“With any business change there is a need to negotiate. The performances within these negotiations are every bit as important as those held during the growth years.”
This article has been written by Steve Gates The Gap Partnership Chairman
As the economy is placed under recessionary pressure, change, buy-outs and mergers not only result in a different set of market dynamics but present business relationships with different negotiation perspectives. Renegotiation becomes necessary as possibilities, dependencies and the balance of power adjust along with the market.
If Manchester United and Liverpool football clubs were allowed to join forces and become one team, and the Premiership were to reduce to nineteen clubs what would be the impact on the rest of the Premier League? Fewer players would be required, there would be more power to buy the best players into one camp, fewer games played and more interest generated from TV and sponsors in one club. The dynamics would change, as would dozens of assumptions, requiring for most club owners a complete re-think about how their club would perform, given these changes.
Although the League can control certain rules of operation, for instance how many teams (businesses) compete, how different would this scenario be from the natural process of one company buying another, and consequently changing the trading dynamics of an entire industry? In business this can, and does, happen every day, because there are no such rules!
As the economy tightens and growth plans evolve into consolidation exercises, new opportunities to improve businesses are presented. Banking, construction and the motor industry, the first to be hit in a recession, have experienced dramatic change in the past two years. With any business change, there is a need to negotiate. The performances within these negotiations are every bit as important as those held during the growth years. In fact, where survival is at stake, they are often more important.
So let’s examine the local implications of a buy-out or merger, where the coming together of two companies changes the dynamics of business, and the need to review your negotiation plans becomes a primary consideration.
“As the economy tightens and growth plans evolve into consolidation exercises, new opportunities to improve businesses are presented.”
As the market contracts, relationship dependency and balance of power change. The need to review ‘contracts to supply’ result in negotiations focused on the harmonising and improving of terms. Figure 1 removes natural competition from Customers A and B as Customer C is formed. C now demands of you better terms because of the increased volume (power) they have and the apparent saving you will make serving only one rather
than two Customers.
Of course you will see this differently, as your overall margins (which used to be different between the two Customers) will be compromised. This transaction is often positioned as offering both you and Customer C with a greater value opportunity; Customer C will usually insist on parity and usually a lowering of costs to the lower level of Customers A & B historical rates. Further leverage will also be sought by Customer C having recognised that better payment terms were historically enjoyed Customer B than A, or vice versa.
“For those facing the consequence of market consolidation we have pulled together a ten point check list of insights exploring the dynamics of negotiations held following a merger.”
1. The need for a strategy
The most effective way of managing pending change is proactively. Positions will be taken up with first movers taking positions and making demands. The idea for any business facing this situation is to state their position first and take control of the agenda, brief all internal stakeholders and understand the risks involved; effectively, the development of a clear strategy.
2. The unilateral demand – the subtle use of power
This is a common tactic employed where the buyer is taken out of the communication process in the short term. A letter from the FD or senior individual positioned in a factual manner simply sets out the new terms and when they will come into effect. The letter is usually written in such a way to reassure the Supplier, yet subtly mention the consequence of non-compliance. The effect of this letter is to flush out those who will capitulate in the first instance as a result of the increased power achieved from volume, and thus dependence is exercised for the first time.
3. Sequencing to increase power
As part of the strategic planning ahead of such negotiations, those seeking price or cost harmonisation start out by categorising the range of Suppliers and determine the differing characteristics of each category group. This allows for separate strategies to be developed, recognising how the balance of power will move once agreement has been achieved by the first group(s). In other words, if you represent a company, for instance Supplier D (below), you are one of very few who have yet to agree terms with your newly formed Customer. Suppliers A, B & C have all agreed terms, the power has now moved against you as you now represent the minority and therefore your Customer can afford to negotiate with you more aggressively.
“As one parties buying power becomes greater the volume incentive discount argument carries greater legitimacy and whether through price, investment or other concessions there is an expectation of a better deal.”
4. The volume argument & market share – the game has just changed
As one party’s buying power becomes greater, the volume incentive discount argument carries greater legitimacy and whether through price, investment or other concessions, there is an expectation of a better deal. The very synergies which substantiated the merger in the first place have to be realised and buying power is one of those. However, for the Supplier who had two independent Customers operating on already good terms, they will need to plan if they are to realise a ‘win’ for themselves. The market has moved against them and they could be compromised.
5. Cherry picking, otherwise known as harmonisation of terms
In Figure 1, Customer C will have examined the best possible terms across all products and services, generating spreadsheets which inform their net position. One of their first requests likely to be for you to align your terms with the best you can offer as illustrated by your historical offers to Customers A & B.
There have been many historical cases when a larger retailer buys a smaller retailer in the market. The smaller retailer has operated through local Suppliers buying smaller volumes but on better terms than have been agreed by the larger retailer with national supplies. Other areas examined can be regional price variations based on brand or market presence by product area. This usually only becomes apparent after the buy-out.
6. Improved overall pricing
With increased volumes and cost efficiencies on offer, Customer C, after harmonising terms, will now insist on price reductions to reflect the synergies that you now ‘enjoy’. The dynamics here can work against high volume Customers as there are fewer Suppliers who can meet the higher volume requirements of the bigger Customer. With few options in the market, the balance of power tilts back in favour of the Supplier. Has the volume really changed? You may choose to point out that your total sales have not increased and that your investment has to remain relative.
7. Staying in the game
Customer C is likely to highlight any reluctant players as being out of sync with the sentiments of the market, ‘first movers’ may be presented in the press as the ‘new partners’, promoting further pressure on you to reconsider your position.
8. Range rationalisation
Customer C clearly needs to rationalise the number of Suppliers and products it uses, so the next threat will be ‘are you in or out of our rationalisation programme?’ This provides Customer C with yet more power.
9. Out to tender
With commodities or private label products which have no brand association, Customer C is likely to re-visit its Supplier base as it examines the implications of its newly found scale.
10. Integration problems
Suppliers are inclined to point to the integration issues faced by Customer C and offer to support them through these challenges as a preferred Supplier. Assumptions around the ethics of how Customer C will behave and negotiate should not be based on how Customers A & B used to behave. It may become a more aggressive partner or equally it could become more ethical as it recognises the dependency that it has on its Suppliers to uphold the service proposition it presents to its own Customers.
We can start to consider the broader issues around how the dynamics of the market are affected by consolidation. In figure 3 we examine the dynamics of the other Suppliers, how they respond and the effect this will have on you.
In figure 3, your competitors, Supplier X, Y and Z have traded with Customers A & B although X had no relationship with Customer B. The new Customer C decides to use competitive pressure as part of its negotiation strategy. If you were supplying a commodity based product, Customer C might decide to keep all
Suppliers within a dual supply contract, allowing it to maintain competitive pressure which would be easy to exercise on an on going basis. For example, retailers involved in buying meat and bread are often exposed to such agreements.
Again, within the context of Retail, as the supply of product ranges come under tender, in both own label and private label areas, the risk is run of reducing product specification to achieve commercial demands, which, in turn, presents implications to the long term sustainability, especially if consumer expectations are not met. In these circumstances, total value solutions should be promoted by you, the Supplier, emphasising quality, consistency, supply chain management, NPD capability, innovation and market knowledge (category management) and other variables for consideration in selection.
Pro-activity, creative exploration and negotiation become critical, as does the climate of partnerships, without which all parties are likely to suffer.
“Use your negotiation strategy to be proactive and seek ways early to work with the new Customer.”
The transitional journey of change over the first eighteen months following a buy-out will present trading pressures over and above those which the economy will naturally provide. The two combined (consumer habit change and Customer relationship change) provide a unique set of circumstances to build and create value. Below, we have set out the three phases of activity to be implemented by Suppliers faced with a consolidating Customer base.
Phase 1
Those responsible for serving Customers A and B (Figure 1) should work together to complete an exercise scoping Customer C in order to fully understand the issues which consolidation will present, for example the risks and opportunities which need to be managed and the forecasting of likely trading performance. Understanding pressures and issues, trading strategy and short term goals will be critical to your performance during the transitional period. The development of a negotiation strategy should take into account market dynamics and your competitor’s behaviour (Figure 3).
Phase 2
Customer C will need to deliver incremental value back to its shareholders, demonstrating that synergies have and will be achieved through improved Supplier trading terms, amongst other benefits. Expect the first few months to be challenging. Use your negotiation strategy to be pro-active and seek ways early to work with the new Customer. If you wait, you will find yourself negotiating from a compromised position. Use your position to escalate and align your strategies early on. Don’t be surprised if heavy demands are placed on you and you experience an apparent cooling in the relationship climate. Your new Customer is adjusting to their ‘new powers’.
Phase 3
Build and promote a broader agenda which allows for pro-active and joint business planning. The creative broadening of an agenda and working together to fulfil mutual commercial goals remains critical to the medium term value opportunity from the relationship. If Phase 2 were defined as Value Distribution then Phase 3 would allow for Value Creation. Largely, power and dependency will govern how long it takes and whether this Phase is exercised, but this should remain your goal.
