The 2009 recession continues to have a profound impact on contract negotiations. Many companies are still adjusting to the new rules of negotiation that evolved during the recession.
After 2009, customers gained bargaining power simply by having business to offer their suppliers. Those customers demanded—and received—price concessions from their suppliers. The suppliers, by and large, did not reduce their service level agreements, though. While the customer was thrilled with the price concession, the supplier was not.
In some industries, suppliers gained the upper hand as competitors left the market or were acquired. Some customers suddenly realized they had fewer viable suppliers to choose from. The remaining suppliers used their power to increase prices (or maintain pricing while decreasing services) and may have also shifted some economic risk back to the customer, such as shortened warranty periods and caps on liability.
Over the last five years, companies and suppliers alike have seen shrinking margins, increased contractual complexity, and strained relationships. Research summarized in this white paper shows how these three trends will continue to shape contract negotiations. Those companies that can adapt their negotiation practices to meet these demands will thrive, despite an increasingly complex economic outlook.
Three forces impacting negotiations: Three new rules for negotiating
- Increased Price Pressures.
Negotiating aggressively to get the lowest—or highest—possible price is not new. What is new are number of customers initiating contract renegotiations to further reduce their costs. According to a study conducted by the International Association for Contract and Commercial Management (IACCM), 70% suppliers reported “major pressure” to renegotiate existing contracts to reduce customer costs.[i] Not surprisingly, procurement departments are driving renegotiations 49% of the time.[ii]
A more alarming trend, in my opinion, is that procurement faces a substantial internal obstacle: savings leakage. The Aberdeen Group found that 66% of companies had no formal process for measuring the savings generated by procurement.[iii] As procurement extracts savings from the supplier base, the internal end user fails to account for the savings. The end user actually spends the savings and sends procurement out to demand further cost reductions from the supply base to reduce their budget. But, without any internal process to document the savings internally, those hard fought savings are lost. In effect, those organizations look to procurement to get more savings again, and again. Personally, I find this troubling and demoralizing for both procurement and sales alike.
New Rule for Negotiating: Focus on Total Cost of Ownership and Away from Price
Price is reactive – cost avoidance is proactive. Procurement teams want price reductions without sacrificing value. The problem is that when all you can talk about is price you sacrifice value. A Fortune 100 company’s internal study found that it lost bids that were 12% lower than the bids it won.[iv] The higher bids that were accepted sold value, not price.
Let’s look at a common example of value and Total Cost of Ownership—printers. By now, we all know that printer ink is expensive. In fact, it can be more expensive over time than the upfront cost of the printer itself. Some inexpensive printers print a lot of pages per cartridge, some don’t. Those that print only a few pagers per cartridge have a higher Total Cost of Ownership over time.
If procurement looks only to reducing price, and has no mechanism for measuring savings, it will be forced to satisfy the immediate need to reduce spend, sacrificing any long term savings. Yet, when experts add in the Total Cost of Ownership into any equation, nearly all buyers will choose the slightly higher priced item with the lowest overall cost of ownership.
A procurement manager for an international consulting firm was desperate to reduce prices from her supply base. When I spoke to the procurement manager, I asked her how much of her spend was like going to a big box store. Meaning, she could push her cart down the aisle and buy any brand of product regardless of performance as long as it was the cheapest item in that category. She hesitated and said that “it was complicated.”
She revealed that many partners in the firm cared about what the firm bought. Partners cared about everything from paper to the phone service. More importantly, the partners had consulting relationships with all of their large suppliers. It was not so easy to simply buy cheap. What she had to do was establish the Total Cost of Ownership for many products and services that her firm purchased. She had to make the case that she was reducing spend by reducing the Total Cost of Ownership, even if that meant buying a slightly more expensive product.
- Increasing Contract Complexity.
80% of Business to Business purchases involve some sort of contract.[v] This fact startled me, even though I am an attorney. More telling, those contracts have become increasing sophisticated. Contracts typically contain rebates, chargebacks and intellectual property (IP) protection. [vi] It is common for contracts to encompass thousands of products, prices, incentives, compliance levels and other complex variables.[vii]
More importantly, non-lawyers are managing almost all of those contracts. That means each company (buyer and supplier alike) have to have personnel who understand U.S. contract law, supplier management and supplier integration. Companies are involving their attorneys in only the most sophisticated types of legal issues, such as IP or Indemnification. Consequently, non-attorneys are drafting contracts, and in some circumstances sending them to legal for review. There are usually circumstances in which no lawyer reviews the contract before both companies sign it.
New Rule for Negotiating: Design a Contract That Fits the Purpose
Make sure the contract says what you agreed to verbally. It is critical that your verbal agreements are properly documented in written form. While everyone cuts and pastes—yes, attorneys do it too—you must understand what you are contracting to receive and/or perform.
A lawyer with a Fortune 1000 legal department was preparing to sue a supplier for a breach of performance. After the matter had been referred to her, she began an internal inquiry. She discovered that the supplier was not contractually mandated to perform in the area that her company was claiming it breached. There were other services in the contract that the supplier was required to perform, and it was performing in those areas.
It will be extremely difficult for the Fortune 1000 company to prove non-performance. The supplier can and will rightfully show that it had an obligation to perform as per the contract and it performed according to the contract. Additionally, the Fortune 1000 company’s policy was to allow non-lawyers to draft contracts of a certain dollar amount. The contract at issue was written by a non-lawyer. The supplier is not performing and there is little the Fortune 1000 company can do because of the poorly written contract.
Best in class organizations consider contract management compliance to be one of the three most important competencies for procurement.[viii] That means that on the procurement side there will be at least one person, if not more, who is dedicated to measuring supplier performance against the contract.
- Declining Trust at the Bargaining Table.
An international study determined that trust between suppliers and customers declined by 44% between 2008 and 2010.[ix] As the economy weakened, negotiators fear that the “other guy” was out to get them increased.
Projection is a subconscious defense mechanism which attributes your character traits to someone else. The reasoning goes like this, “If I’m out for me, and you’re out for you, then you cannot be out for me, and I have to screw you before you screw me.” All of the platitudes about being “partners” flew out the window when the markets seized in 2009.
However, 80% negotiators surveyed by the IACCM said they believe in win/win negotiations, but it was the “other guy” who derailed their intent.[x] So, who is the other guy if it’s not you? I wonder how are we projecting our fears on to one another in a maze of competitive behavior that we all want to get away from.
New Rule for Negotiating: Increase Emphasis on the Relationship
According to IACCM research, “[…] the quality and depth of the customer-supplier relationship has a major impact on the outcome.”[xi] Trust is more than performing according to your contract, or negotiating with “integrity.” Since the recession, trust has taken on a slightly different flavor in business to business negotiations.
Trust is built on factors like speed, creativity, taking ownership and empowered decision making.[xii] More importantly, trust also comes from a willingness to share responsibility for risks and rewards. Therefore, building trust in this economy goes against the grain of competitive negotiation stances.
Account reps for a Fortune 100 company who collaborated with their customers developed greater levels of trust. This trust led to greater sales revenue, despite the fact that the solution sold was not the least expensive solution in the market. These successful account reps spent more time understanding their customers’ businesses, built strong relationships with internal (customer) stakeholders and had greater levels of customer respect. All of that trust led to sales, despite the economy.
Trust is built over time. So is a collaborative atmosphere. You cannot achieve collaboration’s rewards by wishful thinking alone. Your biggest obstacle will be your organizations ability to accept and implement a collaborative approach. Neither organization wants to lose control and neither wants to needlessly invest the time. While you cannot change the other person, you can change yourself. By changing the way you negotiate with the “other guy” you will improve your negotiated outcomes.
Get to We
The key to negotiating in this complex business environment is to Get To We, not just yes, with your partner. Just imagine what it would mean to your business if you could:
- Focus on “Total Cost of Ownership” and away from price,
- Design a contract that fits the purpose, and
- Increase emphasis on the relationship?
Many companies have. And, they are profiled in my third book, Getting to We: Negotiating Agreements for Highly Collaborative Relationships.
“A lot of people talk about collaboration but do just the opposite. Productive, collaborative conversations don’t have to be an oxymoron. Your book made a lot of sense to me.” J. B., Vice President Sales and Marketing.
Getting to We gives business people a very clear idea on how to develop highly collaborative, productive and creative relationships. The book has plenty of real life examples from companies who’ve turned relationships around, and it has questions to help guide you on your collaborative journey.
[i] Has the Economy Killed Collaborative Negotiation? Tim Cummins Velocity reprint. Vol II, No 3, 2009.
[ii] 2009 IACCM Report: Renegotiation
[iii] The CFO’s View of Procurement: Same Page Different Language, The Aberdeen Group. 2007.
[iv] Has the Economy Killed Collaborative Negotiation? Tim Cummins Velocity reprint. Vol II, No 3, 2009.
[v] Digging Out from the Contract Clutter, Andrew K. Reese. Supply & Demand Chain Executive July 2008.
[viii] The CFO’s View of Procurement: Same Page Different Language, The Aberdeen Group. 2007.
[ix] Lecture by Keld Jensen, principal at the Danish research firm MarketWatch. 2011.
[x] Has the Economy Killed Collaborative Negotiation? Tim Cummins Velocity reprint. Vol II, No 3, 2009.