Planning is most important in any negotiations process. Without thorough planning, supply management professionals:
- Are unlikely to know their negotiation position.
- Are unlikely to anticipate what the other party is likely to do or to understand what motivates the other party.
- Are unlikely to know what results or goals they want to achieve.
- Will be unable to respond realistically to the other party’s proposals.
- Will not know whether the negotiated agreement is reasonable.
Eloquence in presenting any specific position is of little value when the planning and preparation underlying that position are weak. An effective supply management professional will spend an appropriate — and often significant — amount of time preparing for negotiations. The supply professional should review the buying organization’s strengths and weaknesses, as well as those of the supplier, and compile this information into Porter’s five forces (Porter 1980) and SWOT analyses. The ISM Glossary (6th edition) defines Porter’s five forces as: the extent and intensity of direct competition; the threat of entrants; the threat of substitute products and services; the power of buyers; and the power of suppliers. SWOT is an acronym for strengths, weaknesses, opportunities and threats. By creating a list of areas to be studied, the supply chain management professional can systematically evaluate all the issues that will impact the outcome of negotiations.
The first item in a negotiation plan should be to conduct an in-depth analysis of the supplier’s proposal. Evaluate price, delivery, specifications, statements of work, terms, and any deviations from your requirements. Thorough knowledge of the supplier’s proposal can be an advantage at the bargaining table. Keep in mind that the supplier’s proposal is usually the beginning point for negotiations (the supplier’s optimistic position).
The next item in the negotiation plan should be to set objectives. Is the goal a lower price, higher quality, an accelerated delivery schedule — or a combination of these? Where do the parties have mutual interest? What type of position will each party adopt in the negotiation? In any case, the negotiator (or negotiating team) should draw up a specific plan and should work toward the plan. If a negotiating team is involved, a team leader (usually the supply management professional) should be selected, and all team members should be briefed on what and what not to say. Generally, team members should respond only to those questions that lie within their own areas of expertise.
1. Negotiation objectives
1.1 Fair and reasonable price
Cost control, a major consideration in all supply management departments, will probably be an important objective. However, there are other critical issues, such as good quality, on-time delivery, and security of supply to consider. The negotiator should not reduce the price so low that the supplier will lose money. It is important that the supplier can cover its costs, make a reasonable profit, and be comfortable with the outcome. The supply management professional may have the power in this negotiation, but if conditions should change, the supply professional might be at a disadvantage. It is best to seek a price that is fair and reasonable to all parties. Further, you may want the supplier to make improvements or add capacity in the future.
1.2 Timely performance
The negotiated agreement should cover important performance issues, including shipment of the specified product according to the production plan or delivery of the service according to the statement of work. Because it minimizes inventory, a just-in-time approach, with good, quality products and services arriving just as they are needed, is the ideal.
1.3 Meeting the minimum essential needs of the organization
One objective of negotiations may be to meet the needs of the buyer’s organization with respect to purchased products and services. If the buying organization has a shortage of necessary commodities, components or services, the supply management professional’s job is to secure an adequate supply from an acceptable supplier. In such a case, the supply professional is not negotiating from a position of strength. The only hope is that the volume of the order will be attractive for a long-term commitment, and that the buying organization is a valued customer. The supply management professional can then assure the supplier that, if it provides the needed product or service, the buying organization will continue to do business with the supplier in times when supply is plentiful.
1.4 Defining must-haves and wants
The supply management professional leading the negotiation team should determine which items are mandatory needs for the organization — the “must-have” items — and which items are “wants.” The wants are items that are not mandatory, but would be nice to have.
1.5 Positions vs. interests
During negotiation, you need to consider your positions and interest as well as the positions and interests of the supplier. In negotiation, the focus often is on the things you want, which are referred to as positions. Interests are the underlying reasons why you want the things that you do. For example, you have a maximum price that you cannot exceed (the position) because this is your annual budget (interest — staying within the budget). The supplier also has positions and interests. By considering these during planning, you may be able to identify creative ways to address the underlying interests of both organizations.
1.6 Control over how the contract is performed
Performance issues should always be clearly defined in the contract. In the planning period, the supply management professional should list all issues that might cause performance problems, and review the steps that should be taken to resolve each issue before problems occur. The consequences of inability to perform as agreed, cancellation clauses, penalties and incentives, and costs should be spelled out in detail. The responsibilities of all parties should be made clear.
1.7 Service level agreement metrics
Service level agreements define the service, set performance expectations, describe how to perform the service, performance metrics, and how the performance will be measured (ISM Glossary 6th edition). The metrics should be directly related to the performance requirements. In addition, negotiations should address the actions and consequences when the expected performance is not met.
1.8 Maximum supplier cooperation
One important objective in a negotiation session is to avoid creating an adversarial atmosphere. The best outcome is a mutually satisfactory agreement between the buying organization and the supplier, where the parties are comfortable with each other and look forward to doing business in the future.
1.9 Sound relations with suppliers
All parties must be able to operate profitably under the terms of the agreement. The supply management professional and the supplier should schedule regular, frequent communication to establish and maintain a positive relationship. Each party should strive to appreciate the other’s perspective. Problem-solving should focus on achieving mutual satisfaction, rather than “win-lose.”
1.10 Negotiation site
It is sometimes best to conduct negotiations at the buying organization’s location. The supply management professional will be most comfortable there; will have all needed data, backup and support; and can essentially control the negotiations. The supply management professional’s stress will be lower, travel fatigue will be eliminated and confidence will be higher. On the other hand, negotiations at the supplier’s site give the supply management professional the advantage of being able to walk away.
Regardless of the negotiation site, wise negotiators pay close attention to security. Experienced negotiators know that they (and their team members) must be careful about what they discuss in public places, must pay close attention to the security of work notes, and must make sure that confidential material is secured. Concerns regarding security apply to both domestic and international negotiations.
- 1.11 Team selection
In some situations, negotiations can be performed by a single person. In other cases, it is best done by a team. A team approach is appropriate when the product or service is complex, and one person does not have sufficient knowledge of all issues. Team members typically represent the functional areas to be addressed in the negotiation process. The team should consist of representatives from supply management and the other departments involved, such as legal, engineering, quality assurance, operations, accounting, and marketing. The supply management professional should ensure that team members understand their individual roles, can work well with the other team members and can support the team leader, even if this means sacrificing their own opinions. Disagreements among team members should never be expressed in the presence of the supplier.
Regardless of the size or makeup of the team, meetings should be held to discuss goals, to plan strategies, and to review the strengths and weaknesses of both sides. A team leader (usually the supply management professional) should be selected to guide the team and to chair the pre-negotiation meetings. The leader should be the main point of contact between the buying organization and the supplier, and should arrange times and locations for the negotiating sessions.
An important aspect of team negotiations is the caucus, a planned or unplanned break in negotiations that gives the negotiation team an opportunity to discuss its strategy, tactics or progress before proceeding. The caucus should be used immediately when disagreement, confusion or misunderstanding occur within the negotiation team.
The caucus may also be used to slow down momentum if negotiations are not going well or to create a pause that causes the supplier’s team to caucus as well. The caucus should be used routinely during negotiations, so that the calling of a caucus does not provide any signals to the other party.
3. Relevant information of Negotiation (e.g., proposals, learning curves, backgrounds of players, social media, price-performance expectations
All information that might have a bearing on the negotiations should be collected and analyzed. Some areas of importance include the following:
- Negotiation objectives.
- Cost data.
- Financial reports on suppliers.
- Records of previous negotiations.
- Market information.
- Financial strength of the supplier.
- Supplier mentions in social media applications (for example, commenting on the supplier’s reputation, quality and image, potentially also including reports of the supplier’s previous customers).
- Strengths of both parties.
- Weaknesses of both parties.
- Price history.
- Expectations of future price developments in longer-term contracts (for example, yearly price-reduction efforts due to learning curve and efficiency effects, tying the price to market indices).
- Quality history.
- Specification or service delivery issues.
- Negotiation styles and personalities of those with whom the supply management professional or team will be negotiating.
- Time available
- Delivery history.
- Security, risk history and issues.
4. Analysis of seller’s and purchaser’s positions
The supply management professional or negotiating team should undertake a thorough study of the supplier to ensure the supplier’s position, and strengths and weaknesses are understood. It may take weeks to assemble all the necessary information, but this is time well spent. The negotiating party that does the most homework will usually achieve the best results. Below are specific topics worthy of investigation.
4.1 Seller’s desire for a contract
An important factor to evaluate before entering into negotiations is the supplier’s degree of desire to sell to the buying organization. Market conditions may be in the supplier’s favor, the supplier may be in an industry with limited competition, or the supplier may have a patented feature, making the organization unwilling to commit to certain requirements. However, the reverse may also be true. An adequate supply and plenty of competition may motivate the supplier to work out a contract more favorable to the buying organization.
4.2 Seller’s certainty of getting a contract
It is important to know the market, the supplier and the product. Is the market tight or is supply plentiful? What is the market likely to do in the immediate and distant future? Is the supplier a leader or a follower within the industry? What can you learn about the supplier’s cash flow? Is the supplier in sound financial condition? Is the product strong, or is it likely to be replaced by more innovative products? Are new producers entering the industry with newer plants, services or lower costs? The supplier’s desire for a contract and its perceived certainty of getting it will both affect and depend on the relative strengths and weaknesses of the supplier and the buying organization at the time of the negotiation.
4.3 Amount of time for negotiation
The amount of time available for negotiations will have a definite impact on their outcome. A deadline puts pressure on both the buying organization and supplier, but few deadlines exist that cannot be extended. The party most severely affected by time constraints will give up negotiating strength. On the other hand, ample time for an extended negotiating session may result in substantial gain.
Both the purchaser’s and the supplier’s alternatives will change depending on the amount of time available for negotiations. Supply management professionals should allow themselves sufficient time to negotiate from a position of strength. During international negotiations, cultural differences regarding the importance of time may result in substantial disadvantages for those who do not provide sufficient time for negotiations.
4.4 Adequacy of cost/price analysis
The ISM Glossary (6th edition) defines quotation as a statement of price which may be given in response to a request or otherwise. A quotation may or may not be a legally binding offer. Quotations are accurate and reliable ways to determine the existing market price.
The ISM Glossary (6th edition) defines price analysis as the examination of a supplier’s price proposal or bid by comparison with reasonable benchmarks, without examination and evaluation of the separate elements of cost and profit making up the price. Price analysis ensures that the price to be paid is reasonable in terms of the market, the industry and the end use. This important step should be taken before entering any negotiations.
The ISM Glossary (6th edition) defines cost analysis as an evaluation of actual or anticipated cost data (material, labor, overhead, general and administrative, and profit). Some buying organizations require suppliers to share actual costs in their bids or proposals. In other cases, suppliers will be unwilling to release information about costs, but with persistence, the supply management professional should be able to gather some information. Useful estimates also may be developed based on accounting analysis, engineering analysis and industry data. Experience, knowledge and judgment are used to estimate reasonable contract costs, which are the basis for buyer-seller negotiation to arrive at mutually agreeable contract prices. Cost analysis identifies unnecessary costs that can be eliminated.
A price history file is another valuable resource. The frequency and percentage of increases or decreases in past periods may enable the supply management professional to project future changes
4.5 Best alternative to a negotiated agreement (BATNA)
The buying organization’s negotiating strength will be greater if the supply management professional has other options available. These options, the next best alternatives to reaching agreement, are commonly referred to as Best Alternative to a Negotiated Agreement (BATNA). If it is possible to purchase from other sources, if there are suitable alternative products or if the products or services can be produced in-house, the supply management professional can negotiate from a position of increased strength. In addition to identifying its own BATNA, the buying organization should also construct the supplier’s BATNA, and then determine how to make the buying organization’s BATNA more attractive than the seller’s BATNA.
Of the three types of alternatives — alternative sources, alternative products and in-house production — alternative sourcing is usually the simplest to pursue, because it may involve only minor differences in a product. The supply management professional should make a careful examination to ensure compatibility and acceptability.
Alternative products or services may involve extensive evaluation, engineering studies or consultations with the internal customers for the service provision. Internal production of a component or delivery of a service may involve capital investment, additional personnel, and the development of additional in-house skills.
4.6 Zone of possible agreement (ZOPA)
An important aspect of preparing for negotiation is to develop a negotiation range for all factors that are to be negotiated. Optimistic, target, and pessimistic levels should be set. For example, for price, the optimistic level might be an estimate of the supplier’s cost, the target is the goal, and the pessimistic level might be the maximum of your budget. The supplier’s negotiating team will also develop similar ranges. It is likely that the buying organization’s optimistic level will be lower than the supplier’s pessimistic level and that the supplier’s optimistic level will be higher than the buying organization’s pessimistic level. However, the ranges should overlap as shown in Figure. The overlapping area is the zone of possible agreement (ZOPA), and the final agreement will be within this range. If there is no overlap of the buying organization’s and the supplier’s ranges, then an agreement is not likely.
4.7 Seller’s competitive position (e.g., sole source)
The supplier’s negotiating power can be strengthened in several ways. The supplier may be the only source for a commodity or service, or it may operate in a limited competitive market where there are only one or two sources. The supplier may have a patented design or feature, or it may merely be the closest producer from a transportation and delivery standpoint. The supplier may have a higher quality product, have better engineering support or have better production capacity for the buying organization’s needs relative to its competitors. The supplier may be the only supplier willing to deal with small volume. Additional sources of bargaining power for the supplier are superior customer service, low reject rates, comfortable payment terms, and a good delivery or performance track record.
4.8 Skill and authority level of the negotiator/negotiation team
What makes a skilled and effective negotiator or negotiating team? Several studies have shown that the following 22 characteristics are helpful:
|Planning ability||Ability to gain respect|
|Desire to achieve||Problem-solving ability|
|Competitiveness||Good knowledge of human nature|
|Persistence||Ability to consider others’ ideas objectively|
|Insight||Ability to listen|
|Self-restraint||Clear, rapid thinking ability|
|Patience/tolerance||High tolerance for ambiguity|
|Verbal clarity||Recognition of the importance of training and practice|
- Professional negotiators agree that planning ability, a high tolerance for ambiguity and a desire to achieve are the most important characteristics of a negotiator.
- Seller’s financial condition — All supply management professionals should be able to read and interpret financial statements within the context of the organization’s industry, and be able to interpret the significance of changes in financial statements over time. In many situations, it is a good idea to consult with the accounting and financial staff to evaluate a potential supplier’s financial condition.
Financially strong suppliers may be less likely to agree to conditions that are unfavorable to them. However, suppliers in a strong financial condition are more likely to be able to fulfill their contractual agreements. Negotiations with a supplier in a weak financial condition should be approached with caution. It does little good to negotiate favorable prices, delivery and service from a supplier that may not have the financial ability to deliver as promised. In some situations, a supplier in an unfavorable financial condition may offer potential, if its financial condition and risks of supply interruption are closely monitored. However, this increases the costs to supply management.
- Buyer’s financial condition — An organization in a strong financial condition is in a better position to negotiate than is an organization in a weak financial condition.
- Other conditions of buyer or seller — Other relevant factors should be considered when planning for negotiation, including the long-term plans and objectives of the buyer, which may mean that a seller should have the potential to grow with the buyer. For example, the supply management professional may have the objective to leverage the seller’s capabilities for the development of innovative new products, which may lead to the development of joint ventures.
The relative location of buyer and seller may also come into play, as a greater geographical distance between the parties may lead to increased transportation costs and decreased flexibility. Closer suppliers may have an advantage over more distant ones.
Buyers may also want to diversify the location of their suppliers to minimize the risk a natural disaster in a specific region can have on the ability of the supply base to deliver.
- Market and product conditions — All things being equal, a seller’s market (demand exceeding supply) gives the supplier a negotiating advantage, and a buyer’s market (supply exceeding demand) gives the negotiating advantage to the buying organization. However, many negotiations are conducted within the context of the overall, long-term relationship between the supplier and the buying organization. Short-term market conditions may give one of them an advantage, but both should realize that taking excessive advantage of market conditions for short-term gain might lead to long-term problems.
- Development of negotiation strategy — Negotiation planning should address three areas:
- Strategic planning concerns the long-range goals of the organization. Strategic planning requires the negotiator to select sources that will optimize attainment of the overall objectives of the buying organization. This type of planning requires knowledge of product market mix; customer and environmental constraints; and the basic goals of the organization concerning technology, price and policy.
- Administrative planning concerns the logistics of getting people and information in place for the negotiations.
- Tactical planning involves achieving optimal results at the bargaining table. It includes setting goals and evaluating the strengths and weaknesses of the other party. For effective tactical planning, a careful study should be made of issues, problems, agenda questions, concessions, commitments, promises, pricing, quality, and delivery performance.
Identify appropriate tactics — A team leader should be selected, and negotiating tactics should be reviewed and discussed. The negotiator or team should plan timing, ways to exploit strengths and weaknesses, and how to use delays and deadlock tactics.
- Cultural factors — Cross-cultural negotiations typically occur between parties of different nations. When conducting cross-cultural negotiations, the supply management professional’s ability to understand the culture of the other party can reduce the number of misunderstandings that inhibit negotiations. Adequate preparation is crucial to cross-cultural understanding. Once both parties understand the other’s culture, communication will improve and negotiations will proceed with fewer misunderstandings.
- Fallback alternatives — When preparing for negotiations, consider that give-and-take is a normal part of the process. If both parties establish inflexible positions for each negotiating point, there will be little opportunity to confer, discuss or bargain to reach an agreement. When preparing for negotiations, the supply management professional (or the negotiation team) should identify optimistic, target and pessimistic positions for each issue. The supply management professional (or negotiation team) should also estimate the optimistic, target and pessimistic positions of the supplier. As negotiations proceed, the supply management professional can assess progress on each issue and on the total package. In some instances, the supply professional may agree to less than the pessimistic position on one issue, if the supplier makes concessions that exceed the optimistic position on another issue. Adequate planning enables the supply management professional (or negotiation team) to anticipate the supplier’s position, to anticipate changes in the supplier’s position and to respond effectively to unexpected changes in the supplier’s position.
Developing a Negotiation Plan
Successful negotiations require planning and preparation. When LG Electronics (LG) prepares for a negotiation with Qualcomm Inc. (one of its key suppliers), the negotiation team spends time gathering market data, analyzing positions, and examining cultural issues because LG is based in South Korea and Qualcomm is in the United States. Time should be spent reviewing the buying organization’s strengths, weaknesses, opportunities, and threats (SWOT analysis), as well as those of the supplier. By creating a list of areas to be studied, a supply management professional systematically evaluates all the issues that will have a bearing on the outcome of the negotiations.
Key Elements of the Negotiation Plan
Four key elements, when integrated, will lead to a well-prepared negotiation plan, as shown in Figure. Of the four elements shown, the supplier’s proposal and the negotiation objectives have the most direct impact on the plan.
Establishing Negotiation Objectives
The first step in the negotiation process is to establish negotiation objectives. For a sourcing negotiation, the internal customer’s requirements, as specified in the RFQ/RFP and their relative importance to each other, provide the starting point for setting negotiation objectives. When setting objectives, it is prudent to consider all the external and internal stakeholders that will be affected by the negotiation’s outcomes. You should work with internal stakeholders to understand the priority of the requirements and how much flexibility there is in each. Some of the objectives are mandatory or “must haves.” Other objectives are “wants,” which would be nice to have but are not essential to the buying organization.
The objectives, what your organization needs and wants, are referred to as positions. However, it is important to understand your organization’s interests, which are the underlying reasons and motivations behind the objectives and their priorities. For example, your position may be to reduce the purchase price by 10 percent. The underlying reason, an interest, is to reduce costs to meet next year’s budget. By focusing on the interest of reducing costs rather than reducing price during the negotiation, you may be able to collaborate with the supplier to find a different solution. Perhaps the supplier is willing to deliver more frequently, reducing your organization’s inventory costs while maintaining the current price.
Although procurement negotiation objectives vary from one setting to the next, there are often some commonalities. Objectives should be set with a long-term perspective. Short-term gains might jeopardize the supply management organization’s long-term reputation or the fundamental relationship with a supplier. Short-term gains may be important, but those that might cause potentially longer-term, negative effects should be avoided. Four of the most common objectives are introduced in this section.
Fair and Reasonable Price. Cost control is a major consideration for all supply management professionals, and generally ranks high on the list of criteria in a negotiating plan. However, cost is not the only factor. When setting objectives you must consider other critical issues such as good quality, on-time delivery, stability of supply or the stable provision of a critical service, supply chain risk, technology, and innovation. The goal should be to attain a fair and reasonable price given the overall bundle of needs. Do not drive the price so low that the supplier is selling below its actual costs because this increases risk. The supplier should be able to meet its costs; otherwise, it may encounter financial problems and may not be able to provide the product or service over the long run, in turn possibly disrupting supply. Being fair and reasonable in negotiations can foster positive supplier relationships that can be beneficial, especially in situations of tight supply.
However, it is often reasonable to expect the supplier to reduce prices over the life of a long-term contract, especially for new products or services. As sales increase, the supplier gains experience, so the learning curve may result in lower labor costs per unit. Also, with higher sales volumes, the supplier may be able to use more efficient processes or get quantity discounts because its suppliers have reduced costs.
Nokia found that fairness in negotiations paid off in the long run. Both Nokia and one of its major competitors were sourcing a critical part from a Japanese supplier. Nokia had a good reputation as a fair customer with this supplier, while the competitor did not. When the part this supplier was supplying became a limited commodity, the supplier ended up shifting all its production to Nokia and nothing to the other organization. The other organization, a well-known cell phone manufacturer, never recovered. Thus, it is best to seek a price that is fair and reasonable to all parties and treat each other with respect.
Timely Performance. The negotiated agreement should cover shipment of the specified product according to the production plan or delivery of the service according to the statement of work (SOW). The supplier should be advised that it will be measured against delivery performance metrics, such as days early, days late, and number of complete orders, and that a tracking system will be in place. The specific performance metrics depend on the internal customer’s requirements. The intent is to motivate the supplier to perform well. The supplier should be informed that late shipments and poor performance of services will not be tolerated because they can potentially cause expensive downtime, missed shipments to customers, and other problems. Early shipments and poor timing of services are equally undesirable. They may result in unnecessary inventory carrying costs or, in the case of services, disruption of operations. Ideally, a just-in-time approach, with good quality products and services arriving just as they are needed, is the goal.
Meeting the Organization’s Essential Needs. Ultimately, the objective of a negotiation is to meet the needs of the buying organization with respect to purchased products and services. If an organization has a shortage of necessary commodities, components, or services, the supply management professional’s job is to secure an adequate supply from an acceptable supplier. In this case, you are not negotiating from a position of strength. The only hope is that the supplier perceives the volume of the order as attractive for a long-term commitment, and that the buying organization is viewed as a valued customer. This can be accomplished by assuring the supplier that if the needed product or service is delivered, the organization will continue to do business with the supplier even in times when supply is plentiful.
Controlling Contract Performance. Performance requirements should always come first and be clearly defined in the contract. For example, when negotiating the purchase of services, service level agreements “define the service, set performance expectations, describe how to perform the service, performance metrics, and how the performance will be measured” (ISM Glossary 6th edition). During the planning period, potential scenarios and all issues that could cause performance problems should be identified and evaluated. The steps that could be taken to resolve each issue should be identified before problems occur. Nonetheless, negotiations must clearly address performance metrics, the supplier evaluation process, what happens if the potential supplier is not able to perform as agreed upon, remediation measures, cancellation clauses, and associated costs. The responsibilities of all parties should be made clear.
Analyzing the Supplier’s Proposal
An in-depth analysis of the supplier’s proposal is also needed when developing the negotiation plan. Evaluate the price, delivery, performance specifications, and Ts & Cs and identify any deviations from the stated requirements in the RFQ/RFP. Internal stakeholders can provide the expertise needed to assess whether any deviations are acceptable.
Because the supplier’s proposal may be organized differently than the RFQ/RFP, it is helpful to create a spreadsheet for systematically comparing the two documents. Thorough knowledge of the supplier’s proposal is essential for a successful negotiation. Keep in mind that the supplier’s proposal is usually the starting point for negotiations; this is commonly referred to as the supplier’s optimistic position. When analyzing the supplier’s proposal, consider the supplier’s positions and interests.
Understanding Supply Market Dynamics
When developing a negotiation plan it is important to understand the competitive forces at work in the supplier’s industry. Pertinent areas of information include the nature of competition in the supplier’s market niche (for example, number of competing suppliers, barriers to market entry) and the specific products or services being procured (for example, availability and readiness of substitutable products or services). Michael E. Porter frames such market forces in his Five Forces model developed for use in strategic planning1 This framework also can be applied when planning for negotiation. The five forces are (1) power of suppliers, (2) power of buyers, (3) barriers to new entrants, (4) substitutes, and (5) industry rivalry. The first four forces interact and converge on the last force, industry rivalry.
The power of suppliers is grounded in how well and how much a supplier can control the market it is in. When a supplier provides a product or service for which there are no substitutes, or it has unique capabilities that other suppliers do not have, and the buying organization depends on this product or service, then the supplier has power. In such a situation, the buying organization typically tries to position itself to become more important to the supplier through long-term contracts or interlocking relationships. One typical strategy is to consolidate purchases across the organization and offer the supplier a large contract predicated on a long-term relationship.
The power of purchasers comes primarily from the buying organization’s ability to control prices. Generally, the buyer’s power is enhanced when there is low demand and high supply. Also, when the product or service purchased is undifferentiated and switching suppliers is relatively easy and low cost, the buyer enjoys leverage over the supplier. In such a situation, the supply management professional would likely take an aggressive posture during a negotiation. For example, in the retail industry, due to its large size, Walmart has high buyer power. In 2013, Exide Technologies Inc., a lead-acid battery supplier, filed Section 11 citing as its primary reason Walmart’s decision to no longer purchase from the company.2
When the supplier’s profit margin is high, the attractiveness of market entry by other organizations is high. At the same time, financial, technical, and regulatory barriers may discourage market entry. For instance, a potential supplier might be discouraged from entering the market if the initial capital investment required is high, unless there is the potential for a significant return on investment. As more organizations enter the market, the competition increases and the overall industry’s attractiveness decreases. For instance, the trucking industry has low barriers to entry; therefore, trucking has many more competitors than the rail industry because of that industry’s high barriers to entry.
Substitutes also operate on two opposing forces. On the one hand, the existence of substitutable products or services offers leverage with suppliers. In many applications, plastic and aluminum can be substituted for each other. On the other hand, even with the availability of substitutes, the cost of doing so is often too high. For example, tooling costs and development time may prevent a buying organization from switching from aluminum to plastic even though either material would provide good performance.
Lastly, industry rivalry is affected by how the other four forces interact. In general, a high level of rivalry among suppliers is advantageous to the buying organization. However, if the volume of the contract is very low, the supplier may not be motivated to do business with the buying organization because of low profit potential. For instance, the passenger airline industry represents an extremely competitive service market with a high level of rivalry. The market is mature and saturated, and in general there is lack of differentiation among the service providers. Nonetheless, individual organizations have virtually no power when purchasing airline tickets because the purchase is negligible from the airline’s perspective.
Detailed Negotiation Preparation
Prior to conducting negotiations, representatives from both sides must do extensive and detailed preparation. Considerations must be given to the negotiation location, who will be on the team, what personality and cultural issues might be involved, how to deploy negotiation tactics, and the alternatives involved.
Determining the Negotiation Location. Buyer-supplier negotiations are generally held either at the buying organization’s or the supplier’s facility. Typically, as a supply management professional, it is best to conduct face-to-face negotiations at your own organization’s location. This is because you will be most comfortable here; you will have easier access to all the needed data, backup, and support; and you will be in the best position to control the negotiations. Stress will be lower, travel fatigue will be eliminated, and confidence will be higher. However, negotiations at the supplier’s site provides better access to supplier information and you can see the supplier’s facility if you have not already done so.
Regardless of the location selected, wise negotiators pay close attention to security at the site. Sometimes, unethical conduct by members of the other party’s negotiation team occurs. Hidden microphones, snooping and surveillance, and stealing work notes are not unheard of. Experienced negotiators are aware that they and their team members must be careful about what they discuss in public places, must pay close attention to the security of work notes, and must make sure that confidential material is secured. Concerns regarding security apply to both domestic and international negotiations.
Selecting Team Members. In some situations, it is desirable for negotiations to be conducted by a single person, but when high spend levels or high levels of complexity are involved, such as with a new product or service, negotiations are best conducted by a team. A team normally is used when one person does not possess sufficient expert knowledge of all the issues. The team should consist of supply management and the other departments involved, such as engineering, quality assurance, operations, accounting, legal, and marketing. It is important to note that not all the team members who are involved in preparation for negotiations need to be involved in conducting the negotiations.
Team members should understand their individual roles, work well with other team members, and support the team leader, even if they do not always agree with the team leader’s opinions or decisions. Disagreements among team members should never be expressed, either verbally or with body language, in the presence of the supplier.
Collecting Relevant Information. The supply management professional needs to gather all relevant information such as the proposals, characteristics of the supplier’s organization, the backgrounds of the participants in the negotiation, and cultural differences. If the supplier’s organization is public, a good source of information is its annual report. A visit to the supplier’s website can provide information about its product line; facilities and locations; corporate officers; customers; sustainability and social responsibility programs; and recent news events. Social media sites such as Facebook and LinkedIn can provide more information about the organization in general, its perceived reputation, and specific information about the background and experience of the supplier’s negotiating team members. The supplier is likely to use these same sources to gather information about the buying organization and its negotiating team. All information that can have a bearing on the negotiations should be collected and analyzed.
When preparing for negotiations with suppliers, it is important to understand cultural differences and how they may affect negotiations. The focus should not just be on understanding the culture of others, but to also understand how culture influences one’s own values and behaviors. Culture is defined as a “unique way of life of a group of people” (ISM Glossary 6th edition). Cultural differences affect things such as business etiquette, verbal and nonverbal communication, decision-making, and behaviors. Culture can differ by country, region within a country, and by type of organization. Hall and Hall (1990) suggest that country culture affects the speed of communication as well as the amount of information needed, personal space, and perceptions of time.3
Understanding the implications of country cultural differences on negotiations is one of the challenges with global sourcing. There are many resources available to provide insight into doing business in different countries. Thus, when planning for negotiation, cultural differences should be considered. For example, don’t try to rush negotiations by sticking to a tight schedule when negotiating with someone from a culture that views time as more flexible.
After information has been gathered and analyzed, a file can be distributed to all or select members of the team that contains all or part of the following information: negotiation objectives; cost data; financial reports on suppliers; records of previous negotiations; market information; financial strength of the supplier; risk rating; strengths, weaknesses, opportunities, and threats for both parties; price history; quality history; specification issues; delivery history; negotiation styles; personalities and experience of those on the supplier’s negotiating team; security and risk history and issues; and time available for negotiations.
Analysis of Supplier’s Positions and Interests
Positions are the objectives that each organization seeks to accomplish in negotiation, and interests are the underlying motivations that drive those objectives. Analyzing the degree of the supplier’s desire for a contract, the supplier’s strategic position, the supplier’s financial condition, the supplier’s competitive position, and a cost/price analysis can help supply management professionals to better understand positions and interests.
Supplier’s Desire for a Contract. An important factor to evaluate before starting negotiations is the degree of desire the supplier has for selling to the buying organization. This depends on several factors. For example, if the supplier’s capacity is highly utilized it may not be interested in new business. Other factors such as the size of the order, the potential for additional future business, the opportunity to get into a new market, and the buying organization’s reputation as a customer all affect the supplier’s desire for the contract.
The supply management professional must investigate and ascertain if market conditions might be in the supplier’s favor, whether the supplier is in an industry with limited competition, or if the supplier has a patented feature or proprietary technology, potentially making the supplier unwilling to agree to certain requirements. The reverse of these factors can work in supply management’s favor. An adequate supply and plenty of competition may motivate the supplier to make a higher number of concessions. The supplier’s desire for a contract and its perceived certainty of getting it will affect the supplier’s willingness to make concessions.
Supplier’s Strategic Position. To understand the supplier’s strategic position relative to the supply market, it is important to know the market, the supplier, and the product or service. Is the market tight or is supply plentiful? Are supply or demand likely to go up or down in the short or long term, and is the supplier a leader within the industry or a follower? Is the supplier positioning itself for a global expansion and, if so, for what strategic reasons? For example, the supplier may be reshoring to reduce logistics costs and delivery time. Questions can be raised about the supplier’s technological status, such as whether its product or service is likely to be replaced by more innovative products or services or if new suppliers are entering the industry.
Supplier’s Financial Condition. The supplier’s financial condition such as its cash flow, debt load, and other financial indicators should be assessed. The supply management professional must be able to interpret financial statements within the context of the supplier’s industry and be able to note the changes in financial statements over time. For public companies, annual reports and 10-K reports can provide insight into financial condition. Typically, accounting and financial staffs can assist in the evaluation of a supplier’s financial condition. Suppliers in strong financial conditions may be less likely to agree to contract terms that are unfavorable to them. At the same time, these suppliers have lower financial risk and thus bring more credibility to the negotiations regarding their ability to fulfill contractual agreements. A financially weak supplier may have cash flow problems that could prevent it from paying its suppliers, which could result in a supply disruption. If volumes are forecast to increase, a financially weak supplier may not be able to obtain credit to make investments and expand. In emerging economies, a supplier’s financial condition should be closely monitored, and a mitigation and recovery plan is needed to minimize the risks of supply interruption.
Supplier’s Sources of Strength. Finally, the negotiation power of a supplier can come about in several different ways: The supplier may be the only source for a commodity or service, or it may operate in a limited competitive market where there are only one or two capable suppliers. The supplier may own a patented design or feature, or merely be the closest producer in terms of proximity from a transportation standpoint. The supplier may offer a higher quality product, possess an excellent reputation for service provision, have better engineering support, or have the best production capacity for the supply management professional’s needs. The supplier also may be the only supplier willing to deal with a small volume. Additional sources of bargaining power for the supplier are superior customer service, low reject rates, comfortable payment terms, and a record of on-time delivery performance — whether it is for services or for products.
Analysis of Buying Organization’s Strengths
Several factors influence the buying organization’s strengths and weaknesses in negotiation. The supply management professional first must consider the skill and the authority level of the negotiator or negotiating team. Depending on the criticality of the products or services being negotiated, the appropriate person or team must be assigned to the project. Time pressures on negotiations, the adequacy of the cost/price analysis, and other options affect the buying organization’s strength.
Negotiator/Negotiation Team Skills and Authority. What makes a skilled and effective negotiator or negotiating team? In general, professional negotiators agree that planning ability, a high tolerance for ambiguity, and a desire to achieve are the most important characteristics of a negotiator. With practice and experience, you can develop the characteristics to be an effective negotiator. Several studies have shown that the following 22 characteristics are helpful when negotiating:
- Planning ability.
- Desire to achieve.
- Personal integrity.
- Analytical ability.
- Verbal clarity.
- Ability to gain respect.
- Problem-solving ability.
- Good knowledge of human nature.
- Ability to objectively consider others’ ideas.
- Ability to listen.
- Clear, rapid ability to think.
- High tolerance for ambiguity
- Recognition of the importance of training and practice.
Amount of Time for Negotiation. The amount of time available to negotiate an agreement invariably has an impact on its outcome. Deadlines put pressure on both parties in a negotiation. In general, the party most severely affected by time constraints tends to give up negotiating strength. Contrarily, ample time for an extended negotiating session may potentially result in substantial gain for the party that has the most flexibility. The conditions and associated alternatives for both organizations may change as the amount of time available for negotiations is increased or decreased. During international negotiations, cultural differences regarding the importance of time may result in substantial disadvantages for those who do not provide sufficient time for negotiations. Be aware that sometimes we create our own deadlines. For example, if negotiating at the supplier’s facility, the time of a return flight creates a deadline. Assess if deadlines are firm (as in the case of an airline reservation) or if there is flexibility.
Adequacy of Cost/Price Analysis. When preparing for negotiations, it is important to understand what is a “fair” price for the purchase. This is accomplished using price or cost analysis. Price analysis is defined in the ISM Glossary 6th edition as “the examination of a supplier’s price proposal or bid by comparison with reasonable benchmarks, without examination and evaluation of the separate elements of cost and profit making up the price.” Price analysis ensures that the price to be paid is reasonable in terms of the market, the industry, and the end use. Evaluating historical prices paid, comparing with published prices or indices, and obtaining quotations from several suppliers are ways to evaluate market prices. It is important to only obtain quotations from qualified suppliers to which your organization would be willing to award business.
Sometimes, in addition to understanding price, an analysis of cost components can isolate and eliminate unnecessary costs. In cost analysis, the application of experience, knowledge, and judgment of data collected is used to project reasonable estimated supplier costs. Information about operating costs, including direct labor, direct materials, overhead, shipping expenses, and administrative expenses, are assessed. You can obtain cost information by explicitly requesting that the supplier provide the detailed data in the RFQ/RFP. Cost estimates also may be developed based on accounting analysis, engineering analysis, and industry data. Some organizations use publicly available data to develop their own “should-cost” models to use to evaluate if the supplier’s bid is reasonable.
Framing the Results of Analysis
Once the analyses of supplier’s and its own position are completed, the supply management professional is ready to make several decisions (as shown in Figure 5) before the face-to-face negotiation meeting. These decision areas are progressive — one leads to another.
Best Alternative to a Negotiated Agreement (BATNA)
Having feasible alternates gives the supply management organization negotiating strength. Alternatives may include purchasing from other qualified suppliers, using suitable alternative products if technically feasible, or insourcing (making the products or services in-house). Among the options listed, using different suppliers is perhaps the least risky and fastest option to pursue. Employing alternative products or methods of service may involve extensive evaluation and engineering studies, while internal production or service provision may involve capital investment, additional labor, and the development of additional in-house skills. The supply management professional, along with members of other functional areas, must carefully evaluate each alternative the buying organization is considering.
BATNA is arguably the most salient source of power for any negotiator. At one extreme, the negotiator that has no BATNA or extremely poor BATNA has little to no power. At the other extreme, the negotiator with a viable and attractive BATNA wields a great deal of power over the other party. How much concession one party is willing to make ultimately depends on how strong its BATNA is. For instance, if both parties have an extremely attractive BATNA, then they are likely to make only small concessions. If the BATNA is not attractive, then larger concessions are expected.
A good negotiator always works hard to determine the BATNA and to improve it. Determining the BATNA often requires in-depth research because it may not be obvious at first. For example, an automaker had been using platinum in the catalytic converter in its emissions system. Platinum was expensive, so the automaker’s engineers worked hard to find a replacement. They succeeded in using palladium for certain key parts.4 This substitutable product to platinum created a BATNA for negotiating a platinum contract. Often a new BATNA emerges from advances in technology.
Improving the BATNA may require working with a different supplier to develop its capabilities. A major automaker was working with a supplier of its center console, the unit that sits between the driver and the passenger seats with a cup holder and a small glove compartment. This supplier was the automaker’s BATNA at the time for the center console assembly, but the automaker did not like the quality of this supplier’s product. Therefore, to pressure this supplier to respond to requests to improve quality, the automaker worked hard to develop the capabilities of another supplier. Once the new supplier developed the technology for making the center console, the automaker found a new BATNA and exercised much more power over the existing supplier during negotiation.
Zone of Possible Agreement (ZOPA)
In preparation for negotiation, the buyer’s and seller’s negotiation teams determine the negotiation ranges for all factors that will be negotiated such as price, quality, delivery, service, warranty, payment terms, and other Ts & Cs. Most teams start by setting the negotiation range for price by establishing a target price, defined in the ISM Glossary 6th edition as “an approach to negotiation and pricing of a supplier’s product or service in which the buying organization’s analysis begins with the highest price it could pay and still sell its product or service competitively in the marketplace.” The target price is obtained from having completed the supply market analysis; an estimation of product, part, or service delivery costs; the budget; and profitability objectives. This involves determining what price can be paid to meet the organization’s profitability objectives for the product or service.
Setting a target price for a service is more difficult than setting a target price for a manufactured good. For some services, performance requirements vary, depending on customer needs and other contextual factors such as when, where, and how frequently the service is to take place. For instance, a training and education supplier finds that requirements for training provided for the same subject (for example, statistical process control or negotiation skills training) may differ depending on the customer’s existing knowledge and experience.
Once the target price is established, then the acceptable range can form around the target price. The range is determined by the most optimistic price and the most pessimistic price. For the buying organization, the most optimistic price is the lowest realistic price. The most pessimistic price is the highest price that the supply management professional will accept. The supplier also has an acceptable range — its target price and the range defined by its most optimistic and pessimistic prices. In this case, the range is created by the supplier’s most optimistic price (highest realistic) and its most pessimistic price (lowest realistic). Typically, the most pessimistic price, if not met, is the point at which the supplier will walk away. When preparing for negotiations it is important to estimate the supplier’s negotiation range and consider its BATNA.
The zone of possible agreement (ZOPA) is the area of overlap between the buyer’s and the supplier’s negotiation ranges. If there is no overlap, negotiation will not occur. Figure 5-4 shows an example of the relationship between negotiation ranges of prices and the ZOPA. Suppose a large national health and fitness chain is interested in purchasing a premium brand foam exercise mat. In Case A, there is no overlap between the negotiation ranges. The pessimistic price of the buyer is lower than the pessimistic price of the supplier. When this happens, there is no ZOPA, and the range of US$0.50 is typically referred to as the negative bargaining zone. As long as both sides adhere to their negotiation ranges, there will be no agreement. However, with re-evaluation by both parties independently, they might find a ZOPA if and when they reconvene.
On the contrary, Case B in below Figure exemplifies a situation where there is an overlap of the negotiation ranges, forming a ZOPA. The zone between the pessimistic price of the buyer and the pessimistic price of the supplier is the ZOPA; in this case, the zone is between US$7.00 and US$8.50. Therefore, the final negotiated price is likely to fall between these prices.