Leveraged – supplier has the power
Unleveraged – neither has power
Leveraged – buyer has the power
Tuesday, July 12, 2011
In a blog about whether penalties or damages drive performance a number of individuals commented about how you don’t need damages or penalties to drive performance, you need strategic relationships. They also said the threat of lost of business will drive performance. Based upon that I decided to discuss strategic relationships.
In a number of writings I’ve seen that describe buyer / supplier relationships they put them into what’s called a Johor box that consists of two rows and two columns.
Unleveraged relationships exist because no one has the power. When the buyer starts to buy more unless the buyer has other sources that create competition, the supplier has the power.
When there are enough alternatives in the marketplace where the Buyer has and can use competition, the Buyer has the power. Unless the buyer has the power, there is no incentive for a supplier to want to enter into a strategic relationship unless they see other benefits like volume stability. If the buyer has the power, they also need to see additional benefits of entering into a strategic relationship. For both parties to want to give something up to enter into a strategic relationship, they both need to see where they will get additional benefits that make it worth it.
Many things that procurement people call strategic relationships really aren’t. I would seriously question if there is any benefit a buyer could receive that would be worth not being able to collect damages in the event of a major problem. I’ve seen Vice Presidents of Procurement fluctuate between not wanting to have the extensive terms with damages and penalties relying on the fact that they had the leverage that the Supplier wouldn’t want to lose the business and would solve the problem. I’ve also seen the impact of that approach when there was a major problem with a huge cost. What I’ve seen in that situation is companies not acting as a strategic relationship. They acted like companies that wanted to avoid that cost and simply did not fear losing the business. The cost of correcting the problem was so large that if they paid to correct it they would have made no profit on the relationship for many years to come. Loss of future business is simply not enough incentive when the cost of correcting problems is substantial.
If you can never have huge problems and costs, strategic relationships may be all you need. If you are in a business where problems can and do happen, your strategic relationship agreement needs to have contract terms that will protect you against at least some of those costs. Trusting someone to solve the problem isn’t always they best idea. It reminds me of a sign that salvage reseller Building 19 in the Boston area had in their store. “In God we trust, all others pay cash”.
If you want to create a strategic relationship the parties must trust and respect each other and they must have been open and honest in their prior dealings. If you don’t have that type of relationship don’t even consider a strategic relationship.
The second step is to look inward and ask a number of questions.
1. What do we want to achieve?
2. What do we feel that want to achieve?
3. Are the goals complimentary?
4. Are they proper partners for the relationship?
5. What do we expect will change over time on our side?
6. What do we expect will change over time for them?
7. What are each party’s roles and obligations?
8. What is there is a problem, how will it be resolved?
9. Are we prepared to share the right information to make them successful?
10. Do we think they will share all the necessary information we will need?
11. How will risks and benefits be shared and are the benefits consistent with that sharing?
12. Are we both going into this with the same agreement on expectations and time to market goals?
13. Based on your history of dealing with them are the individual cultures within each company going to be compatible.
14. Will the people in the trenches see value in it and support it or will they view it as business as usual?
15. What if the relationship doesn’t work out or we decide to go our different ways.
16. If procurement is driving it, will management support it?
What type agreement to you need for a strategic relationship? My preference would be to use the standard contract I would use for those purchases, and have a supplement to the contract that details the strategic relationship and includes any changes to the contract terms that apply during the period in which the strategic relationship is in effect. I would also want the supplement to be subject to termination by either party at any time. While that may seem a little more complicated than needed, I always want to protect against the risk of the other party not meeting their side of the agreement and don’t want my only options to be to either put up with it or terminate the agreement. Change is constantly occurring in the market and you need to be prepared for that. Companies priorities change, and their management staff and how they view the world changes. You always need to be prepared for the potential that the reasons why you wanted and thought a strategic relationship would work in the first place can also change. By doing it as a supplement that can be terminate, if one of the parties begins to act in a manner that is contrary to the goals of the strategic relationship you have options. Reverting back to a traditional relationship may work and having the option to do that also buys you time in the event you need to seek an alternative Supplier.