“Wholesale Transfer Pricing Power”
Wholesale transfer pricing power is an important concept I learned from Tren Griffin, who in turn learned it from John Malone in 1995.
As defined by Malone: “Wholesale transfer pricing = the bargaining power of company A that supplies a unique product XYZ to Company B which may enable company A to take the profits of company B by increasing the wholesale price of XYZ.”
My explanation is this: You own a bakery and sell this incredible dessert, but you can only buy the secret ingredient from a single supplier. After seeing your bakery take off, that supplier can raise their prices to capture all your profits.
For those familiar with Porter’s Five Forces, this is closely related to the “Power of Suppliers,” described as:
how easily suppliers can drive up the cost of inputs. It is affected by the number of suppliers of key inputs of a good or service, how unique these inputs are, and how much it would cost a company to switch to another supplier. The fewer suppliers to an industry, the more a company would depend on a supplier. As a result, the supplier has more power and can drive up input costs and push for other advantages in trade. On the other hand, when there are many suppliers or low switching costs between rival suppliers, a company can keep its input costs lower and enhance its profits.
These concepts are at the root of all negotiations. Before going into a negotiation, you have to know the BATNA for each side (Best Alternative To Negotiated Agreement)
A year ago, I read this WSJ article on Apple and their chief negotiator, Tony Blevins. The headline of the article reads “Apple procurement executive Tony Blevins’s job is to stare down suppliers and slash prices to the bone, an increasingly vital role.”
I’m fascinated by what goes into making an iPhone. For one, there are likely hundreds of parts that go into making a single phone. For reference, just think about what goes into making a single pencil.
As iPhones evolved, the component parts became more advanced, phones lasted longer, and Apple was faced with increasing threats due to the power of suppliers.
Today the supply chain looms larger than ever at Apple. Slowing iPhone sales, combined with the increasing cost of new features, make the job of hammering down expenses critical for a company mining its marquee products for profits as it transitions to a future more focused on selling services.
So what does Apple do? They have a twofold solution. 1) Increase vertical integration and 2) become a SaaS company.
Vertical integration is a “strategy whereby a company owns or controls its suppliers, distributors or retail locations to control its value or supply chain. Vertical integration benefits companies by allowing them to control processes, reduce costs and improve efficiencies.”
As the WSJ article clearly states, “The biggest threat to suppliers comes when Apple decides to develop a component internally.”
Why be solely reliant on a third party supplier for required parts? Just develop and create the parts in-house instead.
Further, Apple utilizes both backward and forward vertical integration. Not only are they creating their own parts, but they are also creating their own distribution channels to directly reach consumers. That’s the logic behind the Apple Store.
Apple has prevented themselves from incurring high switching costs, and they’ve maintained alternatives (preserving BATNA).
Tomorrow I’ll explain why Apple is making waves as both a hardware and software company.
Before then, let’s examine some more examples of WTPP.
Netflix has successfully navigated dangerous circumstances. They saw years ago that streaming services would begin popping up everywhere. Their investments in original content provided them with vertical integration that prevented content owners from capturing more profits from Netflix.
On the flip side, there’s Twitter.
For those with huge followings native to Twitter, they’re at Twitter’s mercy. That’s why it’s important to have control over communication with an audience. If you’re relying solely on a platform like Twitter, YouTube, Facebook, etc. they have leverage over you. That’s not “pricing” in the traditional sense, but it’s the same power.