(FORTUNE Magazine) – He's a small manufacturer in the Midwest--call him Jack. His company makes inexpensive housewares, about $20 million worth every year. His customers include Wal-Mart, Kmart, and Target, three giant retail chains. A few years ago each made him an offer he couldn't refuse.

"We were encouraged--or pushed--into electronic data interchange," Jack says. With computer-to-computer links, the stores entered orders for soap dishes or wastebaskets straight into his system. Errors disappeared, clerical costs fell. He stickered every pallet and piece he shipped with a bar code, saving the retailers more time and money when they received the goods. Initially his customers split the system's cost fifty-fifty with him. A bit later, he notes sardonically, "they decided the savings were so great that I should pay both halves."

Just another case of the big guy putting the squeeze on the little guy? Not quite. If it's any comfort to Jack, all kinds of evidence--share of GDP, percentage of corporate profits--says that large corporations exercise less economic power than they did a generation ago. What's happening is subtler, more fundamental, and more fun. Jack is getting squeezed not because he's smaller but because he's further from the end-user. In industry after industry, power is moving downstream toward the customer, the person with a dollar bill in his hand. Managers had better understand why.

The reason isn't that mantras like "customer delight" are suddenly all the rage. "The customer is always right" was always right. But he wasn't always heard. Today the customer calls the tune because he knows the score. In a knowledge economy, information is more valuable than ever--and generally speaking, customers, who've become savvy about info tech, get more of it. Says Michael Standing, a supply-chain expert at Gemini Consulting: "Information used to be much more enclosed. Now it is increasingly available to the customer, which changes the power balance."

Buyer-supplier partnerships allow your customers to see inside you. Your customer might know how much stock you have on hand and when his order left your warehouse. He might even know details of your manufacturing costs and R&D. With that kind of info, he can demand better terms. Says Robert K. Elliott, assistant to the chairman at KPMG Peat Marwick: "An electronic interface with suppliers is strategic because you can use it to hose them on price. With your customers, it is not strategic, because they can hose you."

Not that they always do it, or that the seller is necessarily hurt. Like people who open their hearts to one another, suppliers curl up and share information with customers because intimacy can be worth it, even though the pain is greater if something goes wrong. As Elliott points out: "If the supply chain is transparent, with all the information visible, you can create the most value for the least resources." How? An electronic link between companies can replace costly working capital by reducing inventory and order-processing time. Partners can eliminate duplicate functions like billing and purchasing, putting them on one side or the other of the partnership, even merging them. Jordan Lewis, whose book on customer-supplier alliances, The Connected Corporation, will be published this fall, estimates that 30% to 40% of savings from customer-supplier intimacy derive from improving such joint processes. In the best partnerships, benefits are big enough to give everyone a big slice and a frosting rose too.

To understand the new economics of buying and selling, you must reexamine the value chain in the light of the know- ledge economy. A value chain, you re-call, shows how a product or service goes from raw material to goods on the shelf. Value is added at each stage. The idea is to add as much value as possible as cheaply as possible, and--most important--to capture that value in your markup.

You must analyze the flow of information along the value chain as well as the movement of goods and services. The most valuable links on the chain tend to belong to people who own knowledge--particularly about customers, who pay for all the upstream hurly-burly. He who controls information in many cases controls the business.

Surprisingly, that doesn't have to be the person closest to the customer. Information is funny stuff: Unlike refrigerators or storefronts, it can move anywhere in nanoseconds. Transporting it costs bubkes. There's no reason it has to pool at the customer end of the river. If you take your Nissan 240SX to a dealer to get retrofitted for a car phone, that information can go to Motorola or Cellular One. Information about customers is always the most valuable knowledge, but it might be worth most to somebody upstream. The fact that you got fitted for contact lenses is worth several dollars to your optometrist but potentially worth a lot more to Johnson & Johnson, if it can get you to buy its disposable lenses.

An alert manager can put information where it has the biggest return. To do so, ask three new questions of the value chain: What information drives the business? Who has it? To whom is it worth most? You might find that you can change what you do to take advantage of what you know--that is, move upstream or downstream to wherever the fish are biting.

MicroAge is a company that did just that, moving a step upstream in order to benefit from information that it gathered downstream. Based in Tempe, Arizona, fast-growing MicroAge (1994 sales: $2.2 billion, up 47% from 1993) began life in 1976. Says CEO Jeffrey McKeever: "Till five years ago we were primarily a wholesaler." MicroAge sold Apple, Compaq, Hewlett-Packard, and IBM computers to corporate clients, adding value the way wholesalers always have: Buying in bulk, holding inventory, matching buyers and sellers, and, in its case, using franchised dealers to service customer sites nationwide.

But in these days of far-flung, heterogeneous PC networks, customers don't need just computers; they need configuration too. Dozens of manufacturers might contribute to a final system--a central processing unit from one company, a hard drive from another, a keyboard from a third, plus sundry peripherals and preloaded software. If the auto industry worked the same way, you could buy a car with a Cadillac body, a Ford engine, and a BMW gearbox, assembled not at the GM factory but at the dealership.

In this environment, a computer is just part of a system. Says McKeever: "We saw value shifting from physical attributes to information attributes." Possessing the pieces was worth relatively less than before; the value of knowing how to put the parts together increased. So MicroAge moved to where the value was. The company tore apart a warehouse and converted it to a factory. Every day, over 125 tons of IT equipment moves through this job shop-cum-logistics center, which assembles customized systems out of monitors and motherboards and other stuff from more than 500 companies. Exploiting a rich pool of information--knowledge of its customers' needs and the cost, capabilities, and compatibilities of manufacturers' products--MicroAge changed its place on the value chain.

Thus, the squeeze isn't on suppliers per se; it's on anyone who is left out of the information flow or fails to take advantage of it. Take the pharmaceutical business. Not long ago the most valuable knowledge in the industry was the stuff that was cooked up in the drug companies' labs. Then managed-care companies began collecting information about what drugs individual patients were using--knowledge that before was dispersed among doctors and druggists.

Armed with that information, companies like Medco Containment Services could--and did--press doctors to prescribe cheaper substitutes for costly brand-name drugs. Their knowledge of customers trumped drugmakers' knowledge of chemistry often enough that margins came under attack (see chart). When Merck & Co. bought Medco in 1993, it wasn't vertically integrating. Medco doesn't push Merck's drugs over competitors'; that would jeopardize Medco. Instead, Merck bought a database--an intangible asset that allows it to recoup margin it was losing in manufacturing.

Understanding the value of intangible assets is essential to constructive buyer-supplier partnerships. If there ever was a company that could be vulnerable to a price squeeze by customers, it's W.W. Grainger (1994 sales: $3 billion). The Skokie, Illinois, outfit distributes maintenance, repair, and operating supplies. Small motors. Safety glasses. Paint sprayers. Toilet paper.

The urge to squeeze the Charmin costs is irresistible. I once worked for a small publisher that employed an indomitable wren of a woman named Rose who kept the files and bought supplies. Rose one day replaced the toilet paper dispensers in the lavatories with hardware that held huge rolls of cheaper paper. Estimating how often the staff used the johns, your correspondent calculated that it would take seven years before the lower paper cost repaid the investment in new dispensers. That didn't stop Rose.

Grainger's solution: Sell a "value package," not homely commodities. Depending on the customer, that might include electronic ordering and payment or reengineering consulting services in the supply management field. Says VP John A. Schweig: "On sales calls these days we're seldom talking about why the motor we sell is better than someone else's motor; we talk about value-added services." Because Grainger knows how to manage inventory inexpensively--with an average order worth just $129, it must keep handling costs low--it can frequently manage a customer's supply closet for less money than the customer can, keeping some of the saving for itself.

How, then, can a company enjoy its customers' embrace while guarding against a margin-squeezing bear hug? The answers are found in developing the following impregnable intellectual assets.

Innovate. Says my Midwestern friend Jack: "The more basic your product, the more they gotcha. If you can keep coming up with new products, you can get some margin. Everybody wins."

Learn the other guy's business. If information flows only one way--away from you--the other guy has you in a game of "heads I win, tails you lose." Reciprocity is the difference between an arm-wrestling match and a handshake. How much information should the two parties share? If you can build the trust, says Jordan Lewis, "the right answer is 100%, except for personnel records and confidential financial data." One tip: When dealing with major accounts, don't leave the job entirely to a salesman or purchaser. Send a team of logistics, marketing, accounting, and engineering people. They can help you understand what the other guy needs, how he makes money, and what extras you can sell.

Become indispensable. Companies like Procter & Gamble and Newell help manage the stock in Wal-Mart's stores, in effect managing a piece of its business. When buyers depend on a seller's services, technology, etc., power comes back into balance. Says Jordan Lewis: "The cost of bringing in a new supplier is very high."

Build brands. An ounce of brand equity is a pound of defense against a margin squeeze. Says Robert Atkins of Mercer Management Consulting: "Brands can make partnerships work. They help you avoid getting price-shopped." They appeal directly to consumers, leapfrogging the distributor.

If you still can't escape the bear hug, look behind you. You bought raw materials from someone, didn't you?