Friday, December 23, 2011

Bargaining Zones - A New Look

In a number of books on negotiation the authors speak about negotiation settlement ranges. The assumption is that both parties have their desired positions and a walk away position. In the Suppliers case they will never go below a certain amount and Buyer will never go above a certain amount. So the premise is the bargaining zone for the negotiation will be where the Buyer's and Supplier's ranges overlap. This iwass a great concept in theory, in practice it’s not very useful as in most negotiations you are not dealing with a single issue such as price alone, you are dealing with many issues that affect the cost of the relationship and your life cycle cost

The simple fact is Buyer’s may be willing to pay more than what they consider to be their worst case price if they see additional value. The may also pay more if they need what the Supplier is selling and simply don’t have an alternative where they can walk away. Similarly, Suppliers have been known to sell for less than their worst case if they see additional value from the sale or they need the business and can’t walk away. This means that depending upon the circumstances of each of the parties at the time of the negotiation and the leverage each party has, their best and worst cases will change and so will the “bargaining zone.”

Even on strict price negotiations who you buy from will impact the bargaining zone. For example if you buy from a Supplier subsidiary their bargaining zone will be impacted by what they had to pay to purchase the product at the transfer price from the Supplier and what overhead and profit they need to make for that subsidiary. If you purchase a product from a distributor their bargaining zone is going to be impacted by the deal they have with the OEM. Most distributor relationships fall into two price models. A common type is the distributor is given a discount off the Suppliers list price, so their worst case selling price be based upon that discount plus what they need to make to cover their overhead and profit. The other distributor model is more of a price protection approach has target selling prices and they get their discounts and margins by staying close to the target selling price, so their bargaining zone may be very small.

As a Buyer going into a negotiation, its important to establish your goals and what your walk away point would be as that sets your own bargaining zone. Its also important to track and consider the impact of each concession on the total cost of the relationship. Where you really get value you may agree to pay more than planned. If the Supplier clearly wants to provide you less under the contract you want to make sure that each time that is proposed you have the expectation that you will pay less as a result.

When should you try to uncover the Supplier’s bargaining zone? Normally I wouldn’t care about the Supplier’s bargaining zone as their responses as part of the negotiation would indicate where it will be. If I felt it appropriate I could include a target price as part of a RFP to serve as an anchor for negotiations. The key is to never head too far down the path with the Supplier (especially if the circumstances could lock you into using them), before you know whether or not the potential deal will be acceptable. I’ve seen too many Buyers have to settle for bad deals simply because they had either invested to much into the relationship to walk away or because they simply did not have the time to start over with another supplier.


In considering the bargaining zone you need to take the concept called “value equivalence into account. Graphically value equivalence looks like this

All value equivalence means there is a relationship between price and value. The more value you get, the more you should be willing to pay. The less value you get, the less you want to pay. To a supplier in selling their goal is to show how the unique features of their product, services or additional services will provide a benefit to you that you will value. If they can do that and they know that their unique features are providing you with value, that may lessen the competition from suppliers whose products or services don’t have the same features or added services. When this occurs they will try to stay closer to their desired price.

If they can’t get you to admit that their unique features will provide you with a benefit that you will value, that forces them compete on price against products that don’t have those features. Value also exists in the contract terms you negotiate as what you agree upon will either add to or reduce your costs and risks in the relationship. Any time a supplier doesn’t want to agree to a term what you need to do is make it clear that they are significantly trying to diminish the value. If you can’t accept the change you make it clear that at those terms the value isn’t there to warrant the purchase. If you can accept the terms, you make it clear that since the value is reduced to you, you need to pay less. Make it clear that changes to what you need won’t be free. There is a cost that will either impact whether you will buy or what you are willing to pay.

The last aspect of value is how much the other party needs or wants your business. If they really need or want your business that will further drive them toward their minimum selling price. Buyers never want to tell suppliers how much they need the supplier as all that will do is provide them with a reason not to lower your price or not agree to your terms.

How does this tie back or relate to the bargaining zone?

The bargaining zone should be a range at a point on the value equivalence line. The bargaining zone could move up or down the value equivalence line as shown with the blue arrows depending upon whether value to the deal is being added or reduced. The supplier’s desired price that is on the high end of the zone is based upon buyer getting maximum value out of the features and service they provide. That increase value is intended to distinguish their product or service from their competitors. The minimum they will accept for the price and terms will depend upon how much they need or want the business.

The buyer’s maximum price will be based upon the value they perceive. The buyer’s desired price can be anything as long as it doesn’t insult or alienate the supplier so they won’t do business with you.

You can use value equivalence to negotiate cost, or push to get greater value. One way to do that is to get prices from competitors that are both higher and lower than the supplier you will be negotiating with. Then compare the features and services that are included with each. Then look at what the price difference is for those features and service to determine if there is sufficient value from those to warranty the cost difference.

If you have a supplier that offers much more at a price that is only slightly more, highlight the differences and tell them that they need to provide more or sell for less because they aren’t offering enough value at their price point. If you have suppliers they don’t have the features who are much cheaper, as long as you haven’t told the supplier that you want or need the product, tell them the added value for the features doesn’t warrant the incremental cost difference. The message is here is what those features or services are worth to me, here is what I can buy another product for that doesn’t have those features. The maximum I want to pay is the sum of the two. The lower price without the features and services and your value for those features and services.

If you don’t need or want those features, let them know that so they know that if they want to make the sale they need to compete on price against companies that don’t have those features.

Just so you understand value equivalence here’s an example. You have Suppliers A, B, C, D who have their price and value plotted on the slide below..

Between A and B the decision should be simple. B offers more value at a lower price. For A to win the business they would either need to provide more value or reduce their price as shown by the red arrows.

Between B and C the difference in value isn’t significant but the price difference is significant. If you wanted to negotiate with C, you use B as the benchmark and only want to pay the reasonable value of the difference in features or services between B and C. You would want to drive C in the direction of the Blue line.

With respect to D, what they are offering at their high price is also the highest potential value, if you value it. There price is consistent with the value. If you valued all they offer you still want to make sure that the incremental price they charge for that is not greater that the combination of the price you were able to drive C to plus the value you place on those incremental features and services as shown by dashed orange line.

Pay when paid.

Pay when paid is a term that prime contractors may try to include in their subcontracts. Instead of having a firm payment period, what pay when paid terms do is make the prime contractor’s responsibility to make payment to a subcontractor contingent upon receiving their payment from the customer. The advantage it provides to the prime customer is cash flow.Instead of having to make payments to their subcontractors and wait until they get paid by the customer, the subcontractors have to wait until the prime gets paid, The prime has no outlay of their own cash or doesn't need to borrow money to pay subcontractors during the project. This reduces the prime contractor's cost. Whether it’s good for the subcontractor will depend upon the circumstances. If the subcontractor was the only subcontractor on the project and they had high confidence that the prime would complete their work in a timely manner without and problems it might be ok as long as prompt payment from the customer could be expected

My of contract terms is you should only take risks that you can control. The greater the number of other subcontractors involved and more work the prime does, the more potential situations where problems caused by someone else would be used to delay or withhold payment, Do you really want to depend upon all the other parties to determine when you will get paid? If you were certain you would get paid in a reasonable period and wanted to take the risk, Further you might be able to include a carrying cost in your price that takes into account the period you are effectively financing the work.

If I had to accept a pay when paid term I would include what I call a safety net.In this the safety net would be the maximum period allowed before you must be paid as long as you met your performance. To me that’s a reasonable request since you have no control over the prime contractors performance or the other subcontractor’s performance. That’s the Prime contractor’s responsibility.

For example:
"Prime Contractors shall pay Subcontractor ten (10) Day after receipt of payment from Customer or net X Days, whichever occurs sooner.

Further to protect against the Prime withholding significant payments for a dispute you might also
want to protect yourself by a term about withholding payment in the event of a dispute which was the topic of a separate post.

Whether a pay when paid clause may be legally enforceable will always depend upon local law. In recent years a number of jurisdictions have enacted laws that are designed to protect smaller contractors against abuses by large contractors.