Creating New Value through Negotiation Wayne Delaney is a relative newcomer to the railroad business. That has not stopped him, however, from using the knowledge ard stills gained fom his many years at General Electric to improve the performance of the subsidiary railroads at a major steel producor. So thaw did he do it? Executive management at the parent steel company directed all operating units (inuding the rairoacs) to concentrate on return on net assets (RONA) as an important performance in- dicatot. Improving RONA forced different functional grups at the railroads to search, bath in- ividually and collectivey, for creative ways to increase earnings while simultaneously reducing assets and other current liabilities. The purchasing group. representing the inter- ests of five separate railnads, focused on reducing the assets required by the railmads to maintain tack, equipment, and facilities. Inventory makes up a large pat of the denoming- tor of the retum on nat assets equation. ‘The purchasing group's approach to higher asset retum relies on negotiated longer-term con- tracts featuring consignment inventory from supplies. Inventory consignment invves defer- ing payment for an item until an internal customer physically uses it. Previously, each railroad purchased its ovn requirements using short-term purchase orders. [though the five raimoads operate as separate entities, Wayne works diectly with each rail- tad to develop and negotiate systemwide contracts. Purchasing identifies potential items for long-term contracts identifies and anajzes potential suppliers, creates benchmark prices to compare final prices agaist, calculates annual demand requirements, and represents the in- terest ofeach railroad during negctiations with suppliers. Each raiload has an opporturity to present its specific needs before purchasing enters a ne- ‘tiation, Interal customers at each site electronically receive a generic contract before a supplier negotition. The railroads have an opportunity i identity the contractual eptons thoy profr, and usors can expand the contract by listing any items they woud like to seo ad- ‘essa in final negotatens. Has Wayne's approach to contracting and negotiation been successful? Over a three-year pe- ‘iod, curent inventory maintained by the ralioads has decreased by over 50%. Longe-term agreements have also allowed for some downsizing at the railoads because suppliers have assumed resporsibilties previously performed by the railreads, such as delivering and plac- ing pysicel inventory in storage. Furthermore, the railoads have realized price reductions due to the combining of common purchase requirements, Over the reilroats now achieve 2 35% return en net assets, prompting sone at the railroad to joke that perhaps the ral- ‘cad should divest itself of the parent steel company, which has failed to achieve ts own op- cating goals. ‘The opening vignette highlights how a supply management professional, using negoti- ation and contracting practices transferred from an unrelated industry, has created new value that has enhanced his company’s competitiveness. The ability to improve return on net assets was possible only through extensive planning, negotiation, and the use of longer-term contracts that combined the requirements of geographically di- verse operating units. Negotiation is a skill that is essential to all purchasing and sup- ply managers.Everyone negotiates something every day, ranging from dealing with other drivers at a four-way stop sign all the way to merging with or acquiring another company. As such, negotiation is generally a highly complex and dynamic process, and many books and articles have been written on how to effectively negotiate in a variety of uations. This chapter highlights important topics that are typically part of any negotia- tion, especially those between buyers and suppliers. We begin this chapter by broadly defining the concept of negotiation. The second section presents negotiation as a five-phase process. Next, perhaps the most important part of any negotiation process— planning—appears in detail. The following sections present common sources of negotia- tion power, the effective use of concessions, negotiation strategies and tactics, and the important topics of win-win negotiation, international negotiation, and the effect of the Intemet on the future of negotiation, What Is Negotiation? ‘One of the most important activities performed by supply managers involves nego- tiating agreements or contracts with their suppliers. Although supply management is certainly not the only group in an organization that negotiates, negotiation is a vital part of every sourcing process. Negotiation is an ideal way to implement the supply management strategies and plans that a business unit develops It is also often an ideal way to convey the buyer's specific sourcing requirements and specifications to Sourcing American Airlines Knows Snapshot the Importance of Negotiation Ina provus era, the sign of a good purchase negotiator was someone who could get 4 rock-bottom price fram supple. Tolay, experienced negotiators realize that nt all negofa~ tions require price focus or the same set of skis. "Low-level negatiatons,” says John Maclean, vice president of purchasing with American Ailes, “imolve products or services that are competitive inthe marketplace but ae rot strategically important to American Air lines." He paints out that getting the best price is a good indicator of effectiveness fr these ‘ypes of items. Maclean also knows the importance of static negotiations when obtaining critical items end senices. “Winn negatiatons,” says MacLean, “are conducted in long- term relationships with suppliers. In these cases itis important thatthe supplier and Ameri- can Ktines fel they are geting good deal beccuse the pan i to work together fre long While” At the mest advanced level, the strategic compatbility of the companies involved say dotormino tho success of a nogtiaton. Says MasLean,“Principle-basoé negotiating is ‘sed in a singe-soute sitvaton or allance where the two parts begin the negatiaton by agresing to cartan principles, such as how the companies plan to grow together.” American Anes recognizes two important grinciples about negotiation. Fst, nt all negotiators are ‘qual in importance or require the same skill st. Second, regotiation is a fundamental part of the companys strategic supoly plans. Source: Adoped fam A.Ciancaeli, "Stcegc Negi Goes For beyond Best Price,” Pucas- Ing Maren 25, 189, 129,4.its supply base. See Sourcing Snapshot: American Airlines Knows the Importance of Negotiation for a discussion of the importance of negotiation for American Airlines. Negotiation has been defined in a variety of ways: “A negotiation is an interactive ‘communication process that may take place whenever we want something from some- ‘one else or another person wants something from us”! "Negotiation is the process of ‘communicating back and forth for the purpose of reaching a joint agreement about differing needs or ideas.” "Negotiation is a decision-making process by which two or ‘more people agree how to allocate scarce resources.”* “Negotiating is the end game of the sales process.”* For our purposes, we define negotiation as a process of formal communication, ci- ther face-to-face or via electronic means, where two or more people come together to seek mutual agreement about an issue or issues. The negotiation process involves the management of time, information, and power between individuals and organizations who are interdependent. Each party has a need for something that the other party has, yet recognizes that an interactive process of compromise or concession is often re- quired to satisfy that need. An important part of negotiation is realizing that the process invelves relation- ships between people, not just organizations. A central part of negotiation involves each party trying to persuade the other party to do something that is in its best inter- est The process involves skills that individuals, with the proper training and experi- ence, can learn and improve upon. Good negotiators are not born; they hone these necessary skills through planning and practice. ‘There are a number of terms with which all negotiators should be familiar BATNA, positions, interests, needs, and wants. A negotiator’s best alternative to a ne- gotiated agreement (BATNA) is also known as the negotiator’s bottom line or reserva~ tion point, that is, that point in the negotiation where it is most advantageous for the negotiator to walk away from the table and implement his or her next-best option.® ‘A negotiator should take extra caution to ensure that his or her reservation point o BATNA is never revealed to the other party because the final settlement is unlikely to vary much from that point.° In addition, all negotiation settlements must ulti- mately be judged in light of the other viable alternatives that existed at the time of the agreement. A negotiators position can be defined as his or her opening offer, which represents the optimistic (or ideal) value of the issue being negotiated. A position is the stated de- mand that is placed on the table by a negotiator. In contrast, the negotiator’s interest is the unspoken motivation or reason that underlies any given negotiation position. In many negotiation scenarios, the negotiator’s underlying interests are unlikely to be expressly stated or acknowledged, oftentimes because they may not be directly ger- mane to the stated position or may be personal in nature. Sharing the underlying in- terests behind a position may cause a negotiator’s power to shift toward the other arty, resulting in a less-than-desired outcome. The negotiator must, in effect, play de- tective to try and discern the other party's interests through a series of open-ended, probing questions. In order to reach a negotiated agreement using principled negotia- tion, a negotiator should always attempt to focus on the other party’s underlying inter- ests, not his or her stated position.” ‘The astute negotiator must also be able to distinguish between the other party’s needs and wants. Needs are considered to be those negotiated outcomes that the nego- tiator must have in order to reach a successful outcome to the negotiation. Warts, onthe other hand, refer to those negotiated outcomes that a negotiaior would like to hhave as opposed to those outcomes that must be achieved. Wants can also be ex- changed as concessions to the other party during a negotiation because they are not as critical to achieving a successful condusion to the negotiation. When a negotiator is planning an upcoming negotiation, it is imperative to prioritize all of the potential issues to be negotiated into needs and wants, thereby knowing what must be achieved and what can be exchanged for something else of value. A simple negotiation planning tool, called “Triangle Talk,” can help the negotiator begin the initial preparation for an upcoming negotiation. This planning process, shown in Exhibit 13.1, consists of the following three steps: (1) know exactly what ‘you want; (2) find out what they want and make them feel heard; and (3) propose ac- tion in such a way that they can accept it® ‘Step 1 in Triangle Talk is determining and formalizing the negotiator's specific goals and objectives for the upcoming negotiation. Being specific with one’s expecta- tions and writing them down helps the negotiator to remain focused on his or her pre- determined priorities during the negotiation. Having them written down also allows the negotiator to refer back to them during the course of the negotiation, when itis of ten easy to be distracted by the other negotiator’s tactics and the pace of the give- and-take process. The more clearly a negotiator can define his or her priorities, the ‘more likely he or she is to obtain them in the final agreement. Step 2 involves trying to discern what the negotiator's counterpart is likely to need ‘or want from the negotiation. It is difficult to develop common ground in the negotia- tion without knowing what the other party is seeking. Ask specifically, "What does the other party need or want?” Delve into the other party’s likely positions and try to Exhibit 13.1 Triangle Talk Step 3: Propose Acton in aWay That They Can Accept / / / ‘Step 1 The ‘Stop 2 row Negotiation Know Exactly Procass Exactly What You What They Want Want AN ‘Sauce K Andarsan, Gating What You Want Wow to Reach Agraamer® and Reais Ganfict Fey Tne New York: Pum, 1994, p14Exhibit 13.2 Five-Phase Negotiation Process barat Pane Cont be Bata seen oie pean ces pene 1 2 fi : . rua suse ky Feo tt + roe reeset intent paris ‘man prreaee “slvntory ‘*Nemanynor-pice © Develop sRocess or caucus “eanack cae iors mane ees nes bakcente © Reorder © Is contract large? © Analyea “= Work to narrow: subcess ot te femspters tem Srinceane ee nega + Now product ‘requiromants, weiss ‘+ Manage time senbpnet cpr ane pees New © Dos contract ‘erormation | ‘= Maintain informal ‘hoes inche pt ese arose sniewpent? —“Cumats Sear “eboes contract aes ogres proces inet seat ts pati? aie sper seni a patted "pais acts? + Dereon stato srutanrenenia "todas hand MEM et esa act te egotationSources of Negotiation Power Researchers have identified six general types of power exercised by individuals or organizations: (1) informational, (2) reward, (3) coercive, (4) legitimate, (5) exper. and (6) referent.” Informational Power Ready access to relevant and useful information is typically the most common ap- plication of power found in a negotiation. It relics on influencing the other party through the presentation of facts, data, and persuasive arguments to support one’s ‘own positions and to mitigate or challenge the other party's positions. However, the effective use of information in « negotiation does not necessarily mean open and com- plete sharing. For example, one party may present only favorable information that supports its position, whereas the other side may present only negative information to refute a position. One party often manipulates information, as a source of power, to control or constrain the options available to the other party. Reward Power Reward power means that one party is able to offer something of perceived value to the other party, such as a purchase contract or access to a new source of technol- ogy. Using rewards represents a direct attempt to exert control over the negotiation, particularly when compared with the use of informational power, which relies more on persuasion. The basis of reward power is the belief that individuals respond and behave accordingly when valued rewards are available. An important risk of reward power is that a negotiation counterpart may eventually leam to respond positively only when offered rewards. Coercive Power Coercive and reward power are somewhat related: they are two sides of the same negotiation coin. If one party can give the other party something of value (reward power), then that party can also take it away (coercive power). Therefore, coercive power includes the ability to punish the other party—finandally, physically, or men- tally. Note that repeated use of coercive power can have damaging effects on longer- term relationships. There is also a strong likelihood that retaliation or escalation can occur if the power structure shifts unfavorably in the future. For example, when sup- ply markets begin to tighten during an economic recovery. suppliers may retaliate against the buyer by pursuing large price increases, not providing excellent service to certain buyers, or even disrupting continuity of supply to the offending buyer. Legitimate Power ‘The job position that an individual holds, rather than the individual him- or herself, is the basis of legitimate power. Parents, pastors, managers, and olitical officeholders are examples of individuals possessing legitimate power. In sourcing, a buyer may have legitimate power simply because he or she legally represents a prominent company and hhas the authority to buy. It is not necessarily the case that individuals with legitimate power have reward or coercive power (eg. a church pastor).Expert Power Expert power is a related and special form of informational power. Successful appli- cation of informational and expert power involves the development and retention of a body of knowledge. Informational power exists when someone has thoroughly re- searched and prepared for a negotiation. An expert is recognized as having accumu- lated and mastered vast knowledge cbout a particular subject, often with verifiable credentials to document that mastery. Expert power can influence others in a negotia- tion by reducing the likelihood that another party will be able to successfully refute the expert’s position. Furthermore, nonexperts are less likely to challenge an expert be- cause of the expert’s perceived depth of knowledge. However, the other party must value the expertise in order for it to be effective Referent Power This source of power comes from attraction based on socially acceptable personal qualities and attributes of an individual, such 2s one’s personality. These qualities could be physical but likely include individual characteristics such as honesty, charisma, friendliness, and sensitivity. In this source of power, the power holder—the referent—has some attributes or personal qualities that attract the other party or make him or her want to be like or respect the power holder. The basis of referent power is that the nonreferent wants the referent to look favorably upon him or her. Referent power is most successful in negotiation when the referents are aware that a counterpart identifies with or has an attraction to them. Parties holding power will likely apply all available types of power to their advan- tage during a negotiation. Negotiators must be careful not to abuse their power, or they risk damaging relationships, inviting retaliation, or diminishing the value of that power. In most negotiations, the sources of power that are usually the most effective are legitimate, informational, and expert. They are usually the sources of power that allow the parties to maintain a positive relationship after reaching agreement. How- ever, referent power can also synergistically interact with the other sources of power, making them stronger or more effective in the influence process.Win-Win Negotiation ‘Many tradiional supply managers believe that the primary objective of negotiation istowin at the expense of supplier We call thiswin-ose negotiation (ko caled com peitive or disribaive bargaining) Win4ase negatiation means that two oF more par- fies are competing over a xed value with the winner taking the larger share. Iti also known as a zero-sum, o¢ fied-sum, game—if one party gan its only atthe ex- pense ofthe other party. Every increase inthe purchase prce benefits only the seller, ind rery decene in price banefits ony the buyer. There are no other posible out ‘comes, The level of competion in awinlose purchase negotiation rarely makes asup- plier anxious to cooperre with a buyer to provide advantage that ae not availble {o other customers There ino inherent advantage forthe supplier vo doso. Win-win negotiation (also called integrative bargaining) secks to expand the value oF resources available to all participants through collaborative negotiation. The parties still negotiate, but they do so to determine how to equitably divide a bigger and ex- panded value pic through the use of creative proposals. For example, increased value to the buyer may mean receiving a more favorable purchase price than a competitor, a shorter onder cycle time from the supplier, joint efforts to reduce duplication oF ‘waste between the partes, or assistance in developing new technology or product de- signs. On the supplier's side, increasing value may mean additonal sles volume, pref- erential treatment for future business, or technical assistance provided by the buyer to help reduce its operating costs, Exhibit 135 contrasts the characteristics of win- lose and win-win negotiation. The fundamental question of win-win negotiation is how the buyer and seller, through a colaborative negotiation proces, can pursue integrative bargaining and ex: ppand the pic available to both parties Previous research has identified five different methods for pursuing integrative (win-win) agreements? «Expand the Pie. Working closely together, the partes identify creative ways to expand available resources or generate new value obtained through 2 nego- tiated agreement. For example, the seller that offers a buyer early access to ‘new technology for inclusion in its own new products can help create new Exhibit 13.5, | characteristics of Win-Lose and Win-Win Negotiations CHARACTERISTICS OF WINLOSE NEBTIAMON CHARACTERISTICS OF WI.WI NEGOTIATION (OISTREUTHVE BARGAIN (ONTECRATVE BARGLINIG) + Assume ri nesting postions. ‘+ Understand each ters needs and wants. Compete erate amount vale ‘+ Fcuson common rater than pesnal irs 1+ Prcticestict use of poner by one party er 1 Candict joint effets to sve pbs ad develop camatie sl nut ‘ons that pride editons va. ‘+ Pusu adversatilrlatunsips. ‘+ Engage inopen sharing of ifumatin.value. If the market embraces the new product, presumably sales will in- ‘rease, and the supplier will receive larger purchase orders. Both parties be- come better off. + Logroll. Successful logrolling requires the partis to identify more than one is- sue where disagreement exists. The parties agree to trade off these issues s0 ‘ach party has a top-priority issue satisfied. This isa form of compromise in which cach party gets more in those issues that are most important to him ‘or her while giving up more on those issues that are less critical yet are im- portant to the other party. + Use Nonspecific Compensation. With this approach, one party achieves his ‘or her objective on an issue while the other receives something of value as a reward for going along, This approach works only when the compensating, party knows what is valuable to the other party and makes a reasonable of- fer to make the other party whole for agreeing. + Cut the Costs for Compliance. With cost cutting, one party (usually the buyer) gets a lower price as the parties work jointly to reduce the seller's costs or the transaction costs of doing business together. The buyer satisfies his or her objective of a obtaining a competitive price while the seller be- ‘comes more competitive in the marketplace due to a reduced cost structure. + Find a Bridge Solution. Bridging involves inventing new options that satisfy ‘ach party’s needs Although bridging solutions will likely not totally satisfy ‘ach party, they are usually satisfactory to each side. As in the third point of ‘Triangle Talk (propose action in such a way that they can accept it), the ne- {gotiators seek to jointly create solutions that satisfy the interests and needs of both parties. A win-win negotiation approach works best for items or services that are impor- tant to the buyer's products or business or when the item involves high-dollar items or services where cost control is critical. It is also appropriate when the supplier adds «thigh level of value to the product or service. When variables such as technology, cy- cle time, quality, and price/cost are important, win-win negotiating may also be the best approach.