Monday, January 17, 2011

Safety Nets

Many times a specific term may be unique to a product or service or class of products. For example the warranty against defects in material and workmanship may be different for different products. The tendency may be to point to another document that would establish the specific term. For example the Warranty period for defects in material and workmanship shall be specified in Appendix A.  That approach works well when you follow each commitment to verify that the term has been established. I’ve run into a number of situations where it wasn’t managed. I’ve seen agreements that point to another document to establish the warranty term only to discover that the document it pointed to never established the warranty term so there was no warranty. I saw a situation where an agreement pointed to another document to establish an epidemic defect rate. When I looked at that document it pointed to another document to establish the rate. When I reviewed the third document, no rate was established. Since there was no threshold rate established to trigger the epidemic defect remedies, we were unable to collect under for what turned out to me a situation where the cost of the defects were in the hundreds of millions of dollars.

To prevent things from falling through the cracks, its best to include what I call a safety net where you establish a minimum. For example:

“Unless otherwise agreed by the parties in writing in Appendix A, the warranty period against defects in material and workmanship shall be two (2) years.”  This creates an automatic 2 year warranty, but allows the parties to agree to something longer or shorter depending upon the circumstances

“The epidemic defect rate shall be one percent (1%) unless the parties agree in writing in Appendix A to a different epidemic defect rate.” This establishes a default rate of 1% that the parties can change by later agreement.

“Sixty days prior to the term of the Agreement, the parties shall meet to negotiate the price for the next twelve months, which shall not be more than the then current Price.” This guarantees that the price for the extension will be no more that the current price, but allows you to negotiate something better so you aren’t locked into a Supplier with no leverage over what the cost would be.

Here’s an example of another form of safety net.

In your negotiation of liability for defects you agree that their maximum liability will be no more than one times the prior years purchases.  However during the first year, there will be no prior year’s purchases. Further a problem could occur more than a year after you stopped purchasing. In both cases, relying on the prior years purchases would limit their liability to zero.  To prevent that you would include a safety net by also including a fixed amount.  For example “Supplier’s liability for _____ shall not exceed one (1) times the prior years purchases by Buyer or one million dollars (US$1,000,000.00), whichever is greater”.  The impact of doing this is you have a minimum amount to rely upon and if sales go up, the limit goes up.

Sales Use Of The Principles Of Persuasion

Principles of Persuasion
In a negotiation both parties seek to persuade the other party to move on their positions. As a negotiator you need to know how to persuade or sell others.

Robert B, Cialdini is a professor and author that identified six basic forms of persuasion. 
1.     Liking. People like those who like them. A weaker argument will convince people who like you. 
2.      Reciprocity. People repay in kind. In general, this goes for cooperation, trust, empathy, help.
3.     Social Proof. People follow the lead of similar others. (Social comparison Theory)
4.     Consistency. People fulfill written, public, and voluntary commitments
5.     Authority. People defer to experts. 
6.     Scarcity. People value what is scarce. Framing that highlights losses or lost opportunities can be very persuasive.
You can read about them in Mr. Caldini’s  book “Influence: The Psychology of Persuasion”

Lets look at this from a procurement negotiation perspective to see how a Supplier might use those principles of persuarion.
  1. Liking. Suppliers may want to entertain you, take you out to dinner or to events. That’s because they want the Buyer’s personnel to like them. If they like you two things will happen. You may accept their weaker argument, or you will give them the benefit of the doubt versus others that you may not like as much.
  2. Reciprocity. When a Supplier has gone above and beyond to help you with a problem, there is an expectation that you will return the favor. If you don’t your future requests may fall on “deaf ears” where they won’t provide the same response.
  3. Social proof is something that suppliers will provide every day and during negotiations by references to either who is purchasing from them or what others have requested or agreed for terms.
  4. Consistency can be used in trying to sell a position of no. If every time you bring an issue up they are consistent in telling you no, they are trying to convince you that the answer will always be no.
  5. Authority in a sale setting is done in many ways.  It can be an expert opinion on their product or service. It can come from the fact that they have standard terms, standard prices, standard discounts they want to use. They will also use the need to get approval from a higher authority and the delay that will create as a means to seel you not to pursue the issue.
  6. Suppliers will use scarcity as a means of persuading you to act. For example, they can tell you about short supply and the need to order. They can tell you about an impending price increase that to beat requires immediate action.
All of these are attempts by the Supplier at trying to persuade the Buyer.

Lets look at the same principals of persuasion that could be used by the Buyer, 
  1. Liking. Instead of focusing on the Supplier liking the Buyer personally the focus is usually on getting the Supplier to like doing business with the Buyer because of the way the Buyer treats the Supplier.
  2.  Reciprocity.  Rather than focus on reciprocity for past acts, most buyers will use future business as way to persuade the suppliers to act.
  3. Social Proof.  As social proof Buyers will remind Suppliers of their competition, what they have provided and what the Supplier needs to provide. 
  4. Consistency. To persuade Suppliers buyers will set expectations of what’s needed and why and what’s not acceptable and why and be consistent in their positions.
  5. Authority. Buyers will use expert opinions and defer to experts to make points. 
  6. Scarcity.  From the Buyers perspective scarcity ties to the Buyer’s business. It can be what it will take the Supplier to replace them as a customer. If can be how long it will be before they get the opportunity again. It could also be making it clear that they have one chance, and if they don’t take advantage of it, they may not get another. For example, once you make an award, it will be that Supplier’s business to lose for the duration of the program and you won’t consider others unless they are not performing.
One of the best tactics in Buyer’s persuasion is taking the time as early as possible to set expectations.


Sales people have also been trained in what I call sales speak.  Here are a few examples 
of what I mean:

I need your OK( approval, initials, etc.)
Please sign this binding commitment.
We have some paperwork to fill in
I want you to sign a binding commitment.
It requires an investment of only .....
Here is the price.
We need an initial investment.
We want an advance or down payment to lock you in.
We can provide something more in line with your budget (more economical)
Here is our lower priced product we would prefer to sell to you rather than discounting the item you want.
There is a service fee
There is an additional charge.
It presents a challenge
There is a problem
Here is our list price
This highest amount we thought we could charge anyone.
You qualify for our standard discount of...
Here is an “authority” type document showing discounting is by purchase volume. I will use it to argue against higher discounts based on your volumes versus the schedule.
This is the market price
Please look at the past prices paid and not the future potential.
I’ve been authorized to offer a special competitive allowance if you buy now.
Here is an additional discount as we want the business and know we are in a competitive situation.
We have a reference account discount.
If we can use you to sell to others we’ll lower our price.
We offer a special price for competitive upgrades.
We want to convert you to our customer so we can get the annuity business (service revenues, new revisions, enhancements etc.) so we’ll discount to get that.
We have several areas of concern
We have objections to your requests/requirements.
This is trade practice.
This is what all suppliers in our industry try to get the customers to agree to.
Trade association, Professional association.
This is an organization made up of Sellers only who may publish standards, standard agreements to give credibility to their position.
These are our standard terms
This is the agreement which is 100% in our favor.
It will require approval by...........
We don’t want to change
I’ll have to speak with my management
I don’t have a good reason so will go back for help.
Here are our standard hourly rates
Here is our list price for people charges
These are industry standard terms
Here are the terms set by our association of Sellers.
There is a shipping and handling fee.
We would like to add additional margin to their price under the guise of shipping and handling charges which either should be included in the price or bear no relationship to cost.
Our customers have a return on investment on our product of _______.
I don’t want you to think about the price and if I can show you savings it will take the pressure off price negotiations.  
Lets make this a Win-win
I want to make the sale at acceptable terms to me.
We would like you to buy thorough our channels / authorized resellers.
We want to maintain our margins by restricting who you can buy from and what discounts we give them.
We can offer a refurbished item
We would like to sell this used item.
Lets split the difference
I want you to pay half of the difference from my highest price versus your offer.


Most Suppliers Hate Competition.

Competition helps drive their price and profits down. There are a number of strategies that Supplier’s employ that are specifically designed to avoid competition either in the initial or follow on purchases.
  1. Rush to be first and get designed in.  To a Supplier being first to market and getting designed into their customer’s product has the ability to reduce competition. Replacing the designed in Supplier's product can require engineering redesign or re-layout that may not be a priority for assigning engineering resources. There will be a costs associated with the change that they may not want to fund unless the return is substantial. Both of these are barriers to change. By being first, you also usually have the ability to charge a premium price as the price curve and impact of competition isn’t at work yet, and even though there may be competition in the market, the barriers to change have a lesser impact on the Supplier that’s designed in. They don’t have to be competitive, all they need to do is not charge such a premium that it inflames the Buyer to make the necessary investments to change. As a Buyer, negotiate hard before you get locked in. Look for opportunity to change Suppliers at times when the barrier is low – e.g. if engineering needs to do a redesign or the product mid-life use that to have them give you the flexibility you need to bring in a lower cost competitor. Highlight the premiums that exist to prompt change discussions based on ROI of investing the design resources.  
  2. Have unique features that can’t be provided by other Suppliers. This is probably the most difficult one to deal with. You manage this by first not letting them know that you need or want those features. Where possible use a value equivalence negotiation approach to highlight the incremental cost for those features versus the competition that doesn’t have them. The incremental feature should have a cost that’s in line with the additional value provided. Provide the Supplier with the message that you will pay for additional value, but the Product still needs to be competitive from a value equivalence perspective.
  3. Use form, fit, or package makes it difficult or costly to switch Suppliers. One simple strategy is to work with other Suppliers to develop products that will be plug and play compatible that create competition.
  4. Take advantage of situations where the use of another Supplier’s products will add to the Buyer’s costs. For example with capital or process equipment if you start to mix suppliers it may significantly impact your service costs as you need to inventory multiple companies spare parts, have people trained on multiple companies products, and potentially have things like operational flexibility be impacted if they aren’t cross compatible. Negotiate the cost of all follow-on purchases before agreeing to purchase the product to manage the follow on cost. Consider negotiating with other Suppliers to get them to agree to purchase you existing inventory and provide you with compatible replacements to reduce the impact. For example, if you had one Supplier’s Air Conditioning equipment and there weren’t being competitive in quoting future needs, and you built a major new extension to your facility, negotiate with another Supplier to not just provide the new units, but replace the existing units to avoid the costs associate with having to manage two different Supplier’s products.
  5. Manage the design of the product so other Supplier’s parts aren’t plug and play compatible.  This is done to protect the service annuity stream of spare parts, maintenance, repairs etc. Make sure that you negotiate the cost of all those future purchases before you are locked in. Use any reluctance to do so to leverage a lower cost for the initial purchase so it’s less costly to change.
  6. Protect against after market competition by things like proprietary interfaces making if difficult to have 3rd party parts be plug and play compatible. Make sure that you negotiate the price of everything you need up front. If you have leverage, push to have them provide a second source for those items. Use the non-competitive nature as leverage to negotiate a lower purchase cost of everything up front so it’s less costly to change.
  7. Provide cash, financing, or services that make the initial use attractive, but be difficult or costly to be replaced.  Make sure that your internal customer understands the real cost of those activities in terms of higher cost on future purchases, services, maintenance or repairs. Always document exactly what is being amortized into the product cost and the basis for the amortization so those costs will be backed out of the price equation once the amortization quantity has been met. Develop alternative Supplier’s and products to use as leverage in negotiations once you have meet and committed quantity.
  8. Provide terms such as extended warranties that make switching sources less attractive. Use that as leverage to get other Suppliers to provide the same or better terms if they want to replace the Supplier.
  9. Provide services that make the Supplier more attractive in comparison to other Suppliers making it more difficult to replace (such as implementing VMI hubs and stocking). Negotiate similar programs with the competition.
  10. Provide convenience in doing business, design tools and support, and other services or support that the Buyer needs or wants that they don’t get from other Suppliers, which makes replacement a less desirable option. For example, Distribution is successful for a number of reasons. One is they will stock items making them easy to get. Another is they will allow purchases in lesser quantities than the Supplier would require which can be attractive.Have the user look at the relationship from a total cost perspective. Show them what the costs would be if competition were involved and compare that to what you are paying with the Supplier to highlight the real cost of those Supplier services. Get the user to tell the Supplier that while they like the convenience, they don’t need it and they aren’t prepared to pay the premiums for it with the message that if they aren’t more competitive in their pricing, you’ll do without the convenience and competitively quote it.
  11. Bundle pricing or make bids “all or none” to use the advantage they have on certain products to avoid competition on others. Consider telling them you’ll give them none. Most Suppliers wouldn’t want to lose out on the total sales and may reconsider their approach to keep the sales they are competitive on or the sales where they have an advantage.

The goal in each and every one of these Supplier tactics is to either eliminate or reduce competition not just on the initial purchase, but for all the follow on business and the annuity business like spare parts, maintenance and repair. The best time to protect yourself is before you make that first purchase. That’s the time to negotiate not just the price of the product, but the price of future purchases of the product, upgrades, options, add-ons, maintenance, service, repair, terms, support, and performance. The focus needs to be on getting the best life cycle cost, not just the lowest initial price.

The more difficult or costly it is change Suppliers, the more important it is to first make sure you selected the right one and that you negotiate the life cycle cost of everything before you make the commitment that locks you in to the Supplier. For those situations where changing Suppliers will be difficult or costly, you should have an exit strategy thought out before you enter into the relationship and make sure that the terms you negotiate support that strategy. For example, if there is difficulty or cost switching, you should be negotiating a number of additional price breaks that automatically apply as you hit certain additional volumes that may occur over the term relationship should the business grow. Structure your agreement so the impact of any change in Supplier is reduced or manageable. When I worked for a Bank and negotiated an agreement for processing of debit card transactions, the term of the agreement was an extremely important term. The reason is that if you ever wanted to change Suppliers at the end of the term, you want to be able to do that when it was best for you and will have the lowest potential impact or risk. The lower the impact or risk of change, the more leverage you have should you want to negotiate an extension. In my banking example, you would never have the term of the agreement expire during the busy times of the year such as the prime shopping periods of November or December because the impact of a problem in changing Suppliers could be huge. The last thing you want is have your agreement term expire when it’s bad for you leaving you with the options of  1) Having to renew the agreement with the Supplier you want to get away from, or 2) Having to negotiate an extension to a point where it will signal your desire to change where they probably can and will can charge a significant premium for that interim period, or 3) Having to make the change at the worst possible time.

Getting locking into a Supplier can happen in a number of ways. I remember being involved in a negotiation of a plastics contract in which we had reduced leverage because only that Supplier’s material was qualified to work in our application. To use other materials would require an expensive change to our tooling which was a barrier to changing suppliers. We knew it and the Supplier knew it and as a result we continued to see the price increases. Quietly we qualified another Supplier’s product for use in our application. We used that in the next round of negotiations. The Supplier came in still thinking that they had no real competition and were seeking another increase. We explained that we had qualified another source and were awarding them minimum of 40% of the Business. Then we gave them the simple message that they had a simple choice, if they wanted to keep the remaining 60%, they needed to significantly roll back their pricing to be competitive with the other Supplier or we would award all the business to the other Supplier. Whenever possible, re-introducing competition into the equation.