Creating Value in Vendor Negotiations

Creating-Value-in-Vendor-Negotiations

I traditionally considered negotiating as a somewhat selfish act with the simple goal of maximizing what I could get out of a deal while minimizing what the other party could get.

This actually may be the best one can hope for in distributive negotiations. These are the ones where you negotiate on only one issue or dimension.

In integrative negotiations, one can go further than win-lose, and even further than win-win. We don’t have to divide the pie as it stands, we can grow the pie so that both parties are much better off by making a deal. This post shows you how to grow the pie and create value through negotiations.

Example of Distributive Negotiation

Let’s start with the case of negotiating solely on the price for one service. If I want to receive a particular single service from a vendor, I will come with a range of acceptable prices I am willing to pay, say $150K to $200K. The vendor will likely have a higher desired range, say $175K to $250K.  Thus, the zone of possible agreements (ZOPA) is $175K to $200K. The closer the final price gets to $175K, the more the pie is distributed in my favor. The closer the price gets to $200K, the more the pie is distributed in the favor of the vendor.

Some might consider a price of $187.5K (a split right down the middle) to be the best outcome, and a win-win solution – where both parties achieved better than their reservation price (the limit they were willing to accept). The buyer was willing to pay up to $200K but only had to pay $187.5K – win. The Vendor was willing to accept $175K but achieved $187.5K – win. Total value of the deal: $12.5K + $12.5K = $25K.

Adding a second issue to the mix may lead to a better deal. Just adding a second issue to the mix, however, does not guarantee that the pie will grow. If we still negotiate each issue independently of the other, then the size of the pie will remain the same. However, when we treat multiple issues as a package and negotiate entire packages, value can be created.

Consider the following Integrative Example

Insurance carrier Capital Now Insurance (CNI) needs to acquire property data to lower their underwriting time and to increase the coverage amount for the policies they write. They are willing to pay between $100K and $200K to acquire the data from Iven, a property data vendor. Iven wants between $150K and $250K to deliver the data. Furthermore, Iven can provide the data for each order within 30 days. CNI would like to have the data in 10 days. They come to the negotiating table and work out the following deal:

$175K to deliver the data in 20 days.

In other words, they did their job, met half way, and went out for seafood afterwards.

Could they have done better? The answer is a resounding YES! Do you not get the feeling that money was left on the table? That there is no synergy between the two companies? That value was not created through this deal? Consider the following alternative scenario.

Ahead of negotiating, Iven’s account manager (AM) calls CNI’s head of underwriting and discovers that CNI cares much more about receiving the data in 7 days than getting it for $100K. The AM was able to learn this valuable information just by asking. Iven’s AM still doesn’t know that CNI can save $20K by getting the necessary data in 7 days rather than 30 days. Still Iven’s AM goes back to prepare for the negotiation knowing that CNI values turn-around-time more than price.

Likewise, during the same pre-negotiating phase, CNI’s head of underwriting calls around and discovers that the much smaller vendor company has negotiated fast turn-around times with CNI’s competitors almost effortlessly. Thus, the head of underwriting at CNI induces that Iven’s AM will care more about price and less about turn-around-time when negotiating. In fact, CNI doesn’t know that it actually costs Iven nothing more to go to 7 days. When they come together, they are able to negotiate the following deal:

$190K to deliver the data in 7 days.

CNI came out feeling that they got the bulk of the pie, because they got what they most wanted – the 7 day turn-around-time. Iven came out feeling that they got the bulk of the pie, because they got what they most wanted – a higher price.

Let’s calculate the value of the first (blind) deal. $175K and data in 20 days. CNI was willing to pay up to $200K but only had to pay $175K, a value of $25K. However, they lose $20K for the longer turn-around-time: $5K. Iven received $25K more than they were willing to receive: $25K.

Total Value of making the fist Deal: $5K + $25K = $30K.

Let’s calculate the value of the second (well-informed) deal: $190K and data in 7 days. CNI will incur a cost of $190K yielding a deal value for them of $10K. Iven will receive $40K more than the $150K they were willing to receive.

Total Value of making the second Deal: $10K + $40K = $50K.

Notice that value was generated in the second deal. In fact, one player did not have to advance at the expense of the other. Both benefited. Don’t give up there, though. Think of other ways you can make this deal even better.

Three ingredients necessary for creating value in vendor negotiations:

  1. Adding multiple issues
    • The first step is to realize that we can grow the pie by bringing more negotiable issues to the table.
  2. Negotiating on packages
    • If you treat each issue independently (in essence, giving each the same weight), then no value can be added to the negotiation. Instead, propose entire packages.
  3. Doing your homework to understand what the other party values most.
    • Creating value does not come for free. It requires negotiators to learn more about their potential business partners.

The example showed two ways of acquiring helpful information. One negotiator asked for the information. The other one asked other industry players for the information. If these methods are not available to you, you could also come to the negotiation table and offer multiple package options that represent equal value to you but possibly not for the other party. The other party’s response would immediately clue you in on what it is they value the most.

Final Points

Increasing the value to one party does not mean that the other party has to suffer. If you are not negotiating to create value, then you are leaving money on the table. Both parties can be much better off if a negotiator learns and practices the tecniques mentioned. Vendor relationships can be strengthen and, no matter what side you are on, your company can take home a bigger piece, a piece of a bigger pie.

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