Every term in contracts and negotiations should be of some value. And each term has an associated cost. As a negotiator, knowing the rationale for a term enables you to articulate the value and identify its cost. The value of the total deal is the aggregate impact of all the terms. If you don’t understand the rationale behind the terms, not only is your credibility impacted, but so is your leverage.
Suppose you are negotiating a private label distribution OEM (original equipment manufacturer) deal, representing the seller. The seller’s standard agreement has a term in the contract that states: “In the event any part fails within the warranty period, the customer may return the part at customer’s expense and supplier will send a replacement part within three business days.”
When the customer sees this, she indignantly raises her voice: “I can’t believe you would expect me to pay for shipping…my people test the parts and it’s your part that fails! I won’t pay shipping costs for defective parts!”
A poor negotiator might make the following response: “Hmm…you are right. This doesn’t make sense to me, either.”
How does the customer feel about that reaction? One possibility is that it creates the impression that the deal is filled with such “throwaway” terms, and that you really don’t understand your own contract. Every part of the deal will now come under greater scrutiny, which will prolong the negotiation and cause further erosion of your terms and prices. In cultures such as Japan or Mexico, where your potential customer highly values the relationship aspects of deal making, they assess credibility early in the cycle. In this instance, surrendering credibility at square one could cause the potential buyer to walk away completely.
When challenged on any term by the other side, first explain the rationale for the term to assure them that the contract is rational and credible. This means that before you offer any terms, you must first understand why the terms are in the contract. In the above scenario, you as the negotiator might say, “Let me explain why this term is in here. The good news is our parts fail infrequently, but if we were to issue credits for shipping, we would need to change our entire receiving process to one that is less efficient and requires an additional person from procurement to issue shipping credits. You get the benefit of a leaner process that lowers costs, but will need to pay for shipping the few times this happens. I could find out what the cost of changing the process would be, but in the past that wasn’t cost-effective, and that cost would affect your overall price. Please let me know if you would like me to look at it again.”
The customer may not be persuaded, but with this approach at least you will keep your credibility. These kinds of issues are especially important in the international context. The responsibility for costs can mean the difference between profit and loss. Increased costs of doing business internationally – shipping or the degree of governmental regulations – should also be part of your value equation.
Remember, there is no “free lunch.” Changing any term has an impact that is usually quantifiable to you or the other side. If you can’t articulate that impact, the other side’s logic should prevail. If that is because of ignorance, the change you make will cost you something. The aggregate effect of making these kinds of changes could ultimately change a profitable deal into an unprofitable one. Just ask the company that was eager to win some outsourcing business with an international financial institution. In competitive negotiations the bank requested that the vendor’s operations support it and its affiliates and subsidiaries, striking the word “named” before affiliates and subsidiaries. The vendor did due diligence and felt they were covered. After the contract, when it turned out that the bank had subsidiaries in certain African countries that were not known to the vendor, the costs of providing that support cost the vendor millions, as did the dispute that ensued. It was a term that cost a lot of money.
With this in mind, it is also important to recognize the two-sided nature of value:
- One side means value to you. What are you giving up to make the deal?
- The other side is the value perceived by the people with whom you’re negotiating.
In the bank example, the change in the term was worth something to the bank that they would have been willing to pay for to ensure coverage. Likewise it had a value (cost) to the vendor.
If the other side perceives that you are giving up something of value, they are more likely to treat a concession you offer as something of value to them. If you are not treating the conceded term as anything of value to you by at least explaining your rationale, the customer will not treat it as anything of value to them in the concession process. As a result, they will not give you something of value in return. A principled concession based on your knowledge of the value of the conceded terms impacts leverage in your favor.
Summary: It is critical to understand the cost and value of all terms in the deal to both parties.
