Wednesday, October 26, 2011

The little publicized fact about win-win negotiations

In books about win-win negotiations the traditional zero sum negotiation is graphically described as a triangle

This showS it as a fixed pie where for either party to get more the other party must get less as is represented by the area in the triangle. The more buyer gets the less supplier receives and vice versa.

When they describe win-win it is graphically described like this where the area is expanded to the pareto optimalization curve:

There is another concept called value equivalence. Graphically that looks like this

The concept of the value equivalence line is simple, the more something costs, the more value you want. Items where the cost is above the value equivalence line would be good for the supplier but bad for the buyer, That’s because the buyer is paying more than what would be warranted for the value received. Items below the value equivalence line would be good for the buyer as they are getting more value for a lower price, they would not be good for the supplier.

When you merge the concepts together what you see is the real story behind win-win.

When you expand the pie the only point in the expanded area where both parties get a win of equal value is when the value of what you are giving up is equal to the value that you are getting
and that falls on the value equivalence line that I highlighted in red..

If the point at which you settle is above the value equivalence line, you may get your win, but the supplier is getting a bigger win. If the point at which you settle is below the value equivalence line, the Supplier may get their win, but the buyer is getting a bigger win.

Whether it’s dividing up the limited pie of the traditional negotiation represented in blue or the expanded area needed for “win-win” negotiation represented in green, you are still dividing the pie. It’s still a negotiation. The other party still wants to win. They also want their win to be much bigger than your win. Unless the cost of what you are giving up to get you win is equal to the value you are receiving to get that win, you really aren’t winning.

I’ve never been convinced that principled negotiations really work in most procurement and while everyone in procurement should understand the concept, they also need to know how to negotiate in a traditional win-lose model. From a procurement perspective, how realistic is it to expect to be able to expand the pie to move into win-win negotiations? If you can't “expand the pie” principled negotiations won't work.

Let's put the idea of expanding the pie into a procurement perspective;

Most companies are best in class in maybe one product or one line of business. I don’t know any that are best in class with all lines of business and all products or services. So the first question is do you want to expand the business you have with the Supplier into those products or lines of business where they are not best in class just to get a win?

You could potentially expand the pie by giving a supplier a larger percentage of your business. There are costs or risks associated with doing that. What happens if there is a problem with their supply and you don’t have an immediate alternative you can use?

You could potentially buy more of their best in class products to expand the pie, but what impact will that have on your ability to leverage your other suppliers? You may wind up getting more from the one but losing with the other.

There will be times when what you are buying is all that you need or want so there is no
opportunity to offer anything more than a good faith promises to use them in the future. Most suppliers that I know need to see a benefit to them today before they will agree to give you a concession.

On major deals you may be able to expand the pie, but that frequently complicates the negotiation. It doesn’t complicate it with the supplier, it complicates it with the internal stakeholders that may be impacted and who will always focus on their interests. Officers of the company that can look at what’s best for the company without being weighed down by individual group’s interests usually have a better chance to use principled negotiations than procurement people.

The one area where I’ve seen win-win or principled negotiations work in procurement is when
both companies have a common goal of teaming together to win a customer’s business. Even there it can be difficult. For example if a supplier has a product or service that the customer wants or has specified and that supplier knows it, the negotiation between the prime contractor and the supplier may be a win-lose negotiation as they know they have the business. So unless the prime can offer them something that relates to another project where the supplier doesn’t have, but wants that business, it’s hard to expand the pie and get into principled negotiations.

The one aspect of principled negotiations that every procurement person can learn from is the advice to focus on interests, not positions. Part of any negotiation is being able to reason or explain to your counterpart what your interests are and why you have the position / interest you have. Most of the time that will open a dialog where since they now understand the issue or the problem they can look at their position and view it against their real interests.

Title and Risk of loss

Title means that legal ownership in the item purchased.Risk of loss describes whose responsibility it is if purchase is lost or damaged in transit.When you use INCOTERMS each different term defines the specific point at which the risk of loss transfers. There is a new version of INCOTERMs that became effective in 2011. Like previous INCOTERMS it does not describe the responsibility for insurance unless a term requiring insurance is specified such as CIF. Buyers should know that insurance coverage under CIF is very limited. It only covers major casualties, so if you want to protect the shipment you should specify your own limits for coverage.

Title is different from risk of loss as the parties can specify a different time and place for title to transfer. For example, a supplier that sold a major piece of equipment to a customer may want to specify that title doesn’t transfer until they receive payment from the Buyer, or they could transfer title subject to a security interest in the product (a lien) that would be released upon payment. A supplier could specify that title will transfer at some point while the item is in transit. For example, A supplier in Country A could specify that title transfers while the item is on the high-seas before it arrives at Country B irrespective of the delivery term.

The reason why a supplier or buyer might want to have title transfer at some other point is the sale legally occurs at the location where the title transfers. Where the sale occurs can be very important. The supplier in Country A with a customer in Country B may not want the sale to occur in Country B. That would make that a local sale within Country B. Being a local sale would subject the supplier to needing to be registered to do business within country B. It would make the supplier also subject to the laws and taxes of Country B,which may not be favorable.

A buyer that was purchasing a product for resale could have a similar concern. For example a Buyer may want to have a simultaneous purchase and sale of the items while it’s on the high seas. They buy the item from the supplier in Country A. The delivery terms will cover the delivery and they will specify that title transfers to them on the high-seas while it is in-transit.So when they get title passed to them while it’s on the high-seas, they may also transfer title to the customer from Country C simultaneously so their sale is not occurring in Country C. That makes it an international sale and the customer in Country C would need to import the product into Country C.

In addition to having title transfer on the high-seas, you could also specify that title will transfer in a free trade zone. A free trade zone is an area located in the country (in our case Country C) that is prior to customs clearance. Since it is prior to customs clearance, a sale there is not considered to be a sale within that country. If you look for Supplier to maintain stocking areas in another country, the use of free trade zones with title transferring in the free trade zone is something you should consider. It allows you to get the material closer to your point of use without subjecting the Supplier to having to register to do business in that country. It avoids having it be a local sale where payment in local currency would be made and the supplier would then need to figure out how to repatriate the funds. It avoids the supplier having to pay taxes on the proceeds of that sale in that country. Lastly, it keeps the Supplier from being responsible to comply with those local laws.