Tuesday, January 10, 2006

Negotiation Quick Tips for Buyers

Buyers that negotiate for goods, services or intangibles (e.g. software) oftentimes look like new golfers playing against Tiger Woods. Buyers have a significant information disadvantage when negotiating with sellers because the seller knows its business and the buyer doesn't. Moreoever, the level of negotiation experience and training is usually greater on the sell-side than the buy-side. How can buyers level the playing field? Here are some things to remember:

1. Plan ahead - The sooner you start planning, the better. Don't wait until your current year budget dollars are about to vanish as year-end draws near or your encumbent vendor's contract is about the automatically renew. Vendors know that time is their enemy (in fact, sales reps have a saying that "time kills deals"). For this reason, vendors do whatever they can to create a false sense of urgency by creating various iterations of the old standard playbook routine of "while supplies last" (e.g. the vanishing discounts if you don't sign by certain date). Vendors know that, as time goes by, you might wise up and realize you have more options than you originally thought.

2. Play Poker - Don't show your hand to the vendor. Sales reps are trained on sales techniques designed to get information out of you. Customers often mistake this as a sign that the vendor is interested in your business and a demonstration of its "partnering" approach. This may be true to a degree, but don't be a babe in the woods. These seemingly innocent questions are like the pop of the starter's gun sending you off to the contract negotiation races. If at all possible, keep the vendor guessing as to whether it will win your business until you've gained acceptable pricing and terms.

3. Bid It Out - Talk to at least one competitor and let the vendors know that you're shopping around. This will help keep them more on their toes. If you're talking small dollar deals and you know a good vendor that'll do you right, then by all means throw them a bone and don't bother with bidding. Otherwise, let market capitalism work its magic.

These 3 points are basic and critical but you'd be surprised how often customers do otherwise. More to come on this subject in future posts.

The Problem With Sourcing Organizations

What prevents sourcing organizations from realizing their full potential?

First, the sourcing function is a support organization - this means that they usually don't call the shots and lack the clout to shut deals down that shouldn't happen. Their internal client is oftentimes a revenue-producing line of business that's like a party girl ready to drive home drunk once the bar lights come on. Besides, the guy she picked up at the bar (a commissioned sales rep) said he'll make sure she gets home safely. Like a person who drinks and drive, internal clients who can't negotiate their way out of a wet paper bag oftentimes want to drive the process, exercising poor judgment along the way - and even sometimes get taken advantage of - while the sourcing "professional" is reduced to the role of glorified admin.

Second, despite all the talk during the last few years of the growing strategic importance of world class supply chain and sourcing functions, sourcing professionals remain and under-appreciated bunch given the value they bring and the even greater value they could bring if empowered to do so. Sourcing organizations typically suffer from high turnover and burnout. The salaries are usually not in line with the demands and potential importance of the role: Only a small percentage of sourcing professionals earn salaries in the six figures - and most of those are in leadership roles. A sourcing professional that saves $1MM in a year is no where near compensated as much as a sales professional who brings in $1MM in revenue. In other words, the corporate world doesn't seem to believe that a penny saved is worth the same as a penny earned. However, in reality, a penny saved is actually worth MORE than a penny earned because a penny earned is taxed.

This lack of due respect for the sourcing professional prevents to development of a learned, experienced and capable corps of sourcing professionals that can greatly impact a company's performance. This organziational challenge can only be fixed by the CEO elevating the sourcing function to a status similar to that enjoyed by revenue-producing organizations--and the compensation should reflect this status. Only when this occurs will sourcing be viewed as a true lifelong career rather than a phase in one's work experience. If viewed as a career, sourcing professional would then "dig in" to their commodity areas and become true subject-matter experts (e.g. by learning their client's business, the industry dynamics of their commodity, the major players, the pricing models, etc.) which would ultimately enable the sourcing organization to become a knowledge organization that derives power through respect for its expertise which compensates for any lack of organizational clout. It will still be a support organization to a degree, but one that commands the respect of the internal client, and like a friend who doesn't let a friend drive drunk, the sourcing professional will take the keys and do the driving in order to protect the client from himself.

Traffic

You know, I'm new to blogs as of a week ago, so I haven't yet figured out how to get anyone to read it besides myself. I look forward to this journey of figuring out how to drive traffic here. After all, once people start posting comments and questions, or perhaps offering their own war stories or lessons learned - or heck, correcting me on something - all that stuff is good because it makes for better content.

If you're confronted with a contracts dilemma, need help interpreting or drafting a clause - whatever, pass it along. If you'd like, I'll keep you anonymous and post my response to this blog for others to comment on. After a few hours or days, hopefully we'll have your conundrum solved!

Sunday, January 08, 2006

Anatomy of an SOW

As part of my efforts to keep my posts short and sweet, I'll cut to the chase:

If you're working on a development project, development of just about anything, then you need a statement of work (SOW). Forget the terms and conditions (legalese) for a second - the SOW is the meat of the agreement when it comes to development deals. It answers the 5W's (and sometimes the How - but this should be avoided or at least kept to a minimum).

Here's a basic SOW structure (there's no ONE right way):

Section I: Project Overview;
Section II: Business Requirements;
Section III: Proposed Solution & Approach;
Section IV: Description of Deliverables;
Section V: Deliverables Schedule (ideally, a table with rows and columns spelling out which deliverables due by which milestone dates, milestone payments associated with acceptance of each deliverable, responsible party(ies);
Section VI: Acceptance Criteria (for customer, the ideal is absolute discretion: "upon acceptance by customer as determined in customer's sole discretion" whereas the opposite (seller view) extreme is acceptance is deemed to occur upon completion of deliverable - somewhere in between you might have to set out objective standards on which to determine if a deliverable is acceptable);
Section VII: Project Assumptions (level of customer involvement/committed personnel, equipment provided or needed, preexisting materials to leverage from or to build upon, technologies with which deliverables must be compatible with, etc.);

How many contracts actually contain such detailed SOWs in the Real World? Few, unfortunately, and it's usually the customer's fault due to lack of time and/or expertise to plan ahead and exercise diligence. This reminds me, Sellers, beware of customers who show a lack of diligence and preparation on the front end. In my experience, most development projects that fail stem not so much from sellers overpromising and underdelivering - but from customers who lack a clear vision for the project coupled with an unrealistic expectation regarding what it will take to do the project right. If you get a sense that the customer is hoping to "throw it over the wall" to you, watch out. This customer type thinks you're the expert who should be able to magically figure it all out at the price they're paying (they'll think this no matter how good a price you gave them).

Interview the person on the customer side who'll lead the project to assess how strong they are as a project manager and how well they grasp the project. Inexperienced project managers on large, complex projects can be your worst customer nightmare. Protect yourself and your company by beefing up the "Project Assumptions" provision and add lots of detail about what the customer will have to do to uphold their end of the bargain. For example, if you need a SME to allocate at least 10 hours per week for reviewing and signing off on deliverables, put it in there and keep track. This may come in handy down the road if the customer wants to terminate and blame the failed project on you (blaming the vendor is always the convenient scapegoat for incompent project manager/customers when they have to explain what went wrong to their boss).

Oops, this post is getting too long. One last critical thing to remember for ALL development projects: Include an intellectual property (IP) clause that spells out who owns what. Customers oftentimes want to own everything since they're paying for it, whereas sellers want to own everything to build out their IP assets, create new products for resale to new customers, charge customers for tweaking the deliverable down the road, etc. Customers will want the IP clause to treat all deliverables as work-for-hire, and as a fallback, an assignment of ownership. Sellers want to own and grant the customer a license to use (usually perpetual with rights to create derivative works). A third option in joint ownership - but customers have to live with the possibility that the vendor will resale to competitors; whereas sellers don't want customers with joint ownership to compete with the seller or have the ability to sell or license their rights to seller's competitors.

"Hey, I'm One of You": The Client-Centered Approach

How do you get a client on board who sees you as just more red tape to cut through versus a partner in success? Here are some thoughts:

Speak your client's language. I can't overstate the importance of this. Do you know how flattering it is when clients realize you're stepping out of your comfort zone to really understand their business, industry, what keeps them up at night, etc.? They will appreciate it, I promise. In fact, after a while, they might even start seeing you as one of them - and that is the holy grail, my friend, because then you start drawing nearer to the inner circle: higher profile meetings, lunches, dinners, happy hours, etc. You start becoming an insider "in the know" and we all know that knowledge is power. As a contracts/sourcing professional, this allows you to get more involved on the "front end" of dealmaking when you have a chance to knead the dough - instead of the old days when everything you got was already half-baked.

But how do you learn to speak the client's language? First, subscribe to every free trade publication you can get your hands on. You don't even have to read every article. Just browsing for buzzwords is better than nothing. It helps to be a learner - I mean someone who really craves growing their synapses by continuously learning new stuff all the time. Another thing you can do is ask them a lot of questions - just showing genuine interest in what they do will flatter them. I like to fancy myself as someone who's good at asking probing questions. I'm careful though not to across as a trial attorney cross-examining someone - I just want them to sense my genuine interest. People don't mind being asked as many questions if they think you're just fascinated by what they do. Use good judgment though.

One final note on building client relations: As much as possible, make your client feel like the only client you have. Hey, I know that's an impossible goal - but if you give this your best shot, they'll immediately notice a difference and it will make you stand out.

If you learn your client's language and they see you as one of them, they will be much more willing to listen to the concerns you raise on their deals. Ultimately, by understanding your client's agenda, you can better serve your agenda which is to get optimal terms and pricing.

Oh, one last, final thought: If sales reps can wine and dine your clients, then why can't you? Get approval from management to use your corporate card to treat your most important clients out to fancy meals when important deals are coming down. I know a lot of companies frown on this, but this could be one reason why the client always seems to favor the sales rep. Never underestimate the power of a good meal and good wine (on someone else's dime) to build good client relations.

Wednesday, January 04, 2006

Spend Analysis

A good strategic sourcing strategy starts with a comprehensive spend analysis. It's a labor intensive process but can yield bountiful fruit. The process involves buddying up with Accounts Payable to pull spend data over a certain period - year-to-date, plus last year or even multi-year data for trend analysis. A good time to start is at the beginning of the current year's 4Q assuming the company's accounting system goes by calendar year. In many cases, the AP data in its raw form will be in an Excel spreadsheet. The level of detail in the AP records will determine how hard it will be to analyze the company's spend. If you're targeting a specific spend categoy and already know that vendors involved, that provides an edge, but hopefully the spend category has its own general ledger code.

So let's say AP has given you a data dump of all of 2005 spend in a massive Excel spreadsheet and you've somehow isolated the line items making up the spend category you're targeting. You've come a long way, baby. You've sifted the raw data down to the discrete line items you want to analyze. What's next? You have your sample data, now you need to decide how to "cut" the data - for example, by:

1. Listing the Top 5, 10, 25, etc. vendors in terms of total dollars spent.
2. Identifying those vendors doing business with more than one department, business unit or division.
3. Identifying instances where multiple vendors are providing the same product and/or service.

You'll want to focus on getting the biggest bang for your buck. Pull all the relevant contracts and gather benchmark data to compare pricing and terms. Make sure to set your baseline from which to measure your savings! If there are multiple vendors providing the same product and/or service and there's no good reason for this, then consolidate down to as few vendors as possible to get volume discounts. Consider a formal RFP process to solicit competitive bids on an apples-to-apples basis (more on this in future posts). Make sure the RFP at least lists the critical needs that the product and/or service must meet in order to be successful. Consider developing a template in which bidders must all input their responses to make side-by-side comparison easier. Finally, you may want to develop a decision matrix or proposal scorecard to objectively score your bidders and reach your final contract award decision.

Content Licensing Nightmare

About 2 years ago, I had a client who was the highest-ranking corporate training executive in one of the largest financial institutions in the U.S. One of her biggest training development initiatives at the time was the development of sales training program for branch employees to increase "wallet share" of existing customers. This meant, for instance, if a teller noticed that a customer cashing a check had only a checking account, the teller was to inquire whether the customer would like a savings account. If the customer had, say, more than $10,000 in savings, the teller was to ask whether the customer had considered CDs (particularly older customers) and so on.

The executive assigned her best project manager to lead a competitive bidding process to select a vendor to develop the program. An RFP was sent to several vendors and it came down to two leading finalists. The first one offered to build the course from scratch with heavy input from several subject matter experts (SMEs) within the bank. The final deliverable would be considered a work-for-hire (or, as a fallback, an assignment of ownership) so that the bank would own the course outright - meaning that it would not have to pay content license fees, would be free to modify the content at will and could prohibit other companies from using the course.

The second vendor was a nationally known sales training company offering to license the bank its "renouned" content and allow the bank to customize it to fit the bank's unique circumstances. The license was not cheap: $500,000 for a perpetual license with rights to make derivative works. The first half ($250K) was due upon delivery of the content in a format acceptable to both sides. The second half was due in January of the following year (i.e. 6 months later) because the training executive wanted to spread the cost over 2 budget years. The second vendor won the contract because of the quality of its content and the fact that it had a "Who's Who in Corporate America" client list.

Two months after the first payment, the training executive's team discontinued the project after concluding that the off-the-shelf content could not be customized to work within the realities of the bank. In other words, it was like trying to fit a square peg into a round hole. It turned out that the training exec was new to the banking industry, having come from the entertainment industry. The bank team decided to write off the $250K as a hard lesson learned and shelved the project indefinitely, hoping to just make it go away - but that was not to happen. Early the following year, the vendor demanded the second $250K payment. The bank executive said "no way" and felt that since they never used the content at all, the vendor should've been happy with receiving a quarter million dollars for doing nothing more than mailing CD-ROMs. However unfair their position may have seemed, the vendor stuck to a strict contract construction argument by pointing to the plain language of the contract stating that the second payment was due in January the following year - without mention of any other requirement other than waiting on the calendar. The vendor had fulfilled its sole obligation to deliver the content. After consulting with the bank's legal department and hearing the bad news that the vendor had the better legal argument, the training executive caved and a second check for a quarter million dollars was sent out. In the end, the vendor was paid a half million dollars to burn its existing content onto 2 CD-ROMs and drop it in the mail. Now that's what I call easy money!

As usual, had the appropriate contract clause been in place, this fiasco could have been avoided. With the benefit of hindsight, we see that the customer should have done several things differently: First, the bank failed to properly analyze the content to make sure it was useable before obligating itself to pay the license fee. It should have negotiated a trial period during which time the bank could evaluate the content carefully to make sure it was useable in the bank's environment.

Second, assuming a successful trial period, the bank should have negotiated to reduce the $500,000 content license by at least half - regardless of whether the license was perpetual and allowed derivative works. This was a ridiculous price for off-the-shelf content that had been in the marketplace for years (as was the case here). The sunk costs associated with the original content development had long since been recouped - meaning that there was extraordinary margin built into the $500K.

Third, the bank should have considered breaking the license fee payments into smaller chunks spread out over time where at any point during the project the bank could have terminated the contract without further payment obligation if it decided, in its sole discretion, that the content simply wasn't going to work. With proper negotiation, I firmly believe all of the above and more could have been negotiated into the agreement to spare the training executive a lot of grief. As is often the case, the root cause to this debacle was an extreme sense of urgency to rush forward on the project without thinking things through. It is in such situations that judgment becomes clouded and customers get burned - and sometimes, careers get damaged as was the case here - the training executive is no longer with the bank.

Quick Tip: Automatic Renewals

Contracts oftentimes contain automatic renewal provisions (also called evergreen clauses). Vendors will say that this is for the convenience of the parties since they avoid additional paperwork otherwise needed to renew the agreement after the initial term is up. Typically, the automatic renewal period runs month-to-month allowing both parties greater flexibility to get out of the agreement after the initial term. Sometimes, however, renewal periods can run longer, such a year-to-year.
I usually don't have a problem with year-to-year auto renewals. From the customer standpoint, assuming the agreement doesn't have a provision allowing the seller to raise prices midstream, a one year auto extension should lock in pricing for another year.

Now, here's where a customer needs to be careful: Beware of auto renewals for extended periods (such as year-to-year) in cases where the contract contains a financial commitment, such a additional license and/or maintenance fees, minimum revenue commitments, etc. Auto renewals tied to a financial commitment can lead to unintended (and unbudgeted!) payment obligations. This is particularly troublesome since most customers do not have contract management systems to track critical contract dates - at least not on the buy-side (the revenue side is oftentimes another story).

My best advice for customers is to negotiate for the removal of auto renewals where such renewal will trigger additional payment obligation, and instead, opt for a window in which to extend the agreement or else the agreement expires (or have it go month-to-month instead of year-to-year). Which of these latter two options you go for is a judgment call based on the circumstances.

Tuesday, January 03, 2006

Strategic Sourcing Quick Hits

If you work for a company that fits the following profile, and you're in a position to influence your company's vendor contracts, this post will show you an easy way to be a hero.

The classic company profile is a small-to-medium sized company (from, say, a few hundred to a thousand or so employees) that has experienced rapid growth over the last few years. This same company has not yet hired a person to act as a purchasing/procurement/sourcing whatever professional whose job it is to squeeze money out of vendors among other things. If your company fits this profile and your in a position to take advantage of this tip, then do this:

1. Pull all your current telecom contracts
2. If you have multifunctional printers, pull these contracts

There is probably a lot more savings opportunity out there in other vendor categories but these two are almost guaranteed if you discover that these contracts are nearing 2 years old or more. At one company, I discovered that the long-distance contract was 4 years old and renewing month-to-month. I placed this out for bid to 3 vendors, and a month later we signed a deal that would save us over $100,000. I did the same with our printers and lowered our monthly printer lease payments by 2/3. It was easy; all you have to do is let the market work. Smaller companies aren't very sophisticated in how to work their vendors and usually are clueless to that fact that they're getting taken advantage of.

As I said, these are just 2 examples. I'll talk more about this in later posts.

Tricky Assignments Clause

Check out this clause contained in a Big Wireless Telco contract:

"Neither party may assign this Agreement without the written consent of the other party except that this Agreement may be assigned without consent to an Affiliate and to an entity acquiring substantially all of the assignor's business."

A mutual non-assignments clause requiring written consent of both parties is standard in most commercial agreements. It's also common to see carve-outs for assignments to affiliates (usually defined as entities:

(i) controlling the contracting entity;
(ii) controlled by the contracting entity; or
(iii) under common control with the contracting entity

"Control" in this context is oftentimes defined ownership of more than 50% of the affiliate's outstanding voting shares or substantially all of the affiliate's assets).

The main point of non-assignment clauses is to control who you're doing business with. If you select party X, you don't want to later find that you're now with party Z that you know nothing about. In the case of Big Wireless Telco, "party z" didn't have adequate cell tower coverage in areas where the customer's footprint was concentrated. Despite the potential problems of unfettered assignment rights, parties are usually willing to allow assignments to affiliates without consent because the agreement is still "in the family" and it would be unreasonable to restrict a company's ability to reorganize itself.

The clause above allowed Big Wireless Telco to undercut the non-assignment clause without written consent by allowing Big Wireless Telco to create a special purpose entity (an Affiliate) to act as a vehicle for making unconsented assignments to a third party. The clause contained a clever, contracting drafting slight of hand: Notice that the last part says "substantially all of the assignor's business" instead of "substantially all of Big Wireless Telco's business." Since Big Wireless Telco was one the largest wireless providers in the U.S., Customer may have accepted the assignment to an Affiliate carve-out as standard and the assignment to an entity acquiring substantially all the business as extremely unlikely since Big Wireless Telecom was perhaps "too big" to be acquired - especially over just a 2 year time horizon (the contract term), so Customer may not have felt the risk warranted haggling over.

However, who is the "assignor" in this sentence? Turns out, Big Wireless Telco said the "assignor" was not Big Wireless Telco but rather the Affiliate. And who was the Affiliate? Just a special purpose entity set up for the sole purpose of having agreements like Customer's assigned to it which Affiliate, in turn, assigned to a third party wireless telco that Customer wanted nothing to do with.

Customer was eventualy able to find another way out of its deal with the third party wireless telco, but not without wasting considerable management time looking for a way out. This uncertainty could have been avoided by substituting the term "assignor" with "Big Wireless Telco" - that way, if the Customer was relying on the unlikelihood of such a large company being acquired, then at least the language would support this.

P.S. Note that parties may also include a sentence in the non-assignment clause stating that a "change of control" shall also be deemed an assignment - in other words, a contracting party that sells out to another party has to get the other contracting party's consent. Otherise, by default, a change of control will be an assignment by operational of law which, unless otherwise agreed to, does not require consent of the non-assigning party.

Coming Soon...

I just want to briefly lay out the scope of what I plan to cover on this blog:

1. Book and article reviews relevant to this blog
2. Lesson learned and other recent "Ah Ha!" Moments
3. Recent news events relevant to this blog
4. Clause of the Month
5. Strategic Sourcing

As I post to this blog, I hope to receive questions, comments and suggestions that will continuously improve the depth and breadth of content on this site. Most importantly, I want this blog to be real world oriented and practical. You won't catch me ruminating over abstract, theoretical, useless academic BS that doesn't matter. Who has the time to read dribble? Perhaps academics.

To clarify the fifth item, the area of strategic sourcing (or simply, "sourcing") is an additional subject that oftentimes relates to my work as a contracts attorney to the extent I work on larger procurement (or purchasing, supply, etc.) agreements. This provides the attorney with an opportunity to add additional value to a deal by negotiating for optimal pricing and other terms. I'll be writing a lot on how contracts attorneys can add this perspective to their approach and provide their clients with bonus value-add.

Monday, January 02, 2006

Welcome

Welcome to my blog. As you can see, I'm starting small but I hope to grow this site over time as the inspiration hits. Don't be surprised if considerable time passes between posts - after all, I have a 2 year old boy and a 1 year old girl! I'll be posting observations about various types of contracts, contractual provisions and various other experiences that arise during contract negotiations.

Contracts help to create the certainty businesses need as they seek to avoid the sandtraps that lie in wait in the business world. Most transactions are straightforward and need only simple standard forms. However, as risk and dollar value increase, the justified paranoia of both sides gives rise to customized and increasingly complex agreements. It is the more complex contracts that I have focused on for the past 10 years. It is a curious obsession of mine.

So much of life can be viewed through the framework of contracts: religion, marriage, the Constitution - to name just a few. I'll explain this more in later posts. Contracts can be a fascinating area for those who have "fallen into" this specialty (no child dreams of becoming a contracts attorney) and it seems to attract or foster certain personality traits: Those who enjoy digging into details, exploring the nuance of language and always thinking of the worst-case scenario while trying not to become a curmudgeon.

If we do our jobs right, nothing happens. In fact, the most successful contract is the kind that disappears into the file cabinet to collect dust only to reemerge when someone realizes the contract term is up. Furthermore, our high points rarely stem from moments where we proudly show our clients that critical clause - so desperately needed to save the day - that just so happens to be there solely because we put it there. More often, we add value by anticipating issues before they come to a head and unambiguously addressing how they will be handled in advance so there's no room for disagreement. In the end, we add value by helping our clients successfully navigate complex transactions. Rather than acting as friction in the form of transaction costs and as inhibitors of business, I hope that we are the oil that helps keep the wheels turning.