Category Archives: Negotiations

If You’re Still Negotiating With the Carrot and the Stick …

… you’re not getting anyone’s attention but good ol’ Bugs. And, generally speaking, giving all the hijinks he causes, it’s best if his attentions are focussed on your competition.

So how should you be negotiating? With facts. Preferably binders of facts (but they can be in e-form on your tablet — no need to kill trees unnecessarily.)

Facts that show:

  • you know what the product should cost to make,
  • you know what margin should be healthy for the supplier,
  • you know what value-add services the supplier can offer more economically than you,
  • you know what performance metrics are reasonable, and
  • you know what the market offers are right now (and whether or not the supplier can beat them).

Suppliers don’t respond to sticks if they believe you really need them and they can get away with what they want, nor do they respond to carrot if other customers seem more enticing. Plus, they will wonder what crawl-out shelter you just climbed out of because no one from a modern organization negotiates like that anymore.

Especially if they are a typical sales organization that is all about the relationship (and talking win-win even if their definition of win-win is win for the organization, win for them at bonus time) or a more modern, Gen-X led, millennial-influenced organization that’s all about the synergy.

In the first case there will be value pitches followed by claims no one can do what they do as well and lots of smooth talk to get you off guard for when they indicate that their price (even if it has a margin that is twice industry average) is really as good as it gets and the latter will try to entice a deal from the synergy.

But regardless of organization type, every organization will respond to fact-based negotiations. With fact-based negotiations, they can’t hide fat margin behind claims of high cost, high-value, or synergy as the only way they can dispute your models, metrics, and market insight is to provide their true costs (or own research from third parties if they expect their costs to rise over the expected contract term).

And the above isn’t that hard to gather. It might take some elbow grease and a category expert, but once you’ve built the proper model and identified the proper data sources, it’s quick to update.

All you need for a fairly accurate should cost model is:

  • the bill of material break down
  • the typical energy required to produce one unit (kWh)
  • the typical labour required (labourer hours by labourer type)
  • the average industry margin

If it’s a contract manufactured product, you have this, if not, you can get an industry expert to help you craft a typical bill of materials. Your current supplier, or an industry expert, should be able to roughly estimate the typical energy overhead (based on typical production process). Similarly, your current supplier (or industry expert) should know average labour requirements against the production line.

All that’s left is understanding the acquisition cost of the materials, energy, and labour. Most raw materials are traded on exchanges, so it’s easy to get an average market cost. Most countries either have electrical utilities as state owned organizations or as highly regulated private organizations with standard prices per kWh. And most countries or labour bureaus compile average labour rates. Industry insight gives you standard margins, and you can see it’s not hard to build a reasonably accurate should cost model with expertise and elbow grease. And since the only way for a supplier to challenge it is to provide their costs, you can get even the model more accurate if their costs are actually higher. (And if they don’t challenge your model, then its relatively accurate or their costs are actually lower. In the latter case, they might get a bit more margin than you want to give in negotiations, but chances are you’ve lowered your cost as well with the model.)

This just leaves an identification of what services they can likely offer more economically, which again comes down to good modelling, and performance metrics (along with cost / profit impacts), which you should be gathering across your supply base. Then you can negotiate for better performance metrics (with penalties if they are not met) with an incumbent that isn’t doing as well as they should and wants to keep the business, or baseline metrics with a new supplier that wants the business based on current average performance across the supply base for the metric in question.

So gather your facts, and give yourself a true edge in negotiations.

The More Things Change … Negotiations

Ten years ago we posted timeless principles to steer you through negotiations and, looking back, they truly were timeless. Each is as true today as it was then as they were a decade before we summarized them.

Negotiating is not about dividing up a limited pie in ways that are divisive. It is about making a bigger and better pie.

If each side sees the pie as small, then each side is going to want a bigger piece of that pie. But if the pie is large, both sides will be happy with a piece that is about half.

Conflict is at the heart of negotiation but only a positive view of conflict will result in a successful outcome.

Both sides must believe that a resolution will occur that both sides will be happy with.

There is a time to speak and a time to shut up in negotiations. When you do more listening than speaking, you actually increase your power.

If you don’t understand what the other side wants, really, really wants, then how do you know what you really need to give up and what you don’t? After all, you must

Recognize that you will only reach agreement by understanding the deeply-held needs of the other side.

Both sides make a lot of demands, but at the end of the day, only a few of the demands will generally be non-negotiable.

In power negotiations, when the stakes are high, let the other side believe what you or they want them to believe. But don’t lie or be dishonest.

If you can distract them away from what the biggest value is to you, it might help.

You can only succeed in negotiations with a win-win attitude.

As per our first point, you have to be focussed on enlarging the pie so you can divide it up in a way that both sides see a win.

Negotiating is an essentially human way of interacting.

That’s why you will get to keep your job when Procurement bot takes over inventory, re-ordering, spot-buying, and the vast majority of your job.

Are Your Suppliers Ripping You Off?

A recent post over on the public defender‘s blog asked if suppliers [are] still ripping us off. And it’s a good question, because it’s a common, constant, fear that is never talked about. Not only is it often the biggest elephant in the room, but it’s the biggest herd of elephants as there’s typically one in every room of every buying organization.

But rather than asking an array of speakers what their thoughts are, we’re going to get right to the point and give you the answer, which, surprisingly, can be summed up in six words.

That depends, are you letting them?

While your job in Procurement is to get the best damn deal you can, keeping costs as low as possible while keeping the benefits high to maximize value, the sales person’s job who is selling to you has, as their job, to get the most amount of money for the least amount of product and service, maximizing their profit and, more importantly, their bonus (which is typically 100% tied to the order value).

If you don’t do your homework and establish the true market price or true should cost price, then its likely that they can convince you that a 3% decrease on their current price (which is 30% over should-cost) is a savings and you walk away thinking you won when you are still being ripped off big time. We have to remember why so many suppliers were, and in some case, still are, resistant to e-Auctions — because these expose fat in supplier margins faster than any other sourcing exercise when you invite new, hungry, suppliers who will lower their margins just to win business.

In certain verticals, such as electronics and office supplies in particular, most suppliers make their profit by charging you as much as possible, which they do by offering you great prices on a small set of products and markups on a large set of related products that your users are just as likely, or more likely to order. For example, an office supplies vendor will give you the best deal on the 5 park of laser cartridges but the 10 pack will be 3 times the cost of the 5-pack, and the office manager, wanting to minimize orders, will order the 10-pack not knowing the 5-pack is the preferred product. And in electronics, they’ll give you a great deal on system configurations that sound good, but are sub-optimal, and then make money on upgrades a year later. For example, a desktop with the brand new processor, lots of space, and a HD screen, but only 4 MB of RAM when they know the default usage means that the machine should really have 8 MB of RAM. But there are only 2 slots, so both chips will have to be replaced at full retail rates down the road (as no special pricing was negotiated on upgrades, only full system replacements).

But it’s not just your indirect and MRO suppliers that will pull a fast one, any sleazy salesperson who sees an opening with a buyer who didn’t do their homework will pull a fast one. So if you don’t do your homework, and negotiate fact based, your organization is probably getting ripped off. Even if the costs are close to what they should be, chances are lack of hard fact-based negotiation means you missed out on value adds.

In summary, This Song’s Just Six Words Long, and whether or not you get ripped off is entirely up to you.

Anchoring Doesn’t Have to be a Problem …

… or even a concern, if you approach negotiations in a fact-based manner, instead of a seat-of-your-pants manner, like most negotiations are approached.

What are we talking about? We’re talking about the tendency for us to fix our thoughts around a particular number, point, or fact rather than thinking logically and independently about a decision. In particular, the fixation that occurs when people consider a particular value for an unknown quantity before estimating the quantity. From that point on, the estimates then stay close to the number considered, even if the estimate is way, way off. The absolutely proven phenomenon discussed in detail in the public defender‘s recent pro piece over on Spend Matters + on how to hone your procurement negotiation skills by learning the right way to think (fist part free, full article requires membership).

Anchoring happens if you begin your negotiation or event with a price that is based on current price, a recent supplier quote, a market index, or some other number that may or may not have any basis in reality. Anchoring is avoided if you start with a price that is based on a should cost model, for a product, or an amalgamated index by a large analyst firm or statistics bureau for services category.

The should cost model should be based on a detailed cost breakdown that takes into account raw material costs (at market indexed rates), average labour costs for a region, average overhead costs, and any advances in production technology. A current cost, a current market cost, or even a project cost from a trusted supplier is not a should cost – and negotiations should ALWAYS be based on should cost. It might seem a waste of time for a product you’ve sourced ten times over the past ten years, or a service that you’ve paid the same rate for from three different manpower suppliers over the past three years, but that’s a very small sample of the market price at large, or the should cost price.

So do a detailed should cost model (or, for a service, detailed market research and break it down against average salaries available through a number of portals, augmented with standard contractor / manpower / outsourcer mark-up) and start your negotiations around that reasonable, logical, point — even if it’s half of what the supplier is quoting. Remember, you can scream that they take their unreasonable cost off the table or you walk because you can say “look, I have a should cost model right here that backs up the reasonableness of my number — so we’re starting within 20% of this and adjusting as necessary, or we’re not starting at all”.

Buy, Buy, Buy, Once Bitten Twice Shy

Many procurement functions and executives see price negotiation and reduction as the primary element of their role. In doing so, they run the risk of missing out on the major benefits that can be obtained by focusing on other aspects of the wider value picture.
Full Value Buying: Moving Beyond Price Negotiation, Peter Smith & Jon Milton, 2015

Why? Is it because they think price trumps all? Is it because they don’t think there’s value in non-price factors and services? Is it because they once focussed too much on the bigger picture, didn’t do their homework, greatly overpaid, did not realize any savings, got hung out to dry, and are now once bitten, twice shy? And does it really matter?

As SI has been proclaiming for years, it’s not TCO (Total Cost of Ownership), it’s TVM (Total Value Management). It’s not how much you pay, it’s the return you receive. As Finance will tell you, it’s all about the ROI. Paying a bit more for a value-added service from the supplier that saves you money is a good return. Paying a bit more in a dual-source strategy to large suppliers with high-volume production lines to prevent otherwise likely stock-outs is often the best insurance policy you can buy. And paying a bit more to use a supplier you are certain does not use child labour, does not subject its workers to poor working conditions, and does not use conflict minerals, banned raw materials, or illegally obtained goods and services costs a lot less than the PR nightmare and lost sales that could result from a brand scandal.

But these are just some ways to increase the value of a purchase. In Mr. Milton and Mr. Smith’s latest paper on Full Value Buying they describe techniques, such as specification improvement and demand management that can generate returns above the 10%+ that an organization can typically save through skillful spend analysis or decision optimization (which are the only two traditional sourcing techniques that generate consistent year-over-year savings in the double digit percentages).

In the paper they address four major mechanisms that can affect the cost of a buy and the upper bound on cost savings that each factor can traditionally bring:

 

Mechanism Saving Potential
Purchase Price (TCO model) 20%
Specifications 30%
Whole-Life Factors 50%
Demand 50%

 

These numbers may seem high, but consider the following. Changing the specifications slightly to allow a lower cost material to be used which can also be used in a more efficient (and cost effective) production process can easily shave 50% to 90% off of 40% (or more) of the cost if a (rare earth) metal that costs $50 an ounce is replaced with a metal that costs $10 an ounce. Changing the design that allows the product to be easily disassembled and valuable metals recovered (upon forced recovery subject to environmental disposal laws) can turn a losing collection business into profitable recovery one. Buying Accounts Payable and Marketing extra monitors so they don’t have to print PDF invoices to enter them or documents they need to reference when composing project specifications can cut organization paper demand by over 50%. And these are just a few examples.

the doctor strongly encourages you to check out Mr. Smith’s (co-authored) latest piece for more details on how these mechanisms can be applied across a range of categories to not only bring costs down, but even value up to the organization. After all, he went to Washington. (Figuratively and literally.)