TRATEGIC SOURCING

Keep thevalue 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?
by Jonathan Hughes and Elizabeth Rayer

T
ILLUSTRATION: ROBIN CHEVALIER

oday’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 At some companies, these pressures have, unfortunately, driven a reversion to outdated and adversarial approaches to dealing with suppliers; refusals to take deliveries and honour contractual commitments, and unilateral demands for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
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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
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FIGURE 1: KEY AREAS OF “VALUE LEAKAGE”
FOR CUSTOMERS • Expected innovation does not materialise • Scope changes lead to additional costs • Off-contract purchasing undermines expected savings • Project delays due to supplier • Quality problems FOR SUPPLIERS • Expected volumes do not materialise • Changes in requirements lead to increased and unrecoverable costs • Customer does not provide committed resources • Project delays due to customer

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” postsourcing and contract award is not new, the magnitude of the problem suggested by our research is staggering.

SOURCE: VANTAGE PARTNERS

Dissatisfied suppliers
On the face of it, it is surprising that suppliers would report delivering so much less than the full potential value of their agreements with customers. Through follow-up interviews after reviewing survey results, sell-side executives and professionals 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: • failing to provide timely access to information needed to deliver on contracts; • failing to meet their obligations to provide staff and resources needed to successfully implement agreements; • changing (often on more than one occasion and at the last minute) specifications and requirements; and • failing to meet contracted commitments for volume of business. 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 negotiation and supply chain management strategies and capabilities. Over 80 per cent of buy-side and sellside respondents perceived negotiations to be highly or somewhat adversarial.
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FIGURE 2: HOW SATISFIED ARE PARTICIPANTS WITH THE OUTCOMES OF DIFFERENT TYPES OF NEGOTIATING RELATIONSHIP?
75

percentage of respondents

50

25

0

Highly adversarial Extremely dissatisfied

Somewhat adversarial Dissatisfied Satisfied

Somewhat collaborative Extremely satisfied

Highly collaborative

SOURCE: VANTAGE PARTNERS

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

Jonathan Hughes ( jhughes@ vantagepartners.com) is a partner and leader of the sourcing & supplier management practice at Vantage Partners, where Elizabeth Rayer is senior adviser. Both are based in Boston

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 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

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FIGURE 3: PERCENTAGE OF TARGETED VALUE ACTUALLY REALISED
Supplier negotiation strategies determined through systematic process informed by category management strategies, type of relationship with supplier, and overall goals for relationship per SRM programme Supplier negotiation strategies primarily determined based on type of relationship with supplier, and overall goals for relationship per SRM programme Category management strategies are the primary determinant of supplier negotiation strategies Category management strategies, SRM programme and strategies, and supplier negotiations strategies are not at all co-ordinated or aligned Our company generally does not follow a formally articulated negotiation strategy when 0% negotiating with suppliers 70%

60%

work with them in a collaborative fashion, and bringing new technology and innovative solutions to these customers. Our analysis indicates that, across the board, suppliers deliver significantly more value during contract implementation to customers that negotiate and work with them on a collaborative basis.

59%

Negotiation misconceptions
According to our research, more than 75 per cent of all buy-side and sell-side respondents believed the other side has more leverage during negotiations than they do. These apparently contradictory findings support the notion that relative leverage in negotiations is largely a matter of perception. Interviews and case study analysis in our study are consistent with our experience in strongly suggesting that structural factors (marketplace 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 informationsharing 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
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54%

44%

25%

50%

75%
SOURCE: VANTAGE PARTNERS

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 individuals 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.

Collaborative approach
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 buyside study participants in terms of self-reported value realised during contract implementation, 63 per cent 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
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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

FIGURE 4: WHERE HIGH PERFORMERS AND LOW PERFORMERS DIFFER
COMMON CHARACTERISTICS OF LOW PERFORMERS
• Negotiations are approached as an adversarial, zero-sum activity. • Negotiation is viewed as an event rather than a process. • Negotiation is an ad hoc activity; there is no formally documented process or methodology for planning or conducting negotiations with suppliers. • Negotiators focus on achieving narrowly defined mandates (specific positions on price, terms and conditions) with little understanding of the business context and objectives that lie behind those positions. • Negotiations focus on getting the most favourable contract terms – little time or energy is focused on ensuring successful implementation. • Negotiation is viewed as a tactical activity that is the primary or sole responsibility of commercial groups (eg, procurement, contract management). • There is little investment in development of negotiation skills, and all of that is focused specifically on individuals in commercial roles.

COMMON CHARACTERISTICS OF HIGH PERFORMERS
• Negotiations are approached as a collaborative activity focused on achieving mutually beneficial outcomes. • Negotiation is viewed and managed as a process, not an event. • There is a formally defined negotiation process that is fully integrated with the organisation’s sales process, sounding process or both. • Negotiators understand and focus on business objectives and context; as a result, negotiations are focused on joint problem-solving and mutual persuasion, rather than haggling. • Negotiations are focused on laying a foundation for working effectively with business partners, rather than simply getting favourable contract terms. • Negotiation is viewed as a strategic activity that requires cross-functional involvement from business technical, and commercial stakeholders. • Significant investments are made in building negotiation skills throughout the enterprise.

SOURCE: VANTAGE PARTNERS

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.

Unstructured, unpredictable
More than half of buy-side and sell-side respondents characterised their negotiations as somewhat or highly unstructured and unpredictable, another shocking statistic given the hundreds of millions of dollars at stake in commercial negotiations for even mid-sized companies, and the billions at stake for larger enterprises. Of the top 10 per cent of buy-side respondents (in terms of value realised from strategic sourcing), a mere 1 per cent characterise negotiations as highly unstructured and unpredictable, and only 32 per cent as somewhat unstructured
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and unpredictable. By contrast, among the bottom 10 per cent of respondents, 69 per cent characterised negotiations as “highly” or “somewhat” unstructured and unpredictable. Over half of the top 10 per cent of study participants reported following a formally defined negotiation process; they were four times more likely to do so than the bottom 10 per cent. These companies consider negotiation strategy development and planning to be key activities that must begin at the earliest stages of strategic sourcing, and be integrated through the sourcing process. By contrast, low performers overwhelmingly tended to describe negotiation as an activity of limited scope that happens only at the tail end of the sourcing process. Our research indicates that negotiation processes ensure that early sourcing activities are undertaken with an awareness of how they set the stage for more formal negotiations over pricing and terms later; that sufficient preparation takes place (a major challenge and a consistently cited barrier by both sides to better results); and that all relevant stakeholders (especially business and technical stakeholders) are involved throughout the negotiation

process, which leads to more robust and realistic agreements and an enhanced ability to work effectively together during contract implementation. Both buy-side and sell-side respondents ranked “creating a foundation of mutual trust, understanding and respect to enable effective contract implementation” low on their list of negotiation priorities (and perceived that the other side also gives this item a low ranking). Our analysis suggests it should be given greater priority in negotiations, and that a focus on building a foundation for effective contract execution and delivery can significantly improve the percentage of potential contract value realised during implementation. A lack of mutual understanding (specifically of expectations and organisational culture) and breakdowns in trust between trading partners were almost universally cited as a primary causes of significant execution problems and lost value. On average, organisations with formal supplier relationship management (SRM) programmes report realising 17 per cent more value from their strategic sourcing efforts than those without. Arguably, the statistical correlation is weaker than might be expected. On the sell side, survey data shows no statistical correlation between the presence of a formal key account management (KAM) programme and satisfaction with customer contracts, or value delivered to customers during contract implementation. Interviews and case study analysis suggest that the absence of a stronger correlation can be explained by two factors. First, many SRM and KAM programmes exist in name only; they are simply not effectively designed or implemented. The second related factor is that SRM programmes are too often divorced from strategic sourcing and supplier negotiations. Interviews and analysis focused on top performers indicate that they almost always exhibit a high degree of alignment and co-ordination between negotiation strategies and processes, and supplier relationship management programs than do other organisations. Buy-side study participants overwhelmingly cited end-users and technical staff working with procurement processes as
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the single biggest barrier to maximising value in negotiations with suppliers. Lack of internal stakeholder alignment, in general, was also reported as a top barrier. Interviews and case study analysis revealed that one of the most significant differences between high and low-performing organisations was the strength of relationships and collaboration between procurement organisations and their internal business partners. This finding mirrors other research we have conducted that indicates the closeness of these relations is one of the most critical determinants of benefits delivered on SRM. Both buy-side and sell-side respondents reported a general need to increase the negotiation skills in their functional areas. In general, procurement executives and professionals saw a much greater need to upgrade negotiation skills than their sellside counterparts did (this was especially true among the many buy-side managers and executives we interviewed who had experience in sales). Top-performing organisations consistently described negotiation as a fundamental business competency that warranted significant training and skill development investments. Low-performing organisations described negotiation in limited and tactical terms, and generally reported minimal investments in negotiation training and skill development.

CHECKLIST

HOW TO BUILD GREATER INDIVIDUAL AND ORGANISATIONAL COMPETENCE IN NEGOTIATION
• Invest in developing individual negotiation skills, inside and outside procurement. Develop negotiators who are strategic, principled and creative, who can be assertive and collaborative at the same time. Augment traditional training with on-the-job coaching, and job rotations between procurement and internal business partners, and between procurement and sales. • Document a formal negotiation process, integrated with the organisation’s strategic sourcing process. Involve internal business partners in the effort, and define clear roles and responsibilities that maximise constructive involvement by technical staff and endusers throughout the process. • Ensure negotiators and negotiation teams prepare effectively. Equip them with practical guidelines, templates and job aids, and then hold people accountable for using them. Conduct random audits or after-action reviews (a time-efficient way to measure compliance and assess the quality of negotiation preparation), and implement meaningful consequences based on audit results. • Ensure integration and alignment between goals and strategies for strategic sourcing, supplier negotiations, category management and supplier relationship management. • Forge close relationships with internal business partners. Insist that members of the procurement organisation understand the strategies, goals and constraints of the business units they support and help them to develop the skills they need to truly operate as trusted advisers, not as order-takers, gatekeepers or compliance police. • Create a cross-functional negotiation centre of excellence as a forum for key procurement, sales and technical staff to exchange negotiation lessons, and to act as coaches and advisers to the rest of the enterprise on critical negotiations. • Re-evaluate the metrics used to evaluate procurement’s value and contribution. Avoid relying solely on simplistic and often misleading metrics such as reductions in contract rate-cards and unit pricing. Develop better ways to measure total cost of ownership. Go beyond a single-minded focus on savings and find ways to measure supplier contributions to innovation and revenue growth. Connect the goals of procurement to measures of enterprise financial performance and demand to be held accountable, then align the incentives of procurement staff with those goals.

Low competency
Both buy-side and sell-side respondents (most of whom were procurement or sales executives or professionals) perceived individuals in technical and financial roles in their organisations as having the lowest competency in negotiation. Given the importance of financial analysis to negotiating and evaluating complex deal structures, and the degree to which successful implementation depends upon technical expertise (both to develop solutions during negotiations and to implement those solutions post-agreement), this is a serious problem. Our findings indicate that many buyside and sell-side professional try to limit the involvement of business and technical stakeholders during negotiations for fear they will say or do things that undermine or otherwise create disadvantage during
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the negotiation process. Ironically, such actions are often what lead internal stakeholders – and suppliers – to try to work around sourcing and procurement processes and policies. Such concerns are, in our experience, a matter of both perception and reality. Regardless, upgrading negotiation skills for all those with a role to play in developing and implementing supply agreements is a major opportunity for most organisations. Our research indicates strongly that realising the full potential of strategic sourcing depends heavily on effective negotiation strategy development and execution. This in turn requires systematic analysis and

preparation; the ability to bring technical and commercial people together to identify and explore cost-innovation opportunities with suppliers; and the ability to engage in tough conversations with suppliers in a principled, fact-based and empathetic manner that preserves (and even strengthens) sound business relationships. CPOs and supply chain leaders who want to reduce costs in sustainable ways, while reducing supply chain risks, preserving supplier viability and leveraging suppliers to drive innovation need to make the case for developing negotiation skills and capabilities not only in procurement, but across the enterprise. 
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About Vantage Partners Vantage Partners, a spin-off of the Harvard Negotiation Project, is a management consulting firm that specializes in helping companies achieve breakthrough business results by transforming the way they negotiate, and manage relationships with, key business partners. To learn more about Vantage Partners or to access our online library of research and white papers, please visit www.vantagepartners.com