Making sourcing more strategic: Negotiating uncertainty during times of turbulence

In a business environment fraught with volatility and uncertainty, CPOs and sourcing and supply chain executives confront unprecedented challenges. Companies are reevaluating global supply chains built over decades in the face of heightened geopolitical tensions.  Supply chain resilience is an imperative, but not sufficient—supply chain agility is now required. Meanwhile, the pressure to reduce costs continues unabated. Navigating this daunting landscape requires a reevaluation of traditional sourcing strategies—with special emphasis on how negotiations between customers and their suppliers create, or destroy, economic value.

Based on research conducted over the past 15 years (spanning the global financial crisis, COVID, and its aftermath) involving more than 600 companies, and more than 800 individual survey responses from both buy-side and sell-side executives and professionals, we share insights and advice for procurement and supply management leaders as they look to weather current challenges and also position themselves for long-term future success.

Reassessing the benefits and limitations of strategic sourcing

It has been decades since the discipline of strategic sourcing transformed purchasing practices within most companies. Significant savings and other benefits (improvements in quality, reduction in supply base complexity and supply risk) have been achieved as a result. 

Notwithstanding the claims by many procurement organizations of significant savings achieved, CFOs and other senior executives have become more skeptical. Often, such savings do not show up in the bottom line nor in key measures of corporate financial performance like return on invested capital (ROIC) or earnings per share. There are many reasons for this, but few procurement leaders have focused significant energy on investigating why this is so often true or what to do about it. 

Strategic sourcing, in practice, has too often translated into a focus on short-term cost reduction versus long-term value. Efforts to apply sourcing discipline to improve quality, reduce supply risks, and drive innovation with suppliers often take a distant back seat to annual price reductions—which may or may not translate into real savings over time.

In fact, at many companies, strategic sourcing has been reduced to a caricature of itself. Sourcing teams and procurement professionals rely almost exclusively on competitive bidding and have neglected other, more complex sourcing strategies like working with suppliers to revise requirements, redesign parts and components, and reengineer forecasting, demand management, and logistics processes. 

In the early days of strategic sourcing, when companies were just gaining control over what had been almost completely ad hoc purchases and began subjecting many suppliers to competitive pressure for the first time, this focus was understandable, and arguably appropriate. Now the low-hanging fruit has been picked. New strategies, organizational competencies, and individual skills are needed.

Perhaps the greatest barrier to the future success of many procurement organizations is an over-reliance on the strategies and techniques that have made them successful over the past thirty years. Procurement has made some progress evolving from back-office, requisition-processing support, but the dream of being viewed as a truly strategic function within the enterprise remains elusive for many.

Strategic sourcing efforts often fail to deliver expected results

While strategic sourcing initiatives have helped many companies reduce costs and improve supplier performance, a significant portion of the value expected to result from strategic sourcing efforts goes unrealized—on average, 45% according to buy-side participants in our study.

Our research and experience working with clients both overwhelmingly suggest that common strategic sourcing techniques like spend and market analysis, RFx processes, and competitive bidding, while still useful, are increasingly less effective. The vast majority of individuals we interviewed who were directly involved in strategic sourcing events and purchasing reported that negotiations with suppliers are the most challenging part of strategic sourcing.

There are many reasons for the reported gap between value targeted and value realized from sourcing initiatives. In some cases, study participants pointed to goals and savings targets that were unrealistic. Far more often, though, they blamed challenges that arose in negotiating contracts with suppliers, and problems that occurred working with suppliers after contracts were signed. Often, challenges negotiating and implementing contracts with suppliers were exacerbated by challenges gaining alignment on negotiation goals, strategies, and roles with internal business partners.

During the past 20 years of conducting research and working with clients, we have observed something of a whipsaw in the primary concern of sourcing and procurement organizations. In markets when commodity and talent shortages tip the balance of power in favor of suppliers, the concern focuses on how to negotiate when suppliers seem to hold all the cards. When supply market capacity outstrips demand, the concern shifts to deciding how aggressively to negotiate with suppliers without driving them out of business or creating significant quality and safety risks, or damaging relationships with long-term supplier partners.

Both customers and suppliers are dissatisfied with the value delivered during contract implementation

Both buy-side and sell-side participants in our research reported that a significant amount of potential contract value isn’t realized during implementation. Not surprisingly, customers grade their suppliers more harshly than suppliers grade themselves. On average, customers reported realizing only 54% of expected or potential contract value during implementation, while suppliers reported delivering 66% 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 striking.

On its face, 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 that we conducted after reviewing survey results, sell-side executives and professionals confirmed that indeed, suppliers themselves are often significantly dissatisfied with the value they deliver to customers. As it turns out, 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 contracted agreements;
• Customers failing to meet their obligations to provide staff and resources needed to successfully implement agreements;
• Customers changing (often multiple times and at the last minute) specifications and requirements; and
• Customers failing to meet contracted commitments for volume of business.

Exhibit 1: Reasons for lost value

Many procurement organizations and professionals acknowledge that they have become overly reliant on competitive bidding as a strategy to reduce costs and motivate suppliers to deliver (or promise to deliver) lower costs, and better performance and value. When confronting situations where competitive pressure is of limited utility (single- and sole-source suppliers, high switching costs, suppliers already operating a relatively lean business and themselves under significant financial pressure), buyers often feel like they have little ability to achieve savings or capture additional value from supply contracts. 

Results from the study mirror our experience that most organizations have, by now, realized gains from relatively low-hanging fruit such as consolidation of spend and introduction of basic competitive bidding discipline, and now need to focus on developing more sophisticated negotiation and supply chain management strategies and capabilities.

Negotiation is generally seen as an adversarial process

Over 80% of buy-side and sell-side respondents perceive negotiations to be highly or somewhat adversarial. Given that virtually all 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.

Interviews we conducted and in-depth case study analysis of dozens of major negotiations bear out the intuitive proposition that adversarial negotiations lead to significant challenges in contract implementation. Companies and individuals who believe 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.

A collaborative approach to negotiations leads to better results

Procurement organizations that report employing a collaborative (versus adversarial) approach to negotiations report greater satisfaction with their negotiated agreements, and with the value realized from those agreements during implementation. Of the top 10% of buy-side study participants (in terms of self-reported value realized during contract implementation), 63% described their negotiations as “highly collaborative” or “somewhat collaborative.”

By contrast, of the bottom 10% of buy-side study participants, 64% characterized their negotiations with suppliers as “highly adversarial” or “somewhat adversarial.” Those employing a collaborative negotiation approach report more positive working relations with suppliers, fewer unexpected problems during contract implementation, and a far greater ability to effectively and efficiently work through problems that do arise.

The chart below shows the correlation between the way study participants characterized the nature of negotiations with their suppliers, and their subjective level of satisfaction with value delivered by suppliers during contract implementation.

Exhibit 2: Satisfaction with contract value delivered based on the nature of the negotiation process

 

A collaborative approach to negotiations doesn’t mean being “soft” or “giving in”

Interviews with high performers reveal an ability to negotiate assertively and collaboratively (both in the sense of treating individual counterparts with a high degree of respect, and in the sense of actively searching out mutually beneficial solutions) at the same time. Average and low performers overwhelmingly perceive a debilitating zero-sum trade-off between being assertive and being collaborative.

Similarly, top-performing procurement organizations balance the use of competitive sourcing and bidding with negotiation strategies and approaches that are highly collaborative (i.e., 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 report increasingly systematic efforts to invest in customers who are willing and able to act as collaborative business partners (irrespective of sales volume), and to limit or sever ties with customers who are not. Sell-side participants also describe consciously assigning their “A-level” delivery teams to customers who negotiate and work with them in a collaborative fashion, and they bring new technology and innovative solutions to these customers as well.

Our analysis indicates that, across the board, suppliers deliver significantly more value during contract implementation to customers who negotiate and work with them on a collaborative basis.

Leverage is largely a matter of perception

According to our research, more than 75% of all buy-side and sell-side respondents believe the other side has more leverage during negotiations than they do. The apparently contradictory nature of these findings supports the notion that relative leverage in negotiations is largely a matter of perception. Interviews and case study analysis conducted during our study are consistent with our experience in strongly suggesting that structural negotiation factors (marketplace supply relative to demand, proprietary technology, etc.) 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, as shown in Exhibit 3. As described below, 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 those agreements.

Exhibit 3: Symmetrical perceptions of lack of leverage fuel adversarial negotiations

 

Based on our analysis, most negotiators consistently overestimate their counterpart’s willingness and ability to walk away, while underestimating their own ability to do so, as well as their own ability to influence the other side. High-performing organizations tend to systematically assess leverage from multiple angles as part of developing and executing formal negotiation strategies. They avoid the common mistake of assuming that because it would be painful for them to walk away from a potential deal, it would necessarily be easy or painless for the other side to do so.

More significantly, while top performers do not ignore questions of leverage, they think about negotiation power in a more robust, 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 creative solutions or identify efficient trades that help both sides achieve their goals.

Disclosure is a major challenge during negotiations

Lack of significant disclosure by the other side was cited as a significant barrier to maximizing value achieved in negotiations by both the buy-side and sell-side respondents (though each side viewed its own lack of disclosure as far less serious). But while both sides recognize the additional value that could be realized by broader disclosure, they also fear that such disclosure will be exploited by their negotiation counterparts. (In the negotiation literature, this is referred to as the “Negotiator’s Dilemma.”)

A lack of trust between trading partners, and a generally adversarial and tactical approach to negotiations, mean that communication and disclosure during negotiations is often highly constrained. This dynamic goes a long way to explaining the enormous value leakage during contract implementation reported by both buy-side and sell-side study participants.

Organizations that implement a formal negotiation process realize better negotiation results 

More than one-half of buy-side and sell-side respondents in our research characterize their negotiations as somewhat or highly unstructured and unpredictable—another striking 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.

Among the top 10% of buy-side respondents (in terms of value realized from strategic sourcing), a mere 1% characterize negotiations as highly unstructured and unpredictable, and only 32% as somewhat unstructured and unpredictable.  By contrast, among the bottom 10% of respondents, fully 69% characterize negotiations as “highly” or “somewhat” unstructured and unpredictable. 

Over half of the top 10% performing companies reported following a formally defined negotiation process; they were 4 times more likely to do so than the bottom 10%. 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 described negotiation as an activity of very limited scope, something 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 awareness of how they set the stage for more formal negotiations over pricing and terms later;
• Sufficient preparation takes place (a major challenge and consistently cited barrier to better results on both buy-side and sell-side); and
• All relevant stakeholders (especially business and technical stakeholders) are constructively involved throughout the negotiation process.

All of the above lead to more robust and realistic agreements, and an enhanced ability to work effectively together during contract implementation. 

Trust and negotiation

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 that this factor should be given greater priority in negotiations, and that a focus on building a foundation for effective contract execution and delivery can significantly improve value realized during contract implementation.

A lack of mutual understanding (specifically of expectations and organizational culture), and breakdowns in trust between trading partners were almost universally cited as primary causes of significant execution problems and value erosion, as Exhibit 4 illustrates.

               

Aligning negotiation with relationship management

Organizations with formal supplier relationship management (SRM) programs report realizing, on average, 17% more value from their strategic sourcing efforts than those without, though 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 KAM (Key Account Management) program 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 programs exist in name only—they simply are not effectively designed or implemented. Thus, while there is a formal statistical correlation, it is significantly weakened because the data do not reflect any assessment of the quality of SRM (or KAM) programs.

That said, buy-side respondents that reported having both a formal SRM program and a formal category management process were 8 times more likely to be in the top 25% of buy-side respondents (versus the bottom 25%) in terms of contract value realized during implementation.

The second related factor is that SRM programs are too often divorced from strategic sourcing and supplier negotiations. Interviews and analysis focused on top-performers indicate that they almost always exhibit a higher degree of alignment and coordination between their negotiation strategies and processes and their supplier relationship management programs than do other organizations, as reflected in Exhibit 5.

Exhibit 5: How different negotiation approaches correlate with value realized

 

Internal alignment is critical to negotiation success

Buy-side study participants overwhelmingly cited end-users and technical staff working around procurement processes as the single most significant barrier to maximizing value in negotiations with suppliers. Lack of internal stakeholder alignment, in general, was also reported as a top barrier.

Interviews and case study analysis reveal that one of the most significant differences between high- and low-performing organizations was the strength of relationships and collaboration between procurement organizations and their internal business partners. This finding mirrors other research we have conducted on supplier relationship management, which indicates that one of the most critical determinants of benefits delivered through SRM is the quality of relationships and collaboration between procurement and internal business partners.

Exhibit 6: How lack of a formal negotiation process and lack of stakeholder involvement contribute to value erosion

 

Developing negotiation skills needs to be a top priority

Both buy-side and sell-side respondents reported a general need to increase negotiation skills within their functional areas. In general, procurement executives and professionals saw a much greater need to upgrade negotiation skills than their sell-side counterparts.  (This was especially true of the buy-side managers and executives we interviewed who had prior experience in sales).

Top-performing organizations consistently described negotiation as a fundamental business competency—one which warranted significant training and skill development investments. Low-performing organizations described negotiation in very limited and tactical terms—and generally reported minimal investments in negotiation training and skill development.

Both buy-side and sell-side respondents (most of whom were procurement or sales executives or professionals) perceived individuals in financial and technical roles within their organizations as having the lowest level of negotiation competency. 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 research findings indicate that many buy-side and sell-side professionals try to limit the involvement of business and technical stakeholders during negotiations due to concerns that they will say or do things that undermine leverage or otherwise create disadvantage during 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 organizations.

Investing in the future of procurement

Our research strongly indicates that realizing 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 simultaneously 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. (Below we summarize seven key strategies leading organizations are employing to build greater individual and organizational negotiation competence.)

At the same time, other companies are balancing the need to take sometimes drastic actions in the short term while keeping an eye on long-term consequences and opportunities. They are renegotiating contracts with suppliers in a collaborative fashion, and with a commitment to finding solutions that work for both sides, and they are emphasizing creative deal structures and leveraging innovation to reduce costs, rather than demands and threats.

Moreover, a significant percentage of companies see a silver-lining in the downturn.  Recognizing that many of their competitors are squeezing suppliers and doing long-term damage to working relations, these companies are actively investing in building closer, more collaborative, and more committed relationships with key suppliers. As the economy improves, they will have privileged access to supplier capacity, innovation, and investment; their competitors will be put on allocation or worse. 

7 strategies for building individual and organizational negotiation competence

1. 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. 
2. Document a formal negotiation process, integrated with the organization’s strategic sourcing process. Involve internal business partners in the effort and define clear roles and responsibilities that maximize constructive involvement by technical staff and end-users throughout the negotiation process.
3. 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.
4. Ensure integration and alignment between goals and strategies for strategic sourcing, supplier negotiations, category management, and supplier relationship management.
5. Forge close relationships with internal business partners. Insist that members of the procurement organization understand the strategies, goals, and constraints of the business units they support, and help them develop the skills they need to truly operate as trusted advisors—not as order-takers, gatekeepers, or compliance police.
6. Create a cross-functional negotiation center of excellence as a forum for key procurement, sales, and technical staff to exchange negotiation lessons, and to act as coaches and advisors to the rest of the enterprise on critical negotiations.
7. Reevaluate the metrics used to evaluate procurement’s value and contribution.  Avoid relying solely on simplistic and often misleading metrics like 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.

About the Authors

Jonathan Hughes is the national managing principal and global leader for BDO Management Consulting. He has consulted to Global 2000 clients on issues of strategy for more than 20 years. A frequent keynote speaker, he has contributed dozens of articles to leading business journals—including MIT Sloan Management Review, Harvard Business Review, Ivey Business Journal, Supply Chain Management Review, California Management Review, and other U.S. and international publications. Jonathan graduated with honors from Harvard University with a degree in philosophy. 

Ashley Hetrick is a principal and the sourcing and supply chain segment leader in BDO USA’s Management Consulting practice. She has spent more than 15 years working with procurement and supply chain organizations, with a focus on semiconductor, biopharmaceutical, and extractive industries. A frequent conference speaker, Ashley has contributed to MIT Sloan Management Review, Supply Chain Management Review, and Ivey Business Journal, among other publications. She received her M.S. from Brandeis University and a bachelor’s in international business from The University of Texas. 

Phil Liu is a Managing Director and the Procurement Transformation practice leader in BDO USA’s Management Consulting practice. He has dedicated his career to help Procurement, Finance, and Global Business Service (GBS) leaders stand up global operating models, drive Source-to-Pay (S2P) Transformations, execute category value creation initiatives, and pilot emerging Procurement AI technology solutions.

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