Chapter8

CUSTOMERNEGOTIATION

Qrurrnn

8Pnrcrnc IN THE

TRENCHR,S

'Ihis chaptur is Mttharcn @itu Da'rid KreidbetgaJ the Struteric Pricit'g Croup, In..

It can be said that pricinS is ihe "moment oI iruth" in marketinS. That mo-ment occurs in the offices of purchasing aSents and field salesPeople, farremoved from the marketinB departments and executive suites whercshategies are created. Consequenily, even well-conceived PricinS strate-gies frequently fail due to ineIl€ctive imPlementalion To caPture value inpricing, sales manage6 and salespeople must learn to assess the negotiat-ing positions that customers employ and to resPond aPProPriately In thischapter, we will

1. Analyze and compare the effects of fixed ve$us neSotiable Pricepolicies

2. Discuss the appropdate negotiation strateSy for three tyPes of

3. Present an analytical method for Preparing closed comPetitivebids when you have just one chance to make the riSht P ce offer

NEGoTIATED VERsus FIXED-PRrCE PoLICIES

During recent years. an ever Iarger share of prices have become negotiableCompanies that for decades enjoyed leading market shares in mainframecompute$, office equipment, or pharmaceutical and ielecommunicationsse ices are today negotiating discounts to retain sales. HosPitals, Iawfirms, and maintenance compani€s are negotiating Prices Ior services.

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E!en in consumct malkeis, substaniiaL discounis arc ne8otiable for high-qualiq/ branded products, hotel rooms/ annual i€es on credit cards, andgeneral merchandise availnble ai local hornc ceniers. lt seems as thor.rgh theprice of an_vthing and cverythint is nor. opcn to disclrssion.

Reasons for negotiating pdce

In manv cases price negotiations are both desirable and necessarl'.Wl'\en cusiomers purchase unique prodricts (for example, ne$, construction, a tclecommunicahons satellite, or a ncw home), netotiabl€ pri.es pcrmii the seller to price based on ihe buyer's abilitv and willin8ness to pay.Moreovcr, l\,hen cusbme^t pur.hase infrcquentlv, thev are unlikelv to develop thc knd{ledge and erperiise k) detcrmine thc prices that other customers pay. ln industrieli $,ith standardizcd, frequ.'ntly purchasedproducts, howevcr prlce ne8otiaiions undernine a firm's abjlity to capiurethe lallrc of its proclucts. Unforfunatcl,v, it is in these industrics that pricenegoiiation appears to be glowing mosi rapidl)'.

During the l970s and 1980s, three forces began pushing companiesbward negotiated prie poiicics. First, price controls during the edrll' 1970sLeft manv companics caught betwoen lixed priccs for their producis andrising costs from external supplicrs. To protect themsel\.cs, companiesraised their pnblishecl lisi prices excessivelv while discoLrnting them surrepritiouslv. If price conLrols s,ere imposed again, it l,\.ould be easy to raiseeffe.tive prjces bv redricing the Lliscounts. Second, in the 19E0s powcr jnconsumer markets shifted toward large retailers such as Safeway grocerysto.es, Wal-Mart rctail storcs, and Home Depot horne ccniers. Thcirttemendous buying vollrme alloil'ed them b negotiate belter deals fromc\'en lcading brand manufacturers.

Finally, many markeis from mainframer conrputers, to home appliances, to legal scn'iccs are now e\periencint the svmptoms of maturityishwcr grd,{th; reduced differcntiaiion; and rnore knowledgeable, valLre-conscious buye'rs. Rather than adiust their pricc policies and margin goalsto morc accuratelJ, rcflect the nch'competitive environmcni, many compa-nies simply bcgin negotiating discounls on an individual account bas;s.Cusiomers learn ihat ihe pricc thev pa!, is related more to negotiittingpowcr and abilit). than tu value reccived. Consequently, sellinS movestrom a cooperative process of tinding the best solution for the customs toan adversarial Frocess of dividing thc gains. Companies in this situationfind that c\,en h'hen they create products of supcrior value, {ustom€rs areunwilling to pay a price that reflccts that value.

Moreo\.er, negotiablc pricc policies teach salespeople to use price as akxrl for closin€i sales rathcr than to raise the cLrsiomers' willingncss to paybv selling ralue. To makc matters r,olse, manv companies that negotiate

prices actually encourage salespeople to se1l on price bv re$'ardhg ihemfo. J, nipiur8.dle- \olum, -.,rhFr rhd I pr^ ,rl,itirr .(c- ApfFndi. q \ r,,.

better sales force compcrlsaiion scheme.)ManaSers must recognize that chanSes in customer value ancl conr-

peiiiive condition-s rcquire ongoing modifications of fixed price structuresto mainiain legitimacy in ihe eyes of customcrs. lvaluatint prichg stntc-tures on a continuing basis ensures ihat comparies capiure the tinique values of individual customer segmcnts and the volume opportunities rh€yrepresent. Unfortunatellr, managcrs unable or un('illlng to capiure thisvalue cede coDlrol over pricing and uliimately over ihe strategic directionof their businesses. Companies thni hope to maintain v,'in wln rclationshipswith their cusiomers by providing cxccptional value have little choicc butio establish and maintain fixed pdce policies that realistically reflect mar,ket conditions.

Before you conclude thai a fixed-price policy camot h'ork h your irldushy, recognize that such a policy need noi be a one pri.e poiicv. You canand should provide /t-trd discounts for volume, long-term contracts, andbundled purchases. You can also majntain dlfferent margins for differentproducts in your lhe (for example, higher margins for Cadillacs than forChevrolets) and for objective customer segments (for examplc, senior citizens). A fix€d-price policy means simply ihai ihe price tur any pariicularoffer (product, quantity, terms, and so forth) sold to someone h a particularcusiom€r segment is rlon egoltable. lf a customer needs a lower price, he orshe mustbe prepared io give up somedring to qualilr for a betier discount.

Undoing the damage

For many companies, ihe problem becomes how to work iheir wayback toward a fixed, \'alue based pricing policy whcn customers hafecome to expect that every price ls neSotiable. The following guidelines willhelp you establish a fixed price polic)' \\rhere account ]e!cl ncgoiiaiion haspleviously proliferated.

1. Prices must accurately reflect ihe unique value of products io dif-ferent customer scgments. If the,v don't, you must further scgmerli arld increase thc standard (nonnegotiable) discounts fo. thc most price sensiti\.ecustomers. If some price sensitive customcrs can'i be segmented, then walkaway from the business to protect thc tcgrity of vour prices to other moreprofitable setments.

2. Salespeople must bc educated on ho$' to sell proctuct value andbe appropdately compensated to do so. (See Appendix 8A.)

3. Use the switch io a ronnegotiable pricint strategy as a promotional tool. Customcls should perceive the fixed pricc policv as a fairchange for both thc buyer and the seller not as a pr.ice nlcrease. This ls

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done most easil\.. b] introducing fixed prices a5 neir products or models

4. Use n.rrpricc "closers" nb an alternatjle k) plice cuts. Addcd\'aluc, in ihe'form of fr'(\'supplies/ exha traitinB, or rlcuJ services, can hclpsalespc()plc close snles to lnlue'sensitive customers tlithout so visiblv un-dermining th€ price lerel. Make sure \ou account aor tho costs ofthesc on a

Per account basis, jost as you rvoll)d a loNer pric€. Otherwise accounts ma!ippear profitablc that actlrally are nol.

Understanding the buying center

Befcnc !'ou can {ormulate effecti\.c negotiation straiegy/ you musi firstundersL.rd who the brycr is and his or her ro)c { ithin the buynlg ccrlter ofthe corporntion. Sales to organizatiols is far more complex than sales to in(titiduals bo.aus€ each mL'mber of lhc buIirlg centc'r eyaluates altornatileproducts and suppliers brsed on unique criteria. Buving centers lienerallyconsisi of individuals $,ho fuliill ihe following rolcs:

1. ,,tlldlo! start the purchdsing procc'ss. Routin€ product purchasesmay bc initiated bv front line production $.orkc'rs or supply persormel. Incomplcx purchases, initiators mitht come from cntineering, rcsearch andJ"\.l. l n\cnl or,l-.uh!r.,il^p,\8,tu,/dr \r'

2. Lls.rs use thc produci or scl\'ice. Allhough easv to identify, usersmav not ha\.e a great dcal of po$.cr in the p u rchaliing process-

3. tsrvcrs h.ve thc formal responsibillty for purchasinS products andser\ i.cs. Alillough purchasing ig€x1ts often fulfill this trRditional rolc, it isnot rrnusudl to hale other embers of ihe organization perform this task,especialh in small org,rnizations or when purchasing capital eqrlipment-

4. 6ri.k ct.rs control the flor\'of information and exrcmal contact$'ith the supplt firms and aro often considcrccl experts in a particulartrroduci are.. Ofiei ihis role is fulfilled by a nondecision maker u,ho caronlv inrluencc the decision proccss. A common mistake is to assumc thatthe gatekccpcris the decision maker.

5. D.riid.rs possess the final authority to selcct ihe vendor(s) wllo$.ill supply thc product. The real dccision maker is often shielded by a hostof individuals fillnrg other roles.:

A common mistake that snlespeopl€ makc is concentrating on a limited .u btx of people, thus unclcresilmating the impact ihat othcr n1cmtrers havc on ihe final decision. A rcquest fronr engnlcering mighi injtiaic anetalua ln based solelv on perform.rnc.e and qualitv; tl,Ie deckion may thcnmove k, purchasing, h'here prrduct attributes arc secondarv to pricc. It isimpcrative that the seller recogrize thai ihese (hangcs nre taking placc nndadjusi their nejlotiation straicgv sccordingly. Srlling differentiaiing attrib-utcs k, I Purchasing agent u,ho docs noi \.alue thcm is a r.rseless exercisc.

There arc several strateEies for

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NEcorrATIoN SrnartcrrsEffeciive negotiators must understand the various buying behaviors associated with different tyt'es of buyers and th€n individual purchasing agen-das. These behaviors are a function of how buyers value differentiatingattributes oF prodrcts alrd their willin8ness to pay for ihem. Although sup-pliers often conccntrate on selling differeniiation value, a buyer's $illing-ness to pav mav be based on other critcria (see Chaptcr.t)- Successlulsellers mrlsi aciapl their negotiation siratcgies accordingly. In this section,h p,lts( -.h. -r[.. rFc,,l..,ticn.lr.r ct]es fL,r oeJlns I\ iln or-.. bLVu\. ,ovab_$ er.. dr J fAe-h-jlr, rsee ( lupler h fur e\Fhn.ltron ,'f this . gmeita-tion s€heme.) Con\.enicnce buv!'rs are excluded bccaus€ they are not con-cerned u,ith !nl c. or pri(e, but merely a\.dilability.

Negotialing wilh price buyers

Pri.? ,r-v./s arc usuallv larger companies and govemment agencicswith the resources and inccntives to qualify multiple vendors. They seek ic)

purchase at thc lor,{est cosi, subjeci to the product and supplier meetingm n.mur.pecific.rtro"-. fhcy \\ill L,! pd\ tur incrercrtdl Fr,dLr.l !aluebevond ther specrrrc.rr,oni nor ror rhe i^i "i^.i.*i;."fi-tr1f,ifii--companylonS-tcrm relati(,nships with sLrppliers. Their narrorv focus on price Breatlyinhibits the abiljiy of the s(ller to ncgotiate bascd on thc value of ihe prod-uct. lhese buyers may elcn limit suppliers' conract $'ith other mcmbers ofth€ buving centcr r-\,ho might acknoB,ledge thc product's incremental valueand justib pa),int a higher price. They may cven require formal bids anduse adversarial negotiatidl tactics designed to play suppliers off ngainsi,r1('drolhe il tl_eir - dr.l_ lo l_, {vestp .p

y('s. rhe-lll!

1'aluc anllle raise their $Jillinif.(q tn fiy r-', f.c"i.g tha+ odded ialu€ is. o-t iusr fr.d. Il'rs , J-r.rl v n.,t l.',eible fur tsne sale-perefi+rn(+i€\ (dloor It rcouiL,. i , ommir lo infesl rcsource\lo bcEUile, u\k'mer. in-lscoqp]lqi:in8 lhcir Fure price onent.ltion. For.)-!n]ple. cJjlsglH.jiLlal5u-p!, Corl,"' .uccu.luL\ Jollllllll!(,j-pitals that wcr€ iraditionallv pice bu]'ers to lalue lruyers b), placing com-

ffEr terminals ln ihe hospital purchasinS departments. Ttese terminalsncre linked to sophisticatc'd information svstcms r4.hich eliminated thcnced to manage larlie inventuries. Thc net result was a more efficieni sys-tcm enablinS the customer k) sa\.e more money from bctier iu\)crltolv mnn-rd. rnerr rl rn b\ f(\.r.tnts -rn.tl\ Jn :ulpl\ pr.. cs.

AlthouSh vour long-tcrm objc.tiYe may be to change price drivcnpurchasing beha\ ior, manv price buycrs h'ill never change. In this casc,scllers must follow a siratc8y of sc/.'.iii,r' frltt.rfnlior, carefully evaluatintthe short-term proiiiabilitv .1nd long-term implicRtiols of th('se transac-

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iions and accepting them only R'hen they (a) pro\.ide incremental contribution arld (b) do not undermlne more profitable business.

Companies often invesi resources to senre pdce buyers in dre vain belief that someday their €fforts will prove profitable. Resist the temptation ionegotiate for a pdce buyer's business in anticipation of future profits theyrarely materialize. If you can't participate in their business profitably, acknowledge the futilitir and walk awa,v. Fortunately, ihe long-term cons€quences of walking away from a pdce buyer's business are minimal. Since,bl, definition, p ce buyers react to low prices, you can al$'ays to back andparticipate in their business later by offerhg a low price tu'Lc, It is si'ategi.d!t! pnrd,\t d,nfuob|, t,,1. -:\4uLinor, tart \r.r.r,:v. or'l .ipahorsends a siSnificant signal io ]rour other cusiomcrs that you're not going toinvest resources where there is no payback. Sales, service, and support personnel focl1s on servicinS valrie buyers and loyal buyers, since profits are

The marketer of an elecironic commodity had an excellent relationship with Ford ar1d considered the company a lo)'al customer. Althorghthey also sold to General Motors for nany years, CM was shictly a pricebuyer. Due to their volume and neSoiiaiing power, CM received a 15 per-ccnt discount on most purchases. lhe supplier was careful, however, io sellGM only its undifferentiated, older technologies. When the supplier developed a nerr technology that saved customers mone]' in the productionprocess, Ford was first io receive it. The supplier (ras reluctant to offer thetechnoloSy to GM fearinS thai its adversarial negoiiators would force thecompany to supply the new technology at a l$ver price or face losing a1l

business wiih GM. Despiie the lonS-ierm and persuasive evidence thatGM's major competitors' value driven purchasing policies are successful,GM remains a pdce buyer by most suppliers, much to its detriment.l

The prospect of walking away ftom pdce buyers is terrifying to manymarketeis since price buycrs are often their largest customers. By selling tolarge customers, many firms are focush8 on the tou€thest negotiators withthe touthest pdce buyers and are losing the opportunity to capture addi-tional profits tuon more profitable segments. Th€ "80/2{l rule" states that80 percent of the volune in a particular industry will come from 20 percentof ihe largest customers. The net result for suppliers rnfortunate enorgh towin business from this scgment is increased sales voiumc but litiie or noprofit. Hundreds of suppliers to ihc auio indusby are in ihis sitr.ration. Anew, morc relevani rule for analyzing customer profiiability is the 201225rule. Recent analysis has sho(n thai some firms are at "break-even" withiotighly 70 percent of ihef cusiomers;20 perceni of the cusiomers provid€225 percent of the profiF; and the remaining 10 percent (the larger accounts) arc actually cosling firms 125 percent of iheir profitsl

Sincc fircd-cost siructures of manufacluring operations are ofien jus-tified by thc voLume ihat large customers represent, it is ctifficutt io totally

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walk awalr from all price buyers' business. Fortunaiely, because targe cus-tomers ofien negotiatc with muliiple suppliers, marketers can look for fa-vorable opportunities for seleciive participaiion. When a bidding waroccurs, it is best to get in at the end of the process, when sellers are lesslikely io be emotionally committed io winnint ihe battle (see Chapter 5).I4rhen it becomes necessary to bid a lower price, it is just as easy to say tothe buyer, "When you're ready io place the purchase order, l'll give youmv best price." This limits the damage that a buver can do by "shopping"the price with competitors and allows the salesperson io take ihe order"off the sireei" and thus limit the likelihood that other competiiors are con-sidered.

A similar option is the "five minute price" tactic. Hcre, the low priceis not put in w tint and is in effect for only a short timc. Without docu-mentation, the price buyer has nothing to sho$, competitors io elicjt theirresponse. U the seller is thc prcferred competitor, the buyer may recognizethat such a low pdcc night noi be offered again and mrist decide if there isanv value ir1 continuing the neSotiaiion process. The risk in emplo),ingsuch a strategv is thai customers malr determjne that the seiler is bluffin8and ignore ihe iactic entirely.Ifthis is likely, avoid this taciic.

Negotiating with loyal buyers

Loyal buyers are tl\e polar opposite of price buyers. The,v value consisient produci quality and performance, and they rely on trusied suppliers tocontinue providing it. lleir ongoing lo),alty is driven fundamentally bythe dsk and uncertainiy associated h'ith untested suppliers. The critical implications of inadeqrate performance outweith for the loyal buyer the benefit of lowcr pricc in thc short t€rn. Here, confid€nce in "tried and true"existing solutions from provcn vendors sustains ongoinS relationships.

Forti4' existing relationships by focusinS atiention on pasi performal.lce. Stress the impact of infedor product performance on the buyer'sfirm, ihe sunk cost of previous investments, and compatibility with futurerequirements. Utilize uni.tue pric€ and quality metrics to make comparisons between and amont vendors more difficult. Above all, make ciearyour commitment to meeiing customer's' current and future needs and toeliminatc iheir inceniive to iook for altemative soluiions. Invest sales andmanagemeni time io thoroughly understand 1oya1 buyers' sources oI value.Over time you will be better positjoned to react io their needs and reinforceyour Position as a trusted vendor.

ln contrast io adversarial negoiiations with price buyers, negotiationswith loyal buycrs arc more amiable and focus on solutions that saiisfy bothbuyer and supplier business goa1s. Less tangible, more augmented featuressuch as technical experiise, reliability of service, and dedication to customcr satisfaction have measurable \'alue iu the evaluation process.

Although satisfactory past performance is turndamenial, a clcar indicaiionof tuture conmitment is also critical.

During the early years of the development of mainframe compute$,IBM was competing with another vendor for a large manufacturing firm'saccountin€i business. The customer, aware that it was making an extremelylorg{crm commihrent for a mission critical application, decided io divideits business bctwccn the hvo vendors and let each one rLrn half the payrolland accounting systems fot onc year. At the end of the year, the results\4'ould be evaluated and a long-ierm contract siSned with ihe premier vendor. Half way ituough the trial peiod, a power surge crashed th€ systemsol both voldors, requiring a three week restart. Thc competitor ass€mbl€da team of 40 englneers and technicians to atiack thc problem and restart thesvsicm. ltsM also assigned technicians b rcstart the system, but in additionIBM recolFized that the cusiomer still had a problem- To solve it, IBM as

scmblcd a team of 300 clerical workers to process the customer's payrolluntil the system was restored. IBM $'on thc contract. lmplemeniing suchcreativc solutions shows commitment to total customer satisfaction andhelps rctain loyal customers for the long run.

Although tlt loyal segment may be large dunng the growth stage, it;nvariably sh nks in maLudtr,, as more competitors develop good reputa-tions and buvcrs bccone more knowled8eable repeat purchasers- The loyalscgmcnt also contracis duin8 recessions, rvhen even oiherwisc loyal buy-ers may be scrambling to crt costs. Thus, a classic dilenma arises: Shouldih company c t its prices and s€ffice l€vels io focus on loyal cusbmersi{ho are migrating to the value segment, or should ii maintain ib pncesand services to focus on the customers who remain loyal? The answer isboih. Bl' nbundling thc costs of service (for example, training, installation)and bv desisning equally reliable but cheaper prodrcts, companies canleverage ihe repritaiion ihey develop whilc buyers call remain loyal andcan conlinue to capture the business of buyers who havc when becomemore value conscious. Thus segmentaiion pricing stratcgy is the key togrowth nr difficult times for such market lcadc'rs as Geneial Eleclric.r

Alihough obiaining business from loyal buycrs justifies the invest-meni of a firm's resources, when ncgotiaiing with loyal customers alrcadybcholden b your competitors ihe theory ol sclcctive participation is onceagiin applicable. By definiitun, these are loyal customers and the likelihood of them changnt suppliers could be extremely ]ow. IntelliS€nt mar-keters must evaluate thelr accounts carefully, selectinS only ihosecusiomers who are likely to s$'itch alrd yield profitable oppotunities.

Negotiating with value buyels

Vaiue buyers represent the largest group of buyers in most markets.They seek neither th€ highesi quality nor the cheapest price. Inst€ad, they

make their purchase decisions by carefully w€i8hin8 attributes arld analyz-int trad€ offs, ultimately purchasing the produci off€rint the highest util-ity per unit price. Unlite price buyers who focus on cost, valu€ buyers bothrecoSnize and cost justify the added utility available &om more expensiveoptions. This segm€nt, therefore, represenis an excepiional opportunity forprofits to the tum that can effectively commrnicate superior value. The dif-ficult challenge with these customers is to rctain thetu business over timesince ihey are constantly reevaluahng iheir aLicmatives.

The decisjon to invest rcsour€es and dcvclop long+crm relationshipswilh value buyers is a difficult one to make. Unlike loyal buycrs, whoclearly justi$, invesiment, or pricebuyers, whose limited payback is readilyapparent, value buyers have no predeiennined allianccs. Although ihcymay indeed repeatedly purchase your compeiitively-priced and well-per-forming product for a while, apparent loyalq' quicklv erodes when com-petitors' products initate your product's features- Civen ihe poiential of a

shorFterm relationship, marketers must once again use a siraiegy of selec-tive participation and caretully analyze whether doint business with ihissegment represents the most effective allocation of ih€ firm's resources.When negotiating with value buyers your objective is to capture the maxi-mum value of your differentiation on each individual sale.

Succcsstul implementation of a value bas€d pricin8 strategtr dependsupon a saiesperson/s ability to distinguish between situations in which a

lower price is required, and situations jn which the cusbmer needs io bebette. educatcd on the value of the product. Salespeople must be kained tounde$tand how customers vaire their products and to use value-basedseling te&niques and negohating skiils to corinunicaie that value to cus-tomers. Finaly, saiespeople must master techniques used to reduce thedamage done when p ce negohations do occrr.

Salespeople must always keep their emotions out of the negotiationsprocess and must keep sight of their objective o{ closing the deal. InChapter 5, we discussed the problem inlterent in adopiinS a "win at allcosls" strategy in competitive pdcing situations. The same holds irue forcustomer neSotiations. It js important for salespeople to maintain a hiShlevel of prol€ssionalism durint the negotiations process, even if the buyerinsists on adopting adversarial taciics. In dre words of Bob Wolf, a famouslawyer and sports a8ent, "You don'i have to be disaSreeable lo disatree."Negotiation is not a war to win, but a process to complet€ to the mutualsatlsfaction of ali those involved."

When conflicts arise, it is important that both paties understand ihebasis of d1e conflict, that is, which issues are negotiable and which are not.Fighting over irreconcilable differences clouds the process and inhibits anoutcome favonble to both parties. Each side begins to mov€ away from anamicable solution, becoming entrenched n opposing positions from whichresoluiion is virtually impossible. Participants must be willing to compro

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mise in order to come to a satisfactolv soluiion. Suppliers mrlst recognizethai cosi contlol ls frmdamental to ftstomers' cornpetiti\.e pricinS, alrd cus-tomers must understand that suppliers are in business io make a profit. Onceboth pariies adopt the objective of "cbshg thc deal" and of being satisfiedwith the results, the process can focus on horv to achieve those objectives.

Avoiding the pdce trap

Managers ofien instruct salespeople io "sell on quality, not on price."They are missing the point. Product qualiiy and added features hold nosignificance until they are vahed by customers.' Although lovai bui'ers$.ill buy feahues, value bryers m1lst bc corllinced ihat those features are'\.orth the cost. Amedcan Express provides a large numbcr of intenlaiiorlaloffices as a differentiator for pcople $'l'ro use th.ir travelcr's checks. Ii wasnot until they communicatcd the value of thosc intemaiional offices in re-placing lost or stolen checks that their ad!criishg ha.1 a posiiivc nnpact on

Several techniques support selling product value. Firsi, a cosi benefitanaLvsis, such as economic value anal,vsis (See Chapter 4), provides crsbmcrs with a clear undersianding of horv voLlr product can save themmoncy or add \.alue to their products. During the sales process, a fonnalproposal dctailinEi ihis valrie analysis should be provided. Many marketcrsavoict this technique because of the effort reguire.l and the dsk of docu-menting specific savings and proctucti\.it]' enhancements. lhis dsk can beminimizcd if conservaiive approaches are used in the analvsis anct if efforiis made, up hont, to ha\-e ihe critical data \.erified by the cllstomer. Sii]1,one nust "se11" the value to the customer and convince the buynlg firmthat it rnusi pay for value. The folloh'ing two tecluiques have been provento suppori selling product value:

S bttaction Techfliqae This tecbni.lue involvcs removinB produci or service attdbutes from the original package to "jusiify" the lower price requestecl bv cusiomers. For example, if a buyer objects to the price of amilling machine, the seller could offer the unit at a ]o{,er price withoutsome of the value-added features such as tlaning or service. This technique helps distinguish among buvers r rho are triing to extraci a priceconcession and buvers \arho do not valuc specific product attributes. ltforces cusiomers io recognize the value of aiiributes unavailable at thelower pice, while refocusinil their atteniion arvay from ihe gain of a ]o$'erprice to ihe loss of ctifferentiating product atiributes. A variant of this rech,nique involves stressing the penalties of doing without your product. Thismethod lequircs eriensive knora'ledge of competitive products. When usedproperlv, this technique provides salespeoplc wiih the opportunity to dis-cuss the "uni+rc benefit" of their products.

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Dirlision Techniqle This iechl1iquc breaks down ihe cost of thc producrinto smalier units relative to the custonrer's process. For examplc, jf vou ar€selling n $100,000 conleyor belt that is priced 20 pcrceni higher than rtre.omp.ri.i,'n. 11. rr,nri(lLreh. L J br..rl n.,,r'hFt.t,,o.t d, ^totr- \tJThe customer's daily productlrn is 10,000 small notors; (2) rhe mobrs seufor $40 with a 50 pcrceni contribution margin, (3) assuming a onc-year life,lhe.u.rol .hcl,lt i.un\ ror' cq| t. Frrnoto rrd,4,rhFo ,rii\, lnp-.,?is less than one cent and more than made up in ihe added sales and profitsfor the customer if ihe new belt can save one day oflost production, rvhich isworth $2{10,000 h con ibution. This techniqre takes actrantage of the endbr nel t Frt(t Jrd tor.e. 1.,, ur,,mer o f... { :/c t -t rr.p.,'. diif.. r.. -insignificant relative to ihe riskof fnilure and (rthcr cosrs of doing busi.ess.-

PnePennvc CoMpETrrrvE BtDs

Competitivc bidding is an altcrratiYe io negotiation for price buycrs. Thebuyer delelops the specificaiions and asks for prices. In some cascs, srjchas sales to government, thcrc is no opporiunity to scl1 "value" and the busi-ness goes to the lowest biddcr.. h other cases, yrru may be able to talk withthe buyers and determine lvhit adcled features mjghi nrake ]'oul b moreattractive despile a higher pricc. Pricnrg all order or prqect lor a compcii-iive bid is the ultimate price-buycr situation.'lt oftcn invohes a huge h-vestment oD the part of thc supplier hopin8 that its bid (.i11 win a ior.Because conrpetitive bidding is used most often for verv larte projects,win]1ing or losing can ha!c an cxceptional impact on a company's financialhealth and L timate surlilal.

In complex bid situaiions, every aspect of pricing {osts, price sensi,tivity, nnd competition-is unceriain to some clegrec. No firm is evcr en-tirely certain h'hat cach nrput $'ill be and how it should impact the finalpricing strategv. lr somc cases, the itegee of unceriainiv is lo\,!'enough ioallor irlorm:. LJq11, r't. tJ b. m.r iF \.4rr),.,n,t.,r i,. ' rou.,r,*.,.t'as construction, telecommunications, computcr :nd svstems integration,i L i \ul\F.l r'l.^r1|.. ur \ 'e-m J d, u.'i,.n. Lrforn:, ludsr*,n..dunoi provide these conrpanies H'ith adequatc solutions for clevclopin't pricinq .!r.rleg) uh r, n.,l (. pn. nb ir (,,r p:t.r.\, ord,i r.g -ih.Jr un. parri.ularly risky. Thus companies placing competitive bids are especiallvwiliing to use more quantitative iechniques to ensure rhat they makc thebest possible decisions.

Quantitative analysis

Quantiiatn/e analysis brings no ne{' daia to thc bidding problcn.lnstcad, it heips nanagers examnlc ihe implications of the daia. Attemptsto make unassisicd pricrnS judgnrents when facing multipte soLrces of un,

zno

certainty are likellr to prove frrrstratinEi if not impossible since ihey requiremanagers to think of more factols simuLtaneously than is humanllr Possi-ble. CoDsequently, managers often disrcgard.:tata that could imProve theirdecisions. Quantitative bidding analysis enables managers to think aboutthe problen in more tractable Pieces, which .an th€n be combined and re-

viewed. It helps to pinpoint souices of disageement and to focus on them

in discussion. Further, it forces the managcr to 8(r to oihcr sources of judg-

meni, and it facilitatcs evaluating risk return irade offs. Finally, since quan-

titative analysis requires documentht the decision, ii helps managers leamtuom past exPeriences.

bxhibii s.1 illustrates a quantiiative analysis for a competitive bidAfter listing possible bids that it might make, ihe comPany calculates theprcfii coniribution associated with cach bid' The company ihen lists the

;ubjective probability of winrring, gilen each possible bid, ar1.l multipliesthai probability times ihc profit contribution if it wins the contract withthat bid. The last colunrn shows the rcsulting expected value of ea.h bid.

The bid with the highest exPected value (in this case, the bid of $38

miilion) is the best choice for companies with many bidding opPortunities.Othem may wish io considei trade offs betra'een eaning ihe highest ex

pected profit with the assurance of earning at teast enough Profit contribution to ivoid severe financial difficultlr' The role of ihe analysis in ihe lattercase is to identify the trade-off. How mrich exPecied Profit must be sacd

ficed for an increase in the probability of lvinninS?Although simple in theory, comPetitive biddhg is quite challengjng

in practice, since neither the profit contributbn nor the Probability of suc-

cesi is ever obvious. The nlcremenial cost of winning a job vades significantly depending on the amount of other business that a company has

already won. If a company has ercess capacitv, the contibution from win-

:t

)t

il

ExI{Brr 8,1

Expected Value of Attemative Conlpctitive Bids

Dollar

$4039313

37

$12llIOI

_24.32.41

$2.93.54_14.2

Nole: Ea?ected 1'alue ol bi.l {column 4) tpresents thc prolll conlribltion lcolumn 2)

multipled bI the probabili\. olsuccess (colunrn :lla Fjgurcs de tn nillions of dollds.

ning a bid may be quiie larg€ since many costs wi11be slu*. However, ifcompletnrg a job requires added capacity or costly delays in other jobs, nrcremental cosis will be high and the profii contribution relatively 1ow.Similarl, a bidder should consider the opportunity cost of committing capacity too early. Bidding low enough to win many early bids may precludebidding on more lucmtive jobs laier on.

Even more diffi.dt is assigning the probability that a given bid wi]t besuccessful. Typicalt assigning probabilities is a blend of research and judg-ntnt. The more a company knows about past biddjng behavior in ihe industlyand ihe cment biddhg sirua hon, the better are its chances of producing a prof-iiable winning bid. There are trro methods For estimatint a bid's probabllity ofsuccess: the average opponert approach an:t the specific oppon€ni approach.'oThe choice between drem depends on the amount of information available.

Probability of success

Aoenge Oppone t Approd.n The average opponent approach is used toestablish probabiliiy of success when a company has liitle knowledge aboutor past experience bidding against anv specific competiiors. The approachtreais all competitors as essentially the same in the ag$€ssiveness of theirbidding. The company using this approach begins with an analysis of pastbidding beha\.ior. First, it collects as much information as possible about bidson past jobs that were similar to the cuuent job. Then, to facilitate comparison of bids ftom diJferent jobs, it expresses each bid as a ratio: the bid pricedivided by ihe tirm's own estimated cosi ofthejob.Ifthe company estimatesthe cost of a job as 95 nlillion, a bid of $6 million is expressed as 1.2 ($6/$5)and a loss leader bid of $4.s million as 0.95 ($4.s/$s). After doing this for as

any jobs as possible, the company calculates the percentage of times thatcompetiiors' bids excceded any partic lar value of ihe ntio, as follows:

Bids Ratio0.951.001.051.101.151201.251.301.35

Competitive BidsExceeding Bid Ratio (%)

r0098928067551220

8

lf managcrnent has no other information, the companv could usethese historical bid frequencies as the probabilities that it would underbidanv single competitor on a slngle bid. For any particular bid ratio, R, wewill label ihe probabilit,v (P) of underbidding ani/ single competitor as P(R),

2n2

that is, ? x R. ln practice, ma.agement usuallv has additional informationabout dilJerenccs between the cunent bl.:t and Prcvious bicts, which ii uses

to make sribjective adjustmerlis to the historical bict frequencies bcforeaclopting them as .lurent bid probabiliiies. For cxanPle, if the industry is

operatint at higher capacltv lel.els now than in ihc Past, management as-

signs subjectir.e probabilities somelvhat hiSher ihan ihe historical bid fre-

qucncies. On the other hand, if ihis job is Palticrilarlv attractive because ofihe additional business tltt winning it mitht prodrice in ihe future, man-

agement might expect comPetitors to bid lower thnn us al ln ihe lattercase, managernent assiSrs subjective Probabilities somewhat lower thanihc historical bid fre.tuencies.

To calculate ihe probabiliq of \^'irxing a Particular iob, rnanagement

must next consider the number of bidding comPetitors. The more bidctingcornpetitors, tlre lower the probability thai any one b will win the job

Sincc ihe average oppon€nt approach assumes that managemcnt cannoidislirlgrdsh among its competitors, the Probabilih of Lllderbidding each ofthen is the same. Consequently, if the numbcr of bidders is N, the proba'biliiv of (,nmlns the job with aj]y pariicular bid ratio is P*i.(R); then

)I

i

P,,,"(R) = P(R)N

lf the historical bid frequencies shown above equal ihe subiectiveprobabilities of underbicl.ding a competito., the Probability of \^'innin8asainst h{o avcrage competitors with a bjd ratio of 1 l is:

P1{n(1 i)=.802= 5'1 or 61"/0

Eahibit 8.2 illustraies the probabiliit' of wlnnint tor cach bid ratio,given two, four, or six opponcnts.

Bidders often do not kno(.how manv comPetiiors the]' rvill be bidding against, s'hich adds furthcr uncerianrry b the Problem Management

must fonnulate sLbjective probabilities for ihe number of exPcctcd oPPo

nents. Tt then uses those sribjccii{e probabjlitics io lveiSht .tifferent calculations of P,,i" that assume diffcrcnt numbers of conPetitols. For examPle, ifmanagement's subjective probabilities ior ihe number of otherbidders are:

2 oiher bid.ters .5

3 other bidders .4

4 othcr bidders .1

the probability of winning uiih a bid ratio of 1.1 in the examPle gilenabole is as follows:"

1,,r,,(1.1) = (.s i.80,) + (.4 x.80r) + (.1 x.801 =.565 or s6.s%

Exhibit a,2Calculating PwN Using the Arerage opponent Approach

Competitive BidsExceediDg

Bid Ratio Bid Ratio(%)

Prcbability of Winnjng Job

2 Opponcnts 4 OpponeDis 6 Opponcnts

2{t3

Specific Opponellt Apploarh The average opponent approach io establishing probabilif, of success is appropriate onllr when a cornpany knowslittle about its individual compeiitors. Usually, hoh'ever, a company doesknow who its conpetitive bictders are and their differeni nrotivations.When bidding for government contracts, for example, Potential biddersmust staie an intention to bid some months beforc the bids are actuallvJu(: Lp li-t or tl-o.e rrrn. ., \ drlrolo o rll . oro(ritJr -. When orJJLnb torspecialized construciion projects, such as large hydro eleciric power plants,the number of qualificd bidders is so small ihat bidding is alr'ays againsiihe same three or four compeiiturs. When a company kno*'s -ho the com-petitors will be and thcir pnor biddnlg behai.iat,t}Le specific opponent ap-/,'od.i carl help then akc more successful bjds.

The specific opponeni approach begins rnuch like the average opponent appmach, with an analysis of hisioical bidding behavior of the competitors. Thc bictdinB behavio. of each competitor, holvever, is separaielyanalyzed. For cxamplc, if both opponeni A and opponent B are frequentbidders, a cornpany usht this approach ('ould separate them from othercompetitors when atiempting io estimate ihe probabilities of underbiddingihem. For each value of the bid ratio, R, it would calculate the number oftimes each speci{ic competitor's bid exceeded R. If other bldders, called priphenl oppanents, are also biddint, theii are ire;ied as a separate groupushg ihe average opponent .rpproach. An analysis ol historical bidding beha!ior might look likc Ixhibii 8.3.

0.95r.o0r.o5t.lol.l5l.201.251.301.35

lOOo/o

9a

67554220

a

l OOO

.964

.446

.6:10

.4:tg_3o2.176.0.10

LOOO.922.7t6.4 to.202.092.03I.oo2

1 OOO

.466

.606

.262

.090

.028

.005

+ Astcisk denores a pr.bal)ilily olless Uran.001

J

As with the averaf oPponent apProach, the company uses al1y infor-mation about differences between this bid and Prcvious bids to adjusi the

historical frequencies before using them as the Probabilities of lrnderbjd-ding competitors on the current job. In addltio& it would adiust the histori-

cal lrequ!'ncies for each sPecific opPonent based on whatever inJomationit has iout that compant. For cxamPle, if opPonent B recenlly lnstalled a

ncw president, who announced coryorate goals including a substantial in-

creas; in market share, one might exPect ihat the Probabfity of B's bid ex-

ceeding any given bid ratio 1 'ould now be iower' Similarly, iJ oPPon€ntA**"ttu *i,"

" 1".g" -ntract committing much of its capacity, one miSht

expectihe probabil;ty that A's bid would exceed any Siven bid ratio wouldno$'be high€r.

The probability of winning the iob, P.i., is the Probabfity of under-

bidding the specific opPonents and ihe periPheral oPponents Let P^(R)

o"6 Pinl 6s ilrc proUibiliiy of underbidding sPecific oPponents A and B,

rcspectively, and let Po(R) be the probability of underbidding one of the

peripheral opponents for any particular bid iatio R. If the current job involves bidding against opponents A and B in addition to N Peripheral oP

poncnts, the proUaUiliiy of winning wiih any given bid ratio R is as

follows:

P.,t"(R) = P^(R) x I'B(R) x Po(R)N

ExIIBrr 8.3Analysis of Historlcal Bid Frequercies: Specific OpponentApproach

Opponenis Competitive Bids Dxceeding Btd Ratio (%)

Bid P€iio Pcnpheral Opponenls

0.95l.oor.o51.101.t51,.20t-25l 30r.35

lO0o/o

9a90ao70554730

lOOo/o

loo957a

605546

9a%95857058403320ll

204

If the historical bid frequencies in Exhibit 8.3 are used withoui adjusiment as the probabilities of underbidding ihe opponents, ihe probability ofwinnin8 a job with a bid ratio of 1.2 ifhcn bidding against opponents Aarld B and two peripheralopponents is as follows:

P*-(1.2) = .ss x .60 x .4u- = .0s3 o/ 5.3%

I{ manag€m€ni is uncerialn wh€ther opponenis A or B *-ill bict, itweights the bids of the specific opponents by the subjective probabiliiy ihateach one would bid. If the company is mcertain about the number of peripheral oppon€nts who wor d bid, it weights th€ calculation of underbidding €xactly as shown for the average opponeni approach.

The winner's curse

Competitive bidding is notorious for causing ihe winning bidders tolose money.'' In fact, rcsearch shows ihat even biddcrs who use sophisti-cated models and formalized techniques often losc money." The reason isihe winner's curse. To understand the curse, imagine first thai )rou are oneoI iwo bidders and you win a bid with the lowcr pricc. You will probablybe quit€ happy. Now imagine thai you are one of ten bidders and you believe that youl competilors are sophisiicated businesspeople who knowhow io bid a job. Again )'ou win. Are you siill as happy? What does itmean ihat yor bid below nine othe. knowlcdgcable bidders? Perhaps itmeans that yor were willing io take less profii on the job. On the otherhand, it could also mean thai you underestimated ihe cosi to complete th€

The more bidders ihere arc, the more likely you *,iLL losc money onevery job you win, cuz, if o alrenEe you esti nte .,sts catrcctlv atld bath VoLtand yout conpetitarc set bids thnt include n rusonabl? nnryin af prcfit . 'lhe rcason: The bids you win are not a random sample of ihc bids you make. Youare much more likely to win jobs for which you have undcresiimatc.l yourcosts and are unlikely to win those for which you have overestimated yourcost. Consequently, the cxpectcd profiiability oI a.job, candilia al on the fIctlturt lau haoe uron it, is much less than the exp€ct€d profitability belore $.inning. The difference beilveen the conditional

'ind unconditional probabili

ties jncreas€s widl the number of.omPetitors against whom you mustbid.The only solution to this is, in effect, to for alizc the principlc of "sc-

leciive participation" described above. You do thatby addtug a "tudgc fac-tor" to each bid to refleci an estimate of how much you are likcly to havcunderestimated your costs if you actually win a bid. Necdlcss to say,adding this factor will reduce the number of bids you win, but it will cn-sure that youwon't ultimately regret having won them.