What is Procurement Negotiation?
Negotiation in procurement management can be defined as a process that involves a formal discussion between the buyer and the supplier toward reaching the desired outcome based on a mutual agreement. The Chartered Institute of Purchasing and Supply defines negotiation as the ability to reach the desired outcome through discussion and compromise.
Table of Content
- 1 What is Procurement Negotiation?
- 2 Phases of Procurement Negotiation
- 3 Interface With Stakeholders
- 4 Types of Negotiation Strategies
- 5 Steps in Development of Negotiation Strategy
- 6 Outcomes of Negotiation
- 7 Methods for Win-Win Negotiation Strategy
Thus, negotiation is a process by which two or more parties, with conflicting requirements, interact to reach a consensus or agreement. The objective of the negotiation process is to ensure the supply of the right product/service at the right price, right time, right location, and the right quantity. Negotiation can be done offline like face-to-face interaction; or online like via social media, email, video conferencing, etc
Phases of Procurement Negotiation
According to Baily (2008), there are three phases critical to the success of a negotiated procurement relationship. These phases are the pre-negotiation phase, the meeting phase, and the post-negotiation phase.
The pre-negotiation phase involves preparatory work before the start of the negotiation. The preparatory work aims to answer questions like what are the objectives of the negotiation exercise, what is the priority of each of our objectives, what results we want to achieve, and what are the entry and exit points?
Here, it is important to understand the concept of entry points and exit points in negotiations. The entry point is the opening bid and the exit point is the walk-away position. The entry point is important as once the opening bid is disclosed, it is unlikely that it can be bettered during discussions. It is also important to know the exit point beyond which the negotiated agreement will not benefit the procurement manager.
For example, he might conclude the negotiation at such a price that he might regret it later when alternative options came to be known. Hence, it is important that proper homework in consultation with internal users is done before starting negotiations with prospective suppliers.
Zero-based Costing (ZBC) is one concept that plays an important role in the pre-negotiation phase. ZBC is a method of budgeting where all expenses must be justified for each function. The costing method starts from a ‘zero base’, and every function within an organization is analyzed for its needs and costs.
After analyzing the need, budgets are decided for the upcoming period regardless of whatever the budget was for the previous year. Thus, in ZBC, costs are built around regardless of whether the total cost is higher or lower than the previous one. This helps the organization in getting more current knowledge on costing. This can further help a buyer in having a strong position while negotiating with a supplier.
Apart from ZBC, ‘Best Alternative to a Negotiated Agreement (BATNA)’ is another important concept in negotiation. The term ‘BATNA’ was coined by Roger Fisher and William Ury in their 1981 book, ‘Getting to Yes: Negotiating Without Giving In’.
BATNA presents the most attractive course of action that an organization could take if negotiation fails and an agreement cannot be made. This ensures that the negotiator does not lose a possible negotiated deal or get involved in a deal that he might regret later.
The meeting phase of negotiation involves three stages: the introductory stage, the discussion stage, and the agreement stage. The introductory stage involves creating an atmosphere for negotiation, validating each other’s assumptions, testing the other party’s position, and clarifying issues.
The discussion stage of the meeting phase involves actual bargaining and negotiation. In this stage, the actual terms and conditions of the respective parties are revealed and discussed. It is important not to use manipulation or ploys while negotiating for long-term supplier partnerships which could be counter-productive in the long term.
Once a negotiated deal is achieved, parties can have an agreement on terms and conditions. The agreement stage involves concluding the deal by recording the full details of the various points agreed upon and formally finalizing the agreement.
The post-negotiation phase involves confirming each other’s responsibilities and implementing the agreement and monitoring the same. This phase is meant to drive home the point that no negotiation exercise can be considered successful until what has been agreed upon gets implemented as per the decisions, reached during the negotiation process.
Interface With Stakeholders
As discussed in an earlier section, procurement management requires proactive purchasing and embracement of the TCO concept. This requires the procurement department to build strong coordination with other departments in the organization.
The interfaces applicable to various internal and external stakeholders are discussed as follows:
Purchasing and Engineering
Interfacing with the engineering department is required during the selection of suppliers for identifying sources of technology and for clarification on material specifications. Technical inputs from the engineering department could be crucial in identifying the right suppliers.
Similarly, inputs from the purchasing manager are required during early product development initiatives. Proactive procurement planning requires early identification of material requirements for new products. It could be done by using scientific techniques for determining the requirements of raw materials, ancillary parts, components, and spares in advance.
The engineering department helps the procurement department in the preparation of a plan for procuring, storing, and handling materials required for producing products.
Purchasing and Production Operations
The purchasing manager always needs to interact with production and operations people who are the originators of material requirements. Though the generation of a bill of material is not the job of the purchasing department, it needs to work with the production department to understand material requirements to facilitate proper purchase order specifications and selection of suppliers.
The procurement manager should have good knowledge of production and material requirements plans. In addition, he/she must understand the process of generating material requirements through these plans.
Purchasing and Suppliers
The purchasing department should closely monitor suppliers with whom it has a long-term partnership. The suppliers are often provided with material requirement plans and forecasts so that they could manage the supply of materials accordingly.
This helps in a smooth supply chain process and ensures continuous production flow. In addition, suppliers are involved in the purchasing department in the early phases of research and development activities to provide inputs for improving the production process.
Purchasing and Finance
Interaction with finance and accounting is required for capital budgeting and making/buying decisions. Inputs from purchase managers are required for capital equipment selection while evaluating capital budgeting projects.
Apart from this, the purchasing department always interacts with the finance department with regard to the accounts payables function which ensures the matching of goods procured before making payments to suppliers.
Though these routine interfaces with other departments are processed through electronic systems, it is necessary for the purchase manager to understand the nature of interaction required as part of various business processes.
Purchasing and Quality
The involvement of quality and inspection personnel is required in supplier selection, supplier quality performance evaluation, supplier development for future projects, and for understanding material requirement specifications.
The purchasing department can provide quality function visibility to the supplier quality processes for arriving at process capability indexes. The interface between the two departments is required for establishing check procedures and handling defective supplies.
Types of Negotiation Strategies
Negotiation is a method whereby two or more parties intend to reach an understanding or to the end point of a discussion. A negotiation strategy includes all action plans and activities required for successfully achieving negotiation objectives. It helps in reaching a mutually beneficial agreement with the supplier. There are two extreme types of negotiation strategies, which are:
Collaborative (or Integrated) Bargaining
It refers to taking a non-confrontational, problem-solving, and collaborative approach to creating multiple options that ultimately lead to expanding bargaining limits.
It involves rigid bargaining that takes place on the basis of concrete facts with the goal of winning or breaking.
Steps in Development of Negotiation Strategy
Most negotiations fall in the middle of these two extremes and depend on two dimensions: competition in the supplier market and buying situation of the buyer. Important steps to be followed while planning and developing a strategy for negotiation:
Create Specific Goals and Objectives
The procurement manager must be clear on the objective of the negotiation before it actually takes place. In procurement negotiation, the primary objective is to reach an agreement on a fair and reasonable price and related procurement terms.
The procurement manager, thus, should be clear as to what is the range of prices and other factors like lead time, quality, etc. that he should focus on while negotiating with suppliers. Here the procurement manager may take the help of BATNA (explained in detail in the previous chapter) to find the best alternative to a negotiated agreement.
Gather All Relevant Information
The next important step is to do proper homework before going to the actual negotiation phase. The procurement manager should study the supply market, industry cost structure, major players, and supplier cost structure, and also perform price and cost analysis if required.
Apart from the knowledge repository of the organization, information can be gathered from trade journals, trade publications, trade associations, government reports, company annual reports, industry credit reports, commercial databases, and the Internet. It is necessary not only to understand the supply market and supplier cost structure but also to know the strengths and weaknesses of the supplier. This helps formulate appropriate negotiation strategies and tactics.
Determine the Levers for Negotiation
The negotiation strategy depends largely on the nature of the procurement situation, which depends on two dimensions: competition in the supplier market and buying situation of the buyer (discussed earlier. Strategic levers of buyers and suppliers can determine the nature of the negotiation strategy adopted.
These levers refer to the power that one negotiation party may use to influence the other party to solidify their negotiating position. The two types of strategic levers and their associated factors that help the buyer/ supplier in holding the leverage position are shown in Figure 4.4:
Buyer’s strategic levers help the buyers bring down the price of products and services they buy. It is usually high when there are multiple suppliers in the market or the buyer purchases a significantly large portion of the product/service from the supplier. In addition, the buyer’s strategic lever is also high if the buyer can easily switch to other organizations.
On the other hand, the supplier’s strategic lever is high in case the supplier is able to increase the price of products supplied to the organization. It is usually high if there are a few suppliers supplying to a relatively high number of buyers in the industry, or if the product or service is unique and there is no good substitute for the products.
Establish the Position on Various Issues
It is necessary to identify various possible issues of conflict that might arise during negotiation between the buyer and seller. Based on the issues identified, a negotiation position should be established. It involves establishing the bargaining zone, i.e. entry and exit points and overlapping positions. Any proposal offered outside this range will most probably be rejected.
The buyer should be clear on the following ideas before the negotiation starts:
- Minimum Acceptable Solution: Anything less would affect the business
- Maximum Supportable Solution: Best proposal possible for the buyer
- Best Alternative to a Negotiated Agreement (BATNA): An alternative that the buyer should take if the supplier refuses to agree to the bottom line. BATNA is the point at which the buyer invokes a switching strategy.
Develop Negotiation Strategies and Tactics
While a strategy refers to the overall approach required to achieve goals, negotiation tactics are short-term plans and actions used to influence the counterparty toward achieving negotiation objectives.
A negotiation strategy is necessary for ensuring that the process is under control and progressing toward achieving the goals. The tactics, on the other hand, are meant to ethically persuade the counterparty to endorse a certain position.
However, manipulative tactics should be avoided which can prove counter-productive for long-term partnerships. However, the knowledge of tactics that the counterparty might use could be highly useful.
Following are some tactics against which the negotiator should be well prepared:
- Lowball: It involves offering an unusually low price in order to get a new business.
- Caucus: It is a tactic of buying time when negotiation is going poorly.
- Trial balloon: These are questions that test acceptability. The on-the-spot reaction to the idea suggests whether the parties should pursue the idea further.
- High ball: In an attempt to shift the bargaining position in his favor, the seller might take an abnormally high initial position with a very high initial price. Any concession from this position may make the position more acceptable to the buyer.
- Best and final offer: This tactic signals the end of a negotiation on a given issue. It forces the other party to take a stand.
- Silence: An awkward silence is meant to encourage further offers and concessions.
- Planned concessions: A tactic to influence the counterparty’s behavior and force the other party to reciprocate.
- Price increase: Sellers might warn that if the buyer does not agree to a certain price, the price will soon increase which could merely be a tactic for a well-prepared buyer who has done an extensive cost and price analysis.
- Brinkmanship: A tactic used to identify BATNA by challenging the existing balance of power
- Single issue bargaining: It is a supplier tactic used for negotiating a cost increase by increasing one cost element.
- Confusion: A tactic to avoid addressing a contentious issue by creating confusion and steering all discussions away from the point at hand
Involve Other Stakeholders and Finalise the Strategy
The procurement function has cross-functional objectives as it impacts several other stakeholders in the organization. You have already studied the importance of procurement interfaces with other disciplines like engineering, marketing, materials, finance, etc in the previous chapter.
It is important to involve other stakeholders, and if required, form a cross-functional team, to analyze various factors involved in the procurement process and formulate an appropriate strategy. For example, whether for TCO analysis-based supplier selection or target pricing-based negotiation, the involvement of all other stakeholders in the P2P cycle process is essential.
Outcomes of Negotiation
The key purpose of any negotiation is to reach a conclusion. This conclusion is called the final outcome. When a buyer negotiates with a seller, he/she should determine the factors that might affect the final outcome of a negotiation. Some of these factors are:
Power and Position
It is one of the keys influencing factors in negotiation. Holding a sound position in the market helps buyers to strongly justify their opinions during negotiation.
It is mastery that a seller should have to hold effective negotiations. This expertise may include communication, knowledge about facts and statistics, decision-making, etc. Thus, a lack of expertise may have an adverse impact on negotiation
Negotiation is not done to accomplish its objective for once. Buyers need to buy products from sellers and indulge in negotiation on a regular basis. Therefore, it is essential for buyers to establish long-term relationships with sellers. Sound relationships may help buyers avail various attractive offers such as price discounts, trade discounts, low shipping costs, etc. from sellers in the long run.
To undergo the entire negotiation, a buyer should know how to communicate with the seller. During communication, some other associated factors are the selection of words, convincing skills, personality, etc.
The outcome of the negotiation is based on the entire process of negotiation. The following are the possible outcomes of the negotiation:
This happens when both parties are reluctant to compromise and conclude the deal with a loss. This type of outcome takes place due to some personality and attitude issues between the parties. Such issues may include ego, stubbornness, aggressiveness, etc.
It is a situation when one party dominates the other due to his/her strong analytical, convincing and ruling personality. In this situation, one party wins against the other in the negotiation process, which may end the relationship between the buyer and seller.
This is the outcome that every negotiator desires to end with. In this situation, both parties are satisfied with the conclusion as their terms and conditions are mutually agreed upon and accepted. The win-win outcome leads to a long-lasting rapport between the buyer and the seller. Thus, the scope of future negotiation also remains wide and open for both of them.
This is the most typical outcome of the negotiation. Stalemate occurs when both the parties end negotiation without winning or losing a point. This is because, by undergoing the disputes and arguments, they both reach to the same point from where they started the negotiation. Stalemate happens when both parties strongly defend their positions and are reluctant to give each other space for compromise.
Methods for Win-Win Negotiation Strategy
As discussed, every negotiator wants a win-win outcome for any negotiation process. There are five different methods for pursuing win-win negotiations. These methods are explained as follows:
Expanding the pie
Negotiation should not result in a zero-sum game. Creative ideas can be formulated to expand the available resources or to generate new values. In a long-term partnership, the cost quoted in the initial proposal is not the only thing when considering future procurement requirements.
Apart from price, several alternatives can be explored to reach a win-win agreement where both parties can gain significantly. In competitive bids, where price alone matters, additional value-creating options that offset the price issue can be considered.
It refers to an agreement to trade off issues so that both parties can satisfy their top-priority issues. Thus, it is a type of cooperative move where both parties gain. Price could be the top priority for the supplier, while the buyer might give equal importance to quality issues. Here, by appropriately structuring the contract, the total cost of ownership for the buyer can be brought down.
Using Non-Specific Compensation
The method aims at reaching a solution, where, if, one party achieves its objectives on an issue, the counterparty also receives something of value as a reward. For example, a buyer may be interested in a supplier committing to a continuous cost reduction program as part of a target pricing initiative. In this case, the buyer can provide their expertise and agree to share any resulting cost savings technique with the seller.
Cutting Costs for Compliance
Both parties work jointly to reduce the supplier’s costs so that the buyer’s target price is achieved. This has now become a normal aspect of supply chain partnerships.
Finding a Bridge Solution
A bridge solution refers to inventing new options that satisfy each party’s needs. This could involve jointly creating solutions that meet the interests of both parties.