Procurement & Supply Chain

Negotiating a Supplier Contract Through the SRM Lens

Contract negotiations with a supplier is the point at which a business should begin building a positive relationship for the long term. The negotiation process is about much more than price. It is about developing a collaborative association to create value for the supplier and buyer.
— By Lena Haram

The supplier has been selected, and now it is time to negotiate the contract terms. The process is often approached as a negotiation over price when it should concern much more, including establishing a positive working relationship from the start. Price is just one factor, and focusing mostly on that one factor ignores the opportunities to develop the foundation of supplier performance that leads to successful supplier relationship management (SRM) and greatest value generation.

In today’s supply chains, other measurable criteria are as crucial as price. For example, business customers expect a quality customer experience which includes things like price, product quality and timeliness of order delivery. Suppliers also play a big role in minimizing supply chain risks because of their knowledge of communities and regions and can become invaluable partners in activities like product designs and technology utilization. Contract negotiations is the ideal time to establish a good working relationship over the life of the contract.

Looking Beyond Price

During supplier contract negotiations, the parties involved may seem to have different goals in mind from the start. The reality is the goals are similar because success on both sides does include negotiating a fair price for the delivery of quality products or services that help both businesses remain competitive and grow.

The goals should not stop there though because the way negotiations are handled and the outcomes that emerge set the tone for the supplier-corporate relationship over the life of the contract. If a corporation only emphasizes price, there is little motivation to develop a mutually beneficial relationship defined by business alignment and continuous improvement.

There are other factors as important as price or cost minimization in today’s business environment. They include minimizing risks, environmental sustainability, on-time performance, maintaining quality, utilization of diverse suppliers, business sustainability, technology, ethics, logistics, human rights, and a host of other issues critical to competitiveness and reputation.

It has become clear over the past few years that supplier behavior, even in the remotest areas, reflects on the purchasing company. The contract negotiation process becomes one of building trust in each other.

Creating Mutual Value with Integrative Negotiation
One of the most difficult processes a company goes through is negotiating a contract. There are two main negotiation types.

One is called integrative negotiation in which more than one issue is negotiated and the parties involved make tradeoffs to create maximum possible value for each on each issue. This type of negotiation embraces creativity and compromise.

The negotiation of prices is called a distributive negotiation. In this type of process, one party benefits and the other party is disadvantaged. Buyers may set a maximum budget, for example, and the supplier can only negotiate within that resource amount.

The integrative negotiation process is a much better process because both sides win. Negotiating a variety of issues one at a time while building on each agreement means both sides win in multiple ways. This is the time to build rapport with the supplier by developing a better understanding of the common interests. Suppliers have businesses to protect just like the buyer, so it is in their best interest to discuss issues like minimizing environmental and compliance risks or maintaining quality or the backup plan should there be a business disruption (common today). There will be numerous discussions, so concentrating on a particular issue at each discussion is more likely to lead to agreement.

The focus is on producing a relationship, supported by the contract terms but not entirely dependent on it. For example, effective SRM develops a relationship in which the supplier brings innovation to the buyer as a means of growing both businesses or the supplier informs the buyer of changes in local government regulations at a global location to help the buyer protect its brand reputation through compliance.

Integration, Joint Gain, Relationship Building
There are some best practices for integrative negotiations that lead to positive supplier relationships.

Approaching the process as if the buyer is doing the supplier a favor by granting a contract will inevitably lead to missed opportunities to solve problems together.
First is to approach the negotiations as a chance to jointly explore opportunities and challenges of working together. In conventional negotiations, it was only what the buyer wanted and needed that was considered, but using that approach today will only stifle creativity and innovation. Suppliers should be approached as collaborators and not vendors lucky to get the chance to do business with a corporation. Remember the principle is to maximize value for both negotiating parties. Getting the lowest price possible is not maximizing value. Talking about potential future opportunities is value creating.

There is plenty of advice available on specific negotiating tactics, but they are not necessarily focused on relationship building. They are focused more on winning power plays.

Metrics can play a big role in ensuring the supplier and the buyer remain in alignment and benefit each other in a collaborative manner. Metrics include identifying new market inroads, on-time deliveries, savings generated, and all the other measurements found on a supplier scorecard.

During negotiations, it is critical to discuss performance expectations and how performance will be measured. If you want to develop a poor relationship with a supplier, never inform the supplier of the process for measuring performance and wait until a problem develops. For the sake of the future relationship, it is also important to discuss the procedures for managing disagreement or conflict.

Negotiations Start with Keeping Perspective
The successful relationship-building negotiation process begins with perspective and not contract details.

Approaching the process as if the buyer is doing the supplier a favor by granting a contract will inevitably lead to missed opportunities to solve problems together. Instead, ask the supplier about his or her company goals, successes, future projects, and innovations.

When it comes down to the bottom line, it is soft skills that produce the greatest long-term value.