Having trouble negotiating successful long-term agreement? Change your tactics!

Supply chain executives - and Nobel-prize-winning economists like Oliver Williamson - agree: Great efficiencies can be achieved by shrinking the supply base and establishing long term-agreements (LTAs) with suppliers. The practice has also been validated by our own practical work in the field, consulting with industry leaders across a broad swath of American business.

And yet, the benefits of establishing LTAs—namely, deep value creation— don't happen automatically. They are the product of constant negotiation; but negotiation of a new and different kind than past practices.

The Problem with Short-term Solutions

Conventional negotiating is based on using the power of the marketplace to gain fair pricing as well as other favorable terms. Traditional purchasing tactics, where buyers force rival suppliers to vigorously compete for their business, gives the supply-chain organization a certain degree of confidence that they are receiving bottom line—or at least fair—pricing.

But exclusive reliance on that approach can raise problems. While the competitive whip of the marketplace may keep supplier organizations on their toes, it also discourages them from investing their time and resources in finding long-term efficiencies for their customer. After all, the business won in the marketplace this year can just as easily be lost next year to a hungrier supplier.

It is only when the purchasing organization commits to doing business with the same supplier over the course of a multi-year agreement that the supplier can commit to taking the steps necessary to add value.

The Negotiating Challenge in Making LTAs Work

The hoped-for dividends from LTAs often bump up against a practical challenge: the loss of purchasing leverage in this new way of doing business. The supplier needs reassurance that their commitment to work on long-term efficiencies for their customer is not going to be undermined by market forces, i.e., being replaced by a competitor offering a better short term deal. But once that assurance is given, the incumbent supplier suddenly finds themselves in a far stronger position and consequently, with far less concern for keeping the customer happy.

Some suppliers follow through on their commitment to boost their performance; others take advantage of their newfound leverage to boost their margins by cutting corners and under-performing. Among supply-chain organizations with whom we have worked, far too many report that LTAs are hit or miss arrangements.

Faced with a relationship that is not working as hoped, purchasers tend to fall back on the tactics they know best: the hard bargaining tactics that depend on market leverage. But once the supplier has assumed a position of greater strength those tactics are now seen as idle threats instead of viable options.

New Tactics to Fit New Conditions

What is the solution? Our advice is that supply-chain professionals need to broaden their horizon in terms of what constitutes the negotiating process. Instead of focusing on just one type of negotiating, use the full continuum of modes that span the negotiating spectrum. This continuum begins with basic bargaining, progresses into creative deal-making, and finally ends with strategic, relationship-based negotiating.

Not only does each mode have its own set of tactics but the tactics that work well in one mode may be counter-productive in another. For example, in forming a LTA, market-based tactics, so effective in bargaining over price, are the wrong ticket when the goal shifts to building a mutually-beneficial, ongoing relationship.

When negotiating under this new working arrangement different tactics are needed; tactics that serve a dual purpose. The first requirement is to build confidence that the relationship will bring benefits to both sides. The second involves tactics to keep the supplier honest. The carrot and the stick.

Confidence-building tactics include making gratuitous concessions, where cost savings and other value-creating benefits are shared liberally with the supplier rather than taking a bargaining approach, where swords are drawn over every penny up for grabs. Yet, as we have seen, supply chain organizations that assume the LTA will automatically work have been sorely disappointed.

Which is why tactics that build confidence only work if they are coupled with another set of tactics: those that insure supplier compliance with the spirit of the agreement. These include: first, establishing KPIs (Key Performance Indicators) to track the progress of the deal; and second, constant monitoring of the supplier's performance. Finally, if necessary, creating a BALTA (Best Alternative to a Long-Term Agreement) to keep market lanes open.

LTAs represent not only an excellent way to add value but potentially may be the wave of the future. Yet, that potential will only be realized if the new relationship is aligned with the proper negotiating tactics.

You can read more about negotiating long-term agreements in the July issue of Supply Chain Management Review.

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