Do price negotiations destroy value?
Should negotiations ever come down to price? Not according to INSEAD professor Horacio Falcao. In a thought-provoking article, Professor Falcao suggests that ‘a focus on price puts both sides at risk of leaving out other interests that are more important’.
I have sympathy with this view, which in large part reflects the eternal debate over price versus cost of ownership. There are certainly many examples where ‘cheap’ means also ‘low quality’ or ‘untrustworthy’, resulting in unexpected costs for the buyer. However, the article seems to be based on two assumptions that may themselves be questionable. First, it depends on detailed market or competitive knowledge. Second, it makes an assertion about supplier behaviour which, in my experience, is not entirely accurate.
Professor Falcao uses the procurement drive for ‘commoditization’ as the foundation for his ideas, on the basis that this is the philosophy that underlies intense price-based negotiation. He makes the point that there are always areas of value that go beyond the core product or service – for example reliability of supply or quality of service and support – and that these must be taken into account when agreeing a price. Clearly this is true. However, comparative competitive data may be difficult to find, so often a buyer tends to address such issues of performance through liquidated damages or service level credits. Arguably, a smart buyer will also embed rights of termination for consistent failures of performance. To the buyer, such terms represent a protection against the consequences of their price-based focus and do not represent a reason to agree a higher price.
So while these additional terms confirm that value is not based on price alone, it is often hard for a supplier with superior service to win a higher price.
The second hypothesis in the article relates to the way a supplier will behave if forced to accept a low price. Professor Falcao contends that this will result in degradation of service. Again, my experience on this is mixed. I have seen many instances where a focus on price actually has the opposite effect, with the supplier either:
a) working harder to show their value in the (often mistaken) belief that they will thereby earn supplier loyalty and potential for future higher prices or additional business; and / or
b) focusing on ways to improve efficiency and reduce their own cost base. Indeed, such price-based pressure is often the source of innovation.
It is indeed true that a smart buyer looks beyond price, but in many instances it is in fact the driver of value, not its enemy.