Tuesday, October 8, 2013

Is Negotiation Only About Price and Discount?.

This was a question that someone asked in a LinkedIN forum. The ensuing exchange of posts brought forth an issue that I thought I would share.

My initial response was there are three stages to any major negotiation. The pre-negotiation stage involves qualification of the supplier and preparation for the negotiation. The better prepared you are, the better results you should achieve. The actual negotiation involves not just price but also contract terms. Contract term can either add to or reduce your cost and add to or reduce your risks. Risks that you assume under your contract that materialize add to your costs. You can have a great price and discount with lousy terms that will cost you more in the end. The third stage of negotiation is contract management. Contract management will determine how much of the deal that you negotiated you actually keep. Contracts that are left unmanaged will always cost you more. So my answer to the question was price and discount are never the only factors to negotiate.

Another responder took the approach to segment Suppliers into four categories using an IACCM segmentation:
1) Commodity
2) Developing
3) Legacy
4) Strategic
Their position was that with Commodity Suppliers, it was only about cost and discount but with other suppliers it involved more.

Based upon this I thought I would write about supplier segmentation and what affect that would have on what or how you would negotiate.

Different companies may segment suppliers differently I decided to first identify how I’ve managed this form of segmentation in the past. My view is based upon the computer industry where products, and the materials used in those products had a life cycle. Those life cycles for production can be as short as six months. You have suppliers that are industry technology leaders who are usually first to market with new products and new technology (“leaders”). You also have companies in those commodities that I call "followers". I define "Followers" as usually being late to market with their focus on low cost to capture market share. “Leaders” are usually classified as strategic and get managed as strategic suppliers. “Followers” are usually classified as commodity suppliers. The key is not how they are segmented, the key is the risks involved and the potential future opportunity they bring.

As there can be the same performance risks between strategic suppliers and commodity suppliers, price and discounts are never the entire focus of at least the initial negotiation. Once you have an existing agreement in place with a commodity supplier, future negotiations may be more focused on just price and discount but that is seldom the only thing that gets negotiated. As you move further out in the product’s life cycle the “followers” may become more important. The reason for this is leaders may end of life the current product you have been purchasing moving to their next leadership product and you may be dependent upon the “followers” for product until you end of life your product or can use the “leader’s” new product.

When you segment suppliers and have developing and legacy suppliers, what you negotiate in terms of your contract should be no different. Again the problems they can create and potential risks and costs they can cause really aren’t any different than commodity or strategic suppliers. The difference you have between those two categories is normally the amount of time you spend managing them or the frequency of the negotiations. A true legacy supplier has been working with you so you don’t need to invest the same amount of time in managing them as a developing supplier that may just be starting to learn what is needed to be successful to grow a long term relationship. You may also have less frequent negotiations with legacy suppliers as the opportunity to reduce cost may be less.

The reason less frequent negotiations with legacy suppliers is without outside influences such as increases in demand, most product pricing follows price curves.“Leaders” who are first to market will set the price high. As more competition enters the market the price will be drive down. When there is maximum competition (especially from “followers” joining the market) you reach the lowest price. Leaders may exit the market to introduce their next leading product and that may create a shortage of supply driving the price up. ( see http://knowledgetonegotiate.blogspot.com/2011/09/price-curves.html )

Segmentation of suppliers is more for determining the amount to time and effort you spend with a supplier and can be a tool to prioritize the frequency of negotiations. It’s not a tool to determine what gets negotiated. What gets negotiated should always depend upon the risk. How frequently things get negotiated depends upon the opportunity.