By Vantage Partners
Keep the Value Attached to Your Contracts
Why are purchasers and suppliers so often disappointed by the results of strategic sourcing, and how can they stop the value leaking out of their hard-won contracts?
Today's business environment, fraught with volatility and uncertainty, confronts CPOs and sourcing and supply chain executives with unprecedented challenges and opportunities. Companies are under increasing pressure to reduce supply costs even as they need to leverage suppliers to drive innovation. Meanwhile, headlines highlight the risks to consumer safety and corporate reputation of poorly managed supply chains.
At some companies, these pressures have, unfortunately, driven a reversion to outdated and adversarial approaches to dealing with suppliers; refusals to take deliveries and honour contractual commitments, and unilateral demands for across-the-board price cuts without evaluating the impact.
At the same time, other companies are balancing the need to take sometimes drastic action in the short term with an eye on long-term consequences and opportunities. They are renegotiating contracts with suppliers in a collaborative fashion, with a commitment to ﬁnding solutions that work for both sides and are emphasising creative deal structures and leveraging innovation to reduce costs, rather than demands and threats. As the economy improves, they will have privileged access to supplier capacity, innovation and investment; their competitors will be put on allocation or worse.
As once-in-a-generation stresses and changes in the economy have unfolded over the past 12 months, we have been conducting a global study (involving over 600 companies and more than 800 individual survey responses from both buy-side and sell-side executives and professionals) of negotiations between customers and suppliers. Below we share highlights of this research, and recommendations for procurement leaders as they look to weather today’s challenges and position themselves for long-term success.
Strategic Sourcing Revisited
If ever there was a time to take a hard look at the quality of savings that procurement is achieving, rethink the goals that it should focus on (and against which it should demand its performance be evaluated) and reconsider the sustainability of approaches to negotiating and working with suppliers, surely it is now.
While strategic sourcing initiatives have helped many companies to reduce costs and improve supplier performance, a signiﬁcant minority of the value expected to result from strategic sourcing eﬀorts – on average, 45 per cent – goes unrealised, according to the buy-side participants in our study.
Our research and experience working with clients overwhelmingly suggest both that common strategic sourcing techniques such as spend and market analysis, RFx processes and competitive bidding, while still useful, are increasingly less eﬀective and not enough to enable sourcing teams to meet their targets. Nearly everyone we interviewed who was directly involved in strategic sourcing events and purchasing reported that negotiations with suppliers are often the most challenging part of strategic sourcing.
There are many reasons for the reported gap between value targeted and value realised from sourcing initiatives. In some cases, study participants said the goals and savings targets were unrealistic. Far more often, though, they blamed challenges that arise in negotiating contracts and working with suppliers after they were signed. Often, challenges negotiating and implementing contracts with suppliers were aggravated by challenges when aligning negotiation goals, strategy and roles with internal business partners.
In the early stages of our research, before the downturn accelerated, the primary concern raised by study participants was how to negotiate eﬀectively in myriad markets where supplier consolidation and shortages of commodities and talent seemed to have tipped the balance of power strongly in favour of suppliers. In the later stages, buy-side respondents were far more likely to say their primary negotiation challenges were knowing how far to push suppliers without driving them out of business or creating significant quality and safety risks, as well as how to justify price decreases even as purchase volumes were being slashed and senior managers were often insisting on much shorter contracts.
Both buy-side and sell-side participants in our study reported that a signiﬁcant potential contract value goes unrealised. Customers grade their suppliers more harshly than suppliers grade themselves. On average, customers reported realising only 54 per cent of expected or potential contract value during implementation, while suppliers reported delivering 66 per cent of potential contract value to their customers. While the idea of “value leakage” post- sourcing and contract award is not new, the magnitude of the problem suggested by our research is staggering.
On the face of it, it is surprising that supppliers would report delivering so much less than the full potentialvalue of their agreements with customers. Through follow-up interviews after reviewing survey results, sell-side executives andprofessionals conﬁrmed that suppliers themselves are often signiﬁcantly dissatisﬁed with the value they deliver, but they blame their customers to a large degree. Reasons cited by suppliers include customers:
When confronting situations where competitive pressure is of limited use – single and sole-source suppliers, industries with high switching costs, and suppliers that are already operating a relatively lean business and are themselves under signiﬁcant ﬁnancial pressure – buyers often feel they have little ability to achieve savings or capture additional value from supply contracts. Results from the study mirror our experience that most organisations have, by now, made the gains from relatively low-hanging fruit such as consolidation of spend and introduction of basic competitive bidding discipline, and need to focus on developing more sophisticated negotia- tion and supply chain management strategies and capabilities.
Over 80 per cent of buy-side and sell- side respondents perceived negotiations to be highly or somewhat adversarial.
Given that virtually all of the contracts that result from such negotiations lead to an ongoing business relationship in which both sides need to work together, this is a damning statistic. Companies and indi- viduals that believed their trading partner took advantage of them (or tried to) during negotiations tend to operate defensively, are reluctant to share information, focus on contract compliance rather than ensuring successful outcomes for their business partner, and, in more extreme cases, actively look to make up for perceived losses (“even the score”) during contract execution.
Procurement organisations that employed a collaborative (versus an adversarial) approach to negotiations reported greater satisfaction with their negotiated agreements and the value realised from those agreements. Of the top 10 per cent of buy-side study participants in terms of self-reported value realised during contract implementation, 63 percent described their negotiations as “highly” or “somewhat” collaborative.
Those employing a collaborative negotiation approach reported more positive working relations with suppliers, fewer unexpected problems during contract implementation, and a far greater ability to work through problems. Figure 2 shows the correlation between how study participants characterised the nature of negotiations with their suppliers and their subjective level of satisfaction with value delivered by suppliers for the contract.
Interviews with high performers revealed an ability to negotiate assertively and collaboratively (both in the sense of treating individual counterparts with a high degree of respect and seeking mutually beneﬁcial solutions) at the same time. Average and low-performers overwhelmingly perceive a debilitating zero-sum trade-oﬀ between assertiveness and being collaborative. Similarly, top-performing procurement organisations balance the use of competitive sourcing and bidding with negotiation strategies and approaches that are highly collaborative (focused on fair and sustainable outcomes for both sides and with an emphasis on joint development of creative and mutually beneﬁcial solutions.)
On the sell side, respondents reported increasingly systematic eﬀorts to invest in customers that are willing and able to act as collaborative business partners (irrespective of sales volume), and to limit or sever ties with customers that are not. Sell-side participants also described consciously assigning their “A-level” delivery teams to customers that negotiate and supply relative to demand, proprietary technology and so on) have far less impact on perceptions of power and leverage in negotiation than eﬀective preparation.
Unfortunately, pervasive perceptions of a lack of leverage, combined with a lack of negotiation skills, perpetuate and exacerbate adversarial approaches to negotiation. A major consequence is that information- sharing and the quality of communication is severely impeded, which in turn greatly inhibits creative thinking during negotiations and ultimately leads to sub-optimal agreements and a compromised ability to successfully implement them.
High-performing organisations tend to systematically assess leverage from multiple angles as part of the development and execution of formal negotiation strategies. Signiﬁcantly, while top performers do not ignore questions of leverage, they think about negotiation power in a more robust and less zero-sum fashion. For example, understanding a trading partner’s business model and strategy is frequently cited by top performers as a critical source of power in negotiations; such knowledge can be used to develop create creative solutions or identify eﬃcient trades that help both sides to achieve their goals.
Lack of significant disclosure by the other side was cited as a signiﬁcant barrier to maximising value achieved in negotiations by both the buy-side and sell-side respondents (although each side viewed its own lack of disclosure as far less serious). But while both sides recognise the additional value that could be realised by broader disclosure, they also fear that such disclosure will be exploited by their negotiation counterparts. This dynamic goes a long way to explaining the enormous value leakage during contract implementation reported by participants on both sides.
A spin-off of the Harvard Negotiation Project, Vantage Partners helps organizations negotiate and manage their most important business relationships, with key customers, suppliers, and business partners. The company is based in Boston, Mass. For more information, go to: http://vantagepartners.com/
George E. Krauter
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