by Michael Schrage

Vendor Negotiation: Squeeze Now, Pay Later

Jul 15, 20036 mins

If you’re a corporate CIO, you care enormously about your company’s profitability. But how much should you really care about your supplier’s profitability? Here’s an original idea: If you want to dramatically cut your costs, dramatically cut their profits. This is a buyer’s market. Go for it.

That insight was inspired by a recent front-page profile in The Wall Street Journal about a cost-cutting telco CIO with a python’s flair for squeezing his suppliers. Need a router or a RAID? Verizon’s CIO encourages his people to check on eBay to price boxes before their vendor negotiations.

“It’s as if you now have a stock market for servers,” he gushed. He’s also launched an “Offware” program that invites software vendors to present discount-licensing schedules to “off” their business rivals. He told HP, IBM and Sun that their share of Verizon’s spending would depend on how low their prices were. “All three immediately lowered their prices 25 percent. Then Sun and HP decided to slash maintenance charges,” the Journal reported.

But wait! There’s more—or less, actually. At a meeting where one of his direct reports insisted that the company “did such a phenomenal job of vendor-squeezing in 2002 that there’s not much more to squeeze,” the CIO bluntly responded: “See how much you can push things.”

There are two ways to read this piece of news: The first is a fist-pumping, “Yes! What goes around, comes around, and we need the savings.” The second is, “Wow, I wonder what happens after the deal gets signed.” This column is about the second reaction. After all, CIOs don’t merely procure information technologies. They have to implement them.

There’s nothing illegal or immoral about squeezing suppliers. It can be an excellent business practice. But it defies human nature to believe that a vendor that has been low-balled, dropped to its knees and capitulated to even the most bizarre buyer demands in a bid to get the business won’t be constantly on the lookout for ways to make its money back. There is a point where the perceived sense of economic fairness is violated. That’s the point at which the extra squeeze creates dangerously false economies. Penny-wise, pound foolish.

I know one company that put the screws to a vulnerable supplier—a network vendor that, in fact, had consistently gone the extra mile in customer support even during the apex of the telecom bubble economy—and renegotiated prices down by one-third. The vendor literally begged to limit the price cuts to 25 percent. The customer declined. The desperate vendor caved. But customer support is now largely e-mailed attachments of technical manual excerpts and hotlinks to relevant FAQs. Crises are handled within 48 hours instead of an afternoon. The two companies hate each other. A friend who works with the customer CIO confided that all of their hard dollar savings had vanished within 100 days of the renegotiation.

“We screwed them, and they screwed us,” he says. “It’s a draw.” Intriguingly, the CIO still looks good inside the organization for driving such a hard bargain with a key vendor. But that’s only because he’s been able to pass the increased support costs to the business units in a way that buries their true origins.

To be sure, no CIO is obligated to care about a vendor’s profitability or cash flow. I could make a very good case that the financials are the supplier’s business model issue, not the CIO’s. But I won’t because that would ignore the realities of implementation. Implementations are about managing relationships, not consummating transactions. When a vendor is prepared to slash prices 30 percent, my reaction is not, “Gee, they’re desperate—and what lush margins they have.” It’s, “Gee, they’re desperate—what are they going to do to us to make up for these givebacks? How are they going to make me pay?”

The only leverage vendors have left in a hostile economic environment of cost-cutting, cutbacks and outsourcing is in the service, support and implementation side of the process ledger. The CIO challenge here is TCI—total cost of implementation—more than TCO. After all, open-source software is ostensibly free. The devil is in the details of implementation. If we save 50 percent in purchasing and procurement at the cost of doubling our service and support overheads, what is the net benefit?

The ultimate issue here has less to do with squeezing suppliers than segmenting them into those you partner with and those you can safely exploit. It’s no accident that companies with hugely successful business models—let’s pick Wal-Mart, Dell and Toyota as the best examples—have built their global preeminence in large part by insisting on supplier transparency. Wal-Mart knows the cost structure of its suppliers perhaps better than the suppliers do. Wal-Mart doesn’t hesitate to make suggestions to suppliers on how best to conform to Wal-Mart’s everyday low pricing ethos.

Similarly, Dell—with virtually no R&D budget to speak of—works intimately with its key suppliers to ensure that they understand what kind of costs and designs are compatible with Dell’s build-to-order direct-business model. Dell knows its suppliers’ costs. Toyota is famous for sending production consultants and design engineers to its first-tier suppliers. Toyota knows its suppliers’ costs too. Supplier transparency is at the core of Toyota’s successful working relationships. Suppliers that can’t—or won’t—be open to information and cost sharing are gradually weeded out.

There’s an important lesson here. In the recessionary 1980s, General Motors created a procurement czar who used his company’s massive buying power to beat up suppliers on price. The world’s largest automobile company earned enmity, horrible relationships and a reputation for building cars that underperformed. By contrast, a desperate Chrysler couldn’t bully its suppliers, so it partnered with them. The feisty company pioneered the concept of “gain-sharing” with its suppliers; that is, Chrysler would let suppliers keep a significant portion of the margins when suppliers came up with innovative ways of cutting costs and adding value. Strong supplier relationships were at the core of Chrysler’s corporate comeback.

I’m not a Pollyanna, and I don’t believe that companies should always partner with their vendors. Indeed, some vendors—particularly those in the software realm—would probably find it easier and cheaper to cut their prices than invest in what it takes to be a good partner with the customers.

Similarly, the reason why CIOs squeeze suppliers is that, frankly, it’s easier than partnering with them. Then again, buying a box is easier than maintaining and upgrading it. CIOs have a business obligation to determine whether the economics of partnership will prove a better investment than the economics of squeezing suppliers. If we really care about successful implementation, CIOs need to respect the reality that even the most artfully negotiated service-level agreement can’t withstand the fact that a vendor has no ongoing business rationale to honor it except avoiding a lawsuit. Incentives matter. Don’t let the procurement squeeze crush the opportunity to profitably partner.