useful framework developed by Michael Porter, a Harvard Business School professor, which can help us assess a company’s competitive advantages and weaknesses.

As investors, those are important things to think about as the presence of a strong competitive edge might mean a company has the ability to compound wealth for shareholders over the long-term.

I had previously shared two of the Five Forces: the threat of new competitors; and the level of competitive rivalry within an industry.

It’s time to move on to the third factor – the bargaining power of buyers.

The power of buyers

Simply said, the bargaining power of buyers refers to the influence that the buyer has over the seller (in this case, the company you own). The presence of buyer power could come from low switching cost, non-differentiated products, or industries where there are only a few buyers in the market.

In such instances, the buyer may have undue influence on the business performance of the seller.

The diamond industry may be an interesting study here. The slide below was shared by Sarine Technologies Ltd (SGX: U77) and it shows the level of customer concentration at different segments of the diamond industry value chain.

2015-03 Sarine

Source: Sarine Technologies’ Analyst Presentation

As Sarine Technologies is focused on providing the tools and technologies used to manufacture diamonds, it is not surprising that majority of its revenue originates from India.

This is seen in the chart below.

image

Source: Sarine Technologies’ Earnings Report

The high degree of concentration on revenue from India can have its impact, as seen in the graph of Sarine Technologies’ revenue over the past decade. Its revenue dramatically plunged in the financial year 2008 and 2009 as customers from India cancelled orders for its systems at the wake of the global financial crisis.

image (1)

Source: Sarine Technologies’ Earnings Report

According to Sarine Technologies’ Chief Executive David Gilbert, the company had little awareness that it was “standing on one foot” before the crisis hit. The episode in 2008 prompted Gilbert to seek a second revenue source.

To its credit, Sarine Technologies has since managed to carve out a new niche for itself. The firm had capitalised on its technological edge to launch a new system of products – the Galaxy family – and is modifying its pricing mechanisms from a one-off sales model to one which can fetch recurring revenue.

Furthermore, the company is looking to expand away from the diamond manufacturing segment into the diamond retail segment with its Sarine Light and Sarine Loupe products.

As a result, Sarine Technologies’ revenue has since recovered to hit new highs.

I hope the above offered food for thought in assessing the competitive strengths and weaknesses in the companies you own. Check back for the next segment on Porter’s Five Forces framework.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.