Charles Dominick of Next Level Purchasing and Soheila R. Lunney of Lunney Advisory Group recently released The Procurement Game Plan: Winning Strategies and Techniques for Supply Management Professionals. In our first post, we set the stage with The Purchasing Professional’s 10 Commandments. In our second post, we covered the first four chapters of the book that discuss organizational role, supply management strategy, talent, and social responsibility — the stage that a modern supply management professional has to act upon. In our last post, we continued our detailed review with a discussion of the chapters on strategic sourcing and supplier qualification. This post begins our discussion on the chapters on negotiations, and our next post, which will complete our discussion on negotiations, will conclude Part II of our review.
The first chapter on negotiations is on negotiating with suppliers: jockeying for position. This is important, because if your instinct is to take the advice of Meatloaf and “go on the red … go on the green … go on all the colours that you see in between … run all the tolls … run all the signs … run all the way across the double white line” as you jockey for position, you’re doing it wrong. (Peel Out by Meatloaf) The first step — after the issuance of an RFP, the receipt of the responses, and the initial evaluation using a weighted scorecard — is to select which suppliers to negotiate with. As the authors note, if you decided to negotiate with a supplier, than all suppliers who ranked higher must also be negotiated with as to do otherwise would not be ethical (and we’ve already covered how important ethics are).
Then, the authors describe a process for structuring the ultimate contract and this is a good starting point. The steps suggested are:
- Identify the best deal for each service/product and term
Best price, payment terms, warranty, lead time, etc.
- Structure the Ultimate Contract on paper
Based on the best terms available for each service, product, and term, what would the ultimate contract look like? This is the overarching goal.
- Decide what could be sacrificed and what an Acceptable Contract Is
Realize that no supplier is going to be so efficient that they are best-in-class in every service, product, and term and decide what contract would be acceptable. Once this is reached, negotiations can be concluded once you have determined that the supplier will do no better.
- Put Yourself in a Confident, Ethical Mindset
Now that you know what is feasible, you can ask for more from the best / preferred bidder because you know at least one supplier can do it. You don’t have to disclose the supplier (as doing so would be unethical), but you can disclose the best offer you got.
The only thing I would add is create a BATNA – Best Alternative to Negotiated Agreement – that you could fall back on should the negotiations be unsuccessful. This way, you will not be under pressure to cave in to a less than optimal contract AND you have a disaster recovery plan in case the supplier that is selected can not deliver. For example, it could be spot-buying every three months, giving the business to an existing supplier (who may not be best-in-class in those products or services or slightly more costly but a supplier that has proven that it will do what is necessary to deliver), or shifting the production / service delivery back in house.
The next topic that is tackled is structuring payments. There are some great ideas in this section, particularly the one on spreading out big up-front payments (like license fees) over multiple years to insure the supplier has an incentive to keep performing, but the example provided is, unfortunately, very bad!
The example the authors give is that of a three-year contract from an (enterprise) software provider for a license to an enterprise software product, implementation of such software, and three years of maintenance. The authors recommend spreading the big up-front licensing fee and implementation fee over three years, which is a great idea, but suggest that you do this by reducing the licensing fee and increasing maintenance. ACK!!! As an enterprise software professional, this scares the bejeebies out of me! (My initial reaction was ZOINKS!) When it comes to enterprise software, due to the high up-front investment and asset value, once a solution is selected, the enterprise always ends up hanging on to it for well beyond the initial projections. This means that the enterprise ends up paying maintenance fees for years beyond the initial depreciation of the asset. And the way maintenance fees work is that the provider always tries to jack them up on renewal by a good 10% to 20% a year. So if you double, or triple, maintenance fees, then you can expect to be paying those inflated fees for the lifetime of the software as these fees are never lowered. So, if the software was used for six years, instead of three, in the authors’ example, and the organization miraculously managed to hold the maintenance fee flat, instead of having a total cost of $372,000 over six years, your organization can expect a total cost of $492,000 over six years! Consider the following tables:
But if you structured it as a three-phase license fee and implementation fee, the costs wouldn’t change. You would end up with something that looks like this: