CUSTOMER

NEGOTIATION
Qrurrnn

Pnrcrnc IN THE
TRENCHR,S
'Ihis chaptur is Mttharcn @itu Da'rid Kreidbetg
aJ

the Struteric Pricit'g Croup,

In..

It can be said that pricinS is ihe "moment oI iruth" in marketinS. That moment occurs in the offices of purchasing aSents and field salesPeople, far
removed from the marketinB departments and executive suites wherc
shategies are created. Consequenily, even well-conceived PricinS strategies frequently fail due to ineIlctive imPlementalion To caPture value in
pricing, sales manage6 and salespeople must learn to assess the negotiating positions that customers employ and to resPond aPProPriately In this
chapter, we

1.

will

Analyze and compare the effects of fixed ve$us neSotiable Price

policies

2.

Discuss the appropdate negotiation strateSy for three tyPes of

3.

Present an analytical method for Preparing closed comPetitive

P ce offer

bids when you have just one chance to make the riSht

NEGoTIATED VERsus FIXED-PRrCE PoLICIES

During recent years. an ever Iarger share of prices have become negotiable
Companies that for decades enjoyed leading market shares in mainframe
compute$, office equipment, or pharmaceutical and ielecommunications
se ices are today negotiating discounts to retain sales. HosPitals, Iaw
firms, and maintenance companis are negotiating Prices Ior services.

190

E!en in consumct malkeis, substaniiaL discounis arc ne8otiable for highqualiq/ branded products, hotel rooms/ annual ies on credit cards, and
general merchandise availnble ai local hornc ceniers. lt seems as thor.rgh the
price 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$, construc
tion, a tclecommunicahons satellite, or a ncw home), netotiabl pri.es pcr
mii 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 de
velop thc knd{ledge and erperiise k) detcrmine thc prices that other cus
tomers pay. ln industrieli $,ith standardizcd, frequ.'ntly purchased
products, howevcr prlce ne8otiaiions undernine a firm's abjlity to capiure
the lallrc of its proclucts. Unforfunatcl,v, it is in these industrics that price
negoiiation appears to be glowing mosi rapidl)'.
During the l970s and 1980s, three forces began pushing companies
bward negotiated prie poiicics. First, price controls during the edrll' 1970s
Left manv companics caught betwoen lixed priccs for their producis and
rising costs from external supplicrs. To protect themsel\.cs, companies
raised their pnblishecl lisi prices excessivelv while discoLrnting them sur
repritiouslv. If price conLrols s,ere imposed again, it l,\.ould be easy to raise
effe.tive prjces bv redricing the Lliscounts. Second, in the 19E0s powcr jn
consumer markets shifted toward large retailers such as Safeway grocery
sto.es, Wal-Mart rctail storcs, and Home Depot horne ccniers. Thcir
ttemendous buying vollrme alloil'ed them b negotiate belter deals from
c\'en lcading brand manufacturers.
Finally, many markeis from mainframer conrputers, to home appli
ances, to legal scn'iccs are now e\periencint the svmptoms of maturityi
shwcr grd,{th; reduced differcntiaiion; and rnore knowledgeable, valLreconscious buye'rs. Rather than adiust their pricc policies and margin goals
to morc accuratelJ, rcflect the nch'competitive environmcni, many companies simply bcgin negotiating discounls on an individual account bas;s.

Cusiomers learn ihat ihe pricc thev pa!, is related more to negotiitting
powcr and abilit). than tu value reccived. Consequently, sellinS moves
trom a cooperative process of tinding the best solution for the customs to
an adversarial Frocess of dividing thc gains. Companies in this situation
find that c\,en h'hen they create products of supcrior value, {ustomrs are
unwilling to pay a price that reflccts that value.
Moreo\.er, negotiablc pricc policies teach salespeople to use price as a
kxrl for closini sales rathcr than to raise the cLrsiomers' willingncss to pay
bv selling ralue. To makc matters r,olse, manv companies that negotiate

prices actually encourage salespeople to se1l on price bv re$'ardhg ihem

fo. 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 conrpeiiiive condition-s rcquire ongoing modifications of fixed price structures
to mainiain legitimacy in ihe eyes of customcrs. lvaluatint prichg stntctures on a continuing basis ensures ihat comparies capiure the tinique val
ues of individual customer segmcnts and the volume opportunities rhy
represent. Unfortunatellr, managcrs unable or un('illlng to capiure this
value cede coDlrol over pricing and uliimately over ihe strategic direction
of their businesses. Companies thni hope to maintain v,'in wln rclationships
with their cusiomers by providing cxccptional value have little choicc but
io 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 irl
dushy, recognize that such a policy need noi be a one pri.e poiicv. You can
and should provide /t-trd discounts for volume, long-term contracts, and
bundled purchases. You can also majntain dlfferent margins for different
products in your lhe (for example, higher margins for Cadillacs than for
Chevrolets) and for objective customer segments (for examplc, senior citi
zens). A fixd-price policy means simply ihai ihe price tur any pariicular
offer (product, quantity, terms, and so forth) sold to someone h a particular
cusiomr segment is rlon egoltable. lf a customer needs a lower price, he or
she 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 way
back toward a fixed, \'alue based pricing policy whcn customers hafe
come to expect that every price ls neSotiable. The following guidelines will
help you establish a fixed price polic)' \\rhere account ]e!cl ncgoiiaiion has
pleviously proliferated.

1. Prices must accurately reflect ihe unique value of products io different customer scgments. If the,v don't, you must further scgmerli arld in
crease thc standard (nonnegotiable) discounts fo. thc most price sensiti\.e
customers. If some price sensitive customcrs can'i be segmented, then walk
away from the business to protect thc tcgrity of vour prices to other more
profitable setments.
2. Salespeople must bc educated on ho$' to sell proctuct value and
be appropdately compensated to do so. (See Appendix 8A.)
3. Use the switch io a ronnegotiable pricint strategy as a promo
tional tool. Customcls should perceive the fixed pricc policv as a fair
change for both thc buyer and the seller not as a pr.ice nlcrease. This ls

t92

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 hclp
salespc()plc close snles to lnlue'sensitive customers tlithout so visiblv undermining 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 first
undersL.rd who the brycr is and his or her ro)c { ithin the buynlg ccrlter of
the corporntion. Sales to organizatiols is far more complex than sales to in
(titiduals bo.aus each mL'mber of lhc buIirlg centc'r eyaluates altornatile
products and suppliers brsed on unique criteria. Buving centers lienerally
consisi of individuals $,ho fuliill ihe following rolcs:

1. ,,tlldlo! start the purchdsing procc'ss. Routin product purchases

bc
may
initiated bv front line production $.orkc'rs or supply persormel. In
complcx purchases, initiators mitht come from cntineering, rcsearch and
J"\.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, users

mav not ha\.e a great dcal of po$.cr in the p u rchaliing process3. tsrvcrs h.ve thc formal responsibillty for purchasinS products and
i.cs.
ser\
Alillough purchasing igx1ts often fulfill this trRditional rolc, it is
not rrnusudl to hale other embers of ihe organization perform this task,
especialh in small org,rnizations or when purchasing capital eqrlipment4. 6ri.k ct.rs control the flor\'of information and exrcmal contact
$'ith the supplt firms and aro often considcrccl experts in a particular
trroduci are.. Ofiei ihis role is fulfilled by a nondecision maker u,ho car
onlv inrluencc the decision proccss. A common mistake is to assumc that
the gatekccpcris the decision maker.
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 host

5.

of individuals fillnrg other roles.:

A common mistake that snlespeopl makc is concentrating on a lim

btx of people, thus unclcresilmating the impact ihat othcr n1cm
trers havc on ihe final decision. A rcquest fronr engnlcering mighi injtiaic an
etalua ln based solelv on perform.rnc.e and qualitv; tl,Ie deckion may thcn
move k, purchasing, h'here prrduct attributes arc secondarv to pricc. It is
ited

.u

impcrative that the seller recogrize thai ihese (hangcs nre taking placc nnd
adjusi their nejlotiation straicgv sccordingly. Srlling differentiaiing attributcs k, I Purchasing agent u,ho docs noi \.alue thcm is a r.rseless exercisc.

193

NEcorrATIoN Srnartcrrs
Effeciive negotiators must understand the various buying behaviors associ
ated with different tyt'es of buyers and thn individual purchasing agendas. These behaviors are a function of how buyers value differentiating
attributes oF prodrcts alrd their willin8ness to pay for ihem. Although suppliers often conccntrate on selling differeniiation value, a buyer's $illingness to pav mav be based on other critcria (see Chaptcr.t)- Successlul
sellers mrlsi aciapl their negotiation siratcgies accordingly. In this section,
h p,lts( -.h. -r[.. rFc,,l..,ticn.lr.r ct]es fL,r oeJlns I\ iln or-.. bLVu\. ,ova
b_$

er.. dr J

fAe-h-jlr,

rsee

( lupler h fur e\Fhn.ltron ,'f this . gmeita-

tion sheme.) Con\.enicnce buv!'rs are excluded bccaus they are not con!nl c. or pri(e, but merely a\.dilability.

cerned u,ith

Negotialing wilh price buyers

Pri.? ,r-v./s arc usuallv larger companies and govemment agencics
with the resources and inccntives to qualify multiple vendors. They seek ic)
purchase at thc lor,{est cosi, subjeci to the product and supplier meeting
m n.mur.pecific.rtro"-. fhcy \\ill L,! pd\ tur incrercrtdl Fr,dLr.l !alue
bevond ther specrrrc.rr,oni nor ror rhe i^i "i^.i.*i;."fi-tr1f,ifii--company
lonS-tcrm relati(,nships with sLrppliers. Their narrorv focus on price Breatly
inhibits the abiljiy of the s(ller to ncgotiate bascd on thc value of ihe product. lhese buyers may elcn limit suppliers' conract $'ith other mcmbers of
th buving centcr r-\,ho might acknoB,ledge thc product's incremental value
and justib pa),int a higher price. They may cven require formal bids and
use adversarial negotiatidl tactics designed to play suppliers off ngainsi
,r1('drolhe il tl_eir - dr.l_ lo l_, {vestp .p
There arc several strateEies for
y('s. rhe-lll!

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!(,jpitals that wcr iraditionallv pice bu]'ers to lalue lruyers b), placing comffEr terminals ln ihe hospital purchasinS departments. Ttese terminals
ncre linked to sophisticatc'd information svstcms r4.hich eliminated thc
1'aluc
.

nced to manage larlie inventuries. Thc net result was a more efficieni systcm enablinS the customer k) sa\.e more money from bctier iu\)crltolv mnnrd. rnerr rl rn b\ f(\.r.tnts -rn.tl\ Jn :ulpl\ pr.. cs.
AlthouSh vour long-tcrm objc.tiYe may be to change price drivcn
purchasing beha\ ior, manv price buycrs h'ill never change. In this casc,
scllers must follow a siratc8y of sc/.'.iii,r' frltt.rfnlior, carefully evaluatint
the short-term proiiiabilitv .1nd long-term implicRtiols of th('se transac-

iions and accepting them only R'hen they (a) pro\.ide incremental contribu
tion arld (b) do not undermlne more profitable business.
Companies often invesi resources to senre pdce buyers in dre vain be
lief that someday their fforts will prove profitable. Resist the temptation io
negotiate for a pdce buyer's business in anticipation of future profits they
rarely materialize. If you can't participate in their business profitably, ac
knowledge 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 and
participate in their business later by offerhg a low price tu'Lc, It is si'ategi

.d!t!
".,t

pnrd,\t d,nfuob|, t,,1. -:\4uLinor, tart \r.r.r,:v. or'l

.ipahor

sends a siSnificant signal io ]rour other cusiomcrs that you're not going to
invest resources where there is no payback. Sales, service, and support per
sonnel focl1s on servicinS valrie buyers and loyal buyers, since profits are

The marketer of an elecironic commodity had an excellent relation

ship with Ford ar1d considered the company a lo)'al customer. Althorgh
they also sold to General Motors for nany years, CM was shictly a price
buyer. Due to their volume and neSoiiaiing power, CM received a 15 perccnt discount on most purchases. lhe supplier was careful, however, io sell
GM only its undifferentiated, older technologies. When the supplier devel
oped a nerr technology that saved customers mone]' in the production
process, Ford was first io receive it. The supplier (ras reluctant to offer the
technoloSy to GM fearinS thai its adversarial negoiiators would force the
company to supply the new technology at a l$ver price or face losing a1l
business wiih GM. Despiie the lonS-ierm and persuasive evidence that
GM'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 many
marketeis since price buycrs are often their largest customers. By selling to
large customers, many firms are focush8 on the touthest negotiators with
the touthest pdce buyers and are losing the opportunity to capture additional profits tuon more profitable segments. Th "80/2{l rule" states that
80 percent of the volune in a particular industry will come from 20 percent
of ihe largest customers. The net result for suppliers rnfortunate enorgh to
win business from this scgment is increased sales voiumc but litiie or no
profit. Hundreds of suppliers to ihc auio indusby are in ihis sitr.ration. A
new, morc relevani rule for analyzing customer profiiability is the 201225
rule. Recent analysis has sho(n thai some firms are at "break-even" with
iotighly 70 percent of ihef cusiomers;20 perceni of the cusiomers provid
225 percent of the profiF; and the remaining 10 percent (the larger ac
counts) arc actually cosling firms 125 percent of iheir profitsl
Sincc fircd-cost siructures of manufacluring operations are ofien justified by thc voLume ihat large customers represent, it is ctifficutt io totally

195

walk awalr from all price buyers' business. Fortunaiely, because targe customers ofien negotiatc with muliiple suppliers, marketers can look for favorable opportunities for seleciive participaiion. When a bidding war
occurs, it is best to get in at the end of the process, when sellers are less
likely 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 to
the buyer, "When you're ready io place the purchase order, l'll give you
mv 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 considered.

A similar option is the "five minute price" tactic. Hcre, the low price
is not put in w tint and is in effect for only a short timc. Without documentation, the price buyer has nothing to sho$, competitors io elicjt their
response. U the seller is thc prcferred competitor, the buyer may recognize
that such a low pdcc night noi be offered again and mrist decide if there is
anv value ir1 continuing the neSotiaiion process. The risk in emplo),ing
such a strategv is thai customers malr determjne that the seiler is bluffin8
and 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 consis
ient produci quality and performance, and they rely on trusied suppliers to

continue providing it. lleir ongoing lo),alty is driven fundamentally by

the dsk and uncertainiy associated h'ith untested suppliers. The critical im
plications of inadeqrate performance outweith for the loyal buyer the ben
efit of lowcr pricc in thc short trn. Here, confidnce in "tried and true"
existing solutions from provcn vendors sustains ongoinS relationships.
Forti4' existing relationships by focusinS atiention on pasi perfor
mal.lce. Stress the impact of infedor product performance on the buyer's
firm, ihe sunk cost of previous investments, and compatibility with future
requirements. Utilize uni.tue pric and quality metrics to make compar
isons between and amont vendors more difficult. Above all, make ciear
your commitment to meeiing customer's' current and future needs and to
eliminatc iheir inceniive to iook for altemative soluiions. Invest sales and
managemeni time io thoroughly understand 1oya1 buyers' sources oI value.
Over time you will be better positjoned to react io their needs and reinforce
your Position as a trusted vendor.
ln contrast io adversarial negoiiations with price buyers, negotiations
with loyal buycrs arc more amiable and focus on solutions that saiisfy both
buyer and supplier business goa1s. Less tangible, more augmented features
such as technical experiise, reliability of service, and dedication to cus
tomcr satisfaction have measurable \'alue iu the evaluation process.

Although satisfactory past performance is turndamenial, a clcar indicaiion

of 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's
accountini business. The customer, aware that it was making an extremely
lorg{crm commihrent for a mission critical application, decided io divide
its business bctwccn the hvo vendors and let each one rLrn half the payroll
and 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 ven
dor. Half way ituough the trial peiod, a power surge crashed th systems
ol both voldors, requiring a three week restart. Thc competitor assmbld
a team of 40 englneers and technicians to atiack thc problem and restart the
svsicm. ltsM also assigned technicians b rcstart the system, but in addition
IBM 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 payroll
until the system was restored. IBM $'on thc contract. lmplemeniing such
creativc solutions shows commitment to total customer satisfaction and
helps rctain loyal customers for the long run.
Although tlt loyal segment may be large dunng the growth stage, it
;nvariably sh nks in maLudtr,, as more competitors develop good reputations and buvcrs bccone more knowled8eable repeat purchasers- The loyal
scgmcnt also contracis duin8 recessions, rvhen even oiherwisc loyal buyers may be scrambling to crt costs. Thus, a classic dilenma arises: Should
ih company c t its prices and sffice lvels io focus on loyal cusbmers
i{ho are migrating to the value segment, or should ii maintain ib pnces
and services to focus on the customers who remain loyal? The answer is
boih. Bl' nbundling thc costs of service (for example, training, installation)
and bv desisning equally reliable but cheaper prodrcts, companies can
leverage ihe repritaiion ihey develop whilc buyers call remain loyal and
can conlinue to capture the business of buyers who havc when become
more value conscious. Thus segmentaiion pricing stratcgy is the key to
growth nr difficult times for such market lcadc'rs as Geneial Eleclric.r
Alihough obiaining business from loyal buycrs justifies the investmeni of a firm's resources, when ncgotiaiing with loyal customers alrcady
bcholden b your competitors ihe theory ol sclcctive participation is once
agiin applicable. By definiitun, these are loyal customers and the likeli
hood of them changnt suppliers could be extremely ]ow. IntelliSnt marketers must evaluate thelr accounts carefully, selectinS only ihose
cusiomers who are likely to s$'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. Instad, they

make their purchase decisions by carefully wi8hin8 attributes arld analyz-

int trad offs, ultimately purchasing the produci offrint the highest utility per unit price. Unlite price buyers who focus on cost, valu buyers both
recoSnize and cost justify the added utility available &om more expensive
options. This segmnt, therefore, represenis an excepiional opportunity for
profits to the tum that can effectively commrnicate superior value. The difficult challenge with these customers is to rctain thetu business over time
since ihey are constantly reevaluahng iheir aLicmatives.
The decisjon to invest rcsoures and dcvclop long+crm relationships
wilh value buyers is a difficult one to make. Unlike loyal buycrs, who
clearly justi$, invesiment, or pricebuyers, whose limited payback is readily
apparent, value buyers have no predeiennined allianccs. Although ihcy
may indeed repeatedly purchase your compeiitively-priced and well-performing product for a while, apparent loyalq' quicklv erodes when competitors' products initate your product's features- Civen ihe poiential of a
shorFterm relationship, marketers must once again use a siraiegy of selective participation and caretully analyze whether doint business with ihis
segment represents the most effective allocation of ih firm's resources.
When negotiating with value buyers your objective is to capture the maximum value of your differentiation on each individual sale.
Succcsstul implementation of a value basd pricin8 strategtr depends
upon a saiesperson/s ability to distinguish between situations in which a
lower price is required, and situations jn which the cusbmer needs io be
bette. educatcd on the value of the product. Salespeople must be kained to
unde$tand how customers vaire their products and to use value-based
seling te&niques and negohating skiils to corinunicaie that value to customers. Finaly, saiespeople must master techniques used to reduce the
damage done when p ce negohations do occrr.
Salespeople must always keep their emotions out of the negotiations
process and must keep sight of their objective o{ closing the deal. In
Chapter 5, we discussed the problem inlterent in adopiinS a "win at all
cosls" strategy in competitive pdcing situations. The same holds irue for
customer neSotiations. It js important for salespeople to maintain a hiSh
level of prolssionalism durint the negotiations process, even if the buyer
insists on adopting adversarial taciics. In dre words of Bob Wolf, a famous
lawyer 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 mutual
satlsfaction of ali those involved."
When conflicts arise, it is important that both paties understand ihe
basis of d1e conflict, that is, which issues are negotiable and which are not.
Fighting over irreconcilable differences clouds the process and inhibits an
outcome favonble to both parties. Each side begins to mov away from an
amicable solution, becoming entrenched n opposing positions from which
resoluiion is virtually impossible. Participants must be willing to compro

198

mise in order to come to a satisfactolv soluiion. Suppliers mrlst recognize

thai cosi contlol ls frmdamental to ftstomers' cornpetiti\.e pricinS, alrd customers must understand that suppliers are in business io make a profit. Once
both pariies adopt the objective of "cbshg thc deal" and of being satisfied

with 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 no
significance 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 intenlaiiorlal
offices as a differentiator for pcople $'l'ro use th.ir travelcr's checks. Ii was
not until they communicatcd the value of thosc intemaiional offices in replacing lost or stolen checks that their ad!criishg ha.1 a posiiivc nnpact on
Several techniques support selling product value. Firsi, a cosi benefit
anaLvsis, such as economic value anal,vsis (See Chapter 4), provides crs
1'

ji

bmcrs with a clear undersianding of horv voLlr product can save them
moncy or add \.alue to their products. During the sales process, a fonnal
proposal dctailinEi ihis valrie analysis should be provided. Many marketcrs
avoict this technique because of the effort reguire.l and the dsk of documenting specific savings and proctucti\.it]' enhancements. lhis dsk can be
minimizcd if conservaiive approaches are used in the analvsis anct if effori
is 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 firm
that it rnusi pay for value. The folloh'ing two tecluiques have been proven
to suppori selling product value:
S bttaction Techfliqae This tecbni.lue involvcs removinB produci or ser
vice attdbutes from the original package to "jusiify" the lower price re
questecl bv cusiomers. For example, if a buyer objects to the price of a
milling machine, the seller could offer the unit at a ]o{,er price without
some of the value-added features such as tlaning or service. This tech
nique helps distinguish among buvers r rho are triing to extraci a price
concession and buvers \arho do not valuc specific product attributes. lt
forces cusiomers io recognize the value of aiiributes unavailable at the
lower pice, while refocusinil their atteniion arvay from ihe gain of a ]o$'er
price to ihe loss of ctifferentiating product atiributes. A variant of this rech,
nique involves stressing the penalties of doing without your product. This
method lequircs eriensive knora'ledge of competitive products. When used
properlv, this technique provides salespeoplc wiih the opportunity to discuss the "uni+rc benefit" of their products.

199

Dirlision Techniqle This iechl1iquc breaks down ihe cost of thc producr
into 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- \tJ
The customer's daily productlrn is 10,000 small notors; (2) rhe mobrs seu
for $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 profits
for the customer if ihe new belt can save one day oflost production, rvhich is
worth $2{10,000 h con ibution. This techniqre takes actrantage of the end
br 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. The
buyer delelops the specificaiions and asks for prices. In some cascs, srjch
as sales to government, thcrc is no opporiunity to scl1 "value" and the business goes to the lowest biddcr.. h other cases, yrru may be able to talk with
the buyers and determine lvhit adcled features mjghi nrake ]'oul b more
attractive despile a higher pricc. Pricnrg all order or prqect lor a compciiiive bid is the ultimate price-buycr situation.'lt oftcn invohes a huge hvestment 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 financial
health 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 entirely certain h'hat cach nrput $'ill be and how it should impact the final
pricing strategv. lr somc cases, the itegee of unceriainiv is lo\,!'enough io

i,. ' rou.,r,*.,.t'

allor irlorm:.

LJq11, r't. tJ b. m.r iF \.4rr),.,n,t.,r

as construction, telecommunications, computcr :nd svstems integration,
L \ul\F.l
ur 'e-m J
u.'i,.n. Lrforn:, ludsr*,n..du

i i

r'l.^r1|..

d,

noi provide these conrpanies H'ith adequatc solutions for clevclopin't pric
inq .!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 especiallv
wiliing to use more quantitative iechniques to ensure rhat they makc the
best 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. Attempts
to make unassisicd pricrnS judgnrents when facing multipte soLrces of un,

zno

certainty are likellr to prove frrrstratinEi if not impossible since ihey require
managers to think of more factols simuLtaneously than is humanllr Possible. CoDsequently, managers often disrcgard.:tata that could imProve their
decisions. Quantitative bidding analysis enables managers to think about
the problen in more tractable Pieces, which .an thn be combined and reviewed. 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 judgmeni, and it facilitatcs evaluating risk return irade offs. Finally, since quantitative analysis requires documentht the decision, ii helps managers leam
tuom past exPeriences.
:t

)
t

il

bxhibii s.1 illustrates a quantiiative analysis for a competitive bid

After listing possible bids that it might make, ihe comPany calculates the
prcfii coniribution associated with cach bid' The company ihen lists the
;ubjective probability of winrring, gilen each possible bid, ar1.l multiplies
thai probability times ihc profit contribution if it wins the contract with

that 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 contribu
tion to ivoid severe financial difficultlr' The role of ihe analysis in ihe latter
case 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 succesi is ever obvious. The nlcremenial cost of winning a job vades signifi
cantly depending on the amount of other business that a company has
already won. If a company has ercess capacitv, the contibution from win-

ExI{Brr 8,1
Expected Value of Attemative Conlpctitive Bids
Dollar
$12

_24

39

ll

313

IO

.32
.41

$40

37

$2.9
3.5
4_1

4.2

Nole: Ea?ected 1'alue ol bi.l {column 4) tpresents thc prolll conlribltion lcolumn 2)
multipled bI the probabili\. olsuccess (colunrn :ll
a Fjgurcs de tn nillions of dollds.

ning a bid may be quiie larg since many costs wi11be slu*. However, if
completnrg a job requires added capacity or costly delays in other jobs, nr
cremental cosis will be high and the profii contribution relatively 1ow.
Similarl, a bidder should consider the opportunity cost of committing ca
pacity too early. Bidding low enough to win many early bids may preclude
bidding on more lucmtive jobs laier on.
Even more diffi.dt is assigning the probability that a given bid wi]t be
successful. Typicalt assigning probabilities is a blend of research and judgntnt. The more a company knows about past biddjng behavior in ihe industly
and ihe cment biddhg sirua hon, the better are its chances of producing a profiiable winning bid. There are trro methods For estimatint a bid's probabllity of
success: the average opponert approach an:t the specific opponni approach.'o
The choice between drem depends on the amount of information available.

Probability of success
Aoenge Oppone t Approd.n The average opponent approach is used to
establish probabiliiy of success when a company has liitle knowledge about
or past experience bidding against anv specific competiiors. The approach
treais all competitors as essentially the same in the ag$ssiveness of their
bidding. The company using this approach begins with an analysis of past
bidding beha\.ior. First, it collects as much information as possible about bids
on past jobs that were similar to the cuuent job. Then, to facilitate compari
son of bids ftom diJferent jobs, it expresses each bid as a ratio: the bid price
divided by ihe tirm's own estimated cosi ofthejob.Ifthe company estimates
the 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 that
competiiors' bids excceded any partic lar value of ihe ntio, as follows:
Competitive Bids
Bids Ratio
0.95
1.00
1.05
1.10
1.15

lf

Exceeding Bid Ratio (%)

r00
98
92
80
67

120

55

1.25
1.30
1.35

12
20
8

managcrnent has no other information, the companv could use

bid frequencies as the probabilities that it would underbid
anv single competitor on a slngle bid. For any particular bid ratio, R, we
will label ihe probabilit,v (P) of underbidding ani/ single competitor as P(R),
these historical

2n2

that is, ? x R. ln practice, ma.agement usuallv has additional information

about dilJerenccs between the cunent bl.:t and Prcvious bicts, which ii uses
to make sribjective adjustmerlis to the historical bict frequencies bcfore
aclopting them as .lurent bid probabiliiies. For cxanPle, if the industry is
operatint at higher capacltv lel.els now than in ihc Past, management assigns subjectir.e probabilities somelvhat hiSher ihan ihe historical bid frequcncies. On the other hand, if ihis job is Palticrilarlv attractive because of
ihe additional business tltt winning it mitht prodrice in ihe future, management might expect comPetitors to bid lower thnn us al ln ihe latter
case, managernent assiSrs subjective Probabilities somewhat lower than
ihc historical bid fre.tuencies.
To calculate ihe probabiliq of \^'irxing a Particular iob, rnanagement
must next consider the number of bidding comPetitors. The more bidcting
cornpetitors, tlre lower the probability thai any one b will win the job
Sincc ihe average opponnt approach assumes that managemcnt cannoi
dislirlgrdsh among its competitors, the Probabilih of Lllderbidding each of
then 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
P,,,"(R) = P(R)N

)
I

frequencies shown above equal ihe subiective

a competito., the Probability of \^'innin8
underbicl.ding
probabilities of
with a bjd ratio of 1 l is:
avcrage
competitors
asainst h{o

lf the historical bid

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 bid
ding 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 calcula
tions of P,,i" that assume diffcrcnt numbers of conPetitols. For examPle, if
management's subjective probabilities ior ihe number of otherbidders are:
bid.ters .5
bidders .4
4 othcr bidders .1
the probability of winning uiih a bid ratio of 1.1 in the examPle gilen
abole is as follows:"
2 oiher
3 other

1,,r,,(1.1) = (.s

i.80,)

+ (.4 x.80r) + (.1 x.801

=.565

or

s6.s%

2{t3

Specific Opponellt Apploarh The average opponent approach io estab

lishing probabilif, of success is appropriate onllr when a cornpany knows
little about its individual compeiitors. Usually, hoh'ever, a company does
know who its conpetitive bictders are and their differeni nrotivations.
When bidding for government contracts, for example, Potential bidders
must staie an intention to bid some months beforc the bids are actuallv
Ju(: Lp li-t or tl-o.e rrrn. ., \ drlrolo o rll . oro(ritJr -. When orJJLnb tor
specialized construciion projects, such as large hydro eleciric power plants,
the number of qualificd bidders is so small ihat bidding is alr'ays againsi
ihe same three or four compeiiturs. When a company kno*'s -ho the competitors will be and thcir pnor biddnlg behai.iat,t}Le specific opponent apcarl help then akc more successful bjds.
The specific opponeni approach begins rnuch like the average oppo
nent appmach, with an analysis of hisioical bidding behavior of the com

/,'od.i

petitors. Thc bictdinB behavio. of each competitor, holvever, is separaiely

analyzed. For cxamplc, if both opponeni A and opponent B are frequent
bidders, a cornpany usht this approach ('ould separate them from other
competitors when atiempting io estimate ihe probabilities of underbidding
ihem. For each value of the bid ratio, R, it would calculate the number of
times each speci{ic competitor's bid exceeded R. If other bldders, called pr
iphenl oppanents, are also biddint, theii are ire;ied as a separate group
ushg ihe average opponent .rpproach. An analysis ol historical bidding be

ha!ior might look likc Ixhibii

8.3.

Exhibit a,2
Calculating PwN Using the Arerage opponent Approach
Prcbability of Winnjng Job

Competitive Bids

Bid

Ratio

ExceediDg
Bid Ratio(%)

0.95

lOOo/o

r.o0
r.o5

9a

t.lo
l.l5
l.20
1.25
1.30
1.35

Opponcnts 4 OpponeDis 6 Opponcnts

OOO

LOOO

.964
.446

.922

.6:10

.7t6
.4 to

67
55

.4:tg

.202

_3o2

.092

42

.176

.03I

20
a

.0.10

.oo2

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

OOO

.466
.606

.262
.090
.028
.005

As with the averaf oPponent apProach, the company uses al1y information about differences between this bid and Prcvious bids to adjusi the
historical frequencies before using them as the Probabilities of lrnderbjdding competitors on the current job. In addltio& it would adiust the historical lrequ!'ncies for each sPecific opPonent based on whatever inJomation
it has iout that compant. For cxamPle, if opPonent B recenlly lnstalled a
ncw president, who announced coryorate goals including a substantial increas; in market share, one might exPect ihat the Probabfity of B's bid exceeding any given bid ratio 1 'ould now be iower' Similarly, iJ oPPonntA
**"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 would

no$'be highr.
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 in
volves 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 8.3
Analysis of Historlcal Bid Frequercies: Specific Opponent
Approach
Opponenis Competitive Bids Dxceeding Btd Ratio

Pcnpheral Opponenls

Bid Piio
0.95

lO0o/o

l.oo
r.o5
1.10

9a
90
ao

1.t5

70

1,.20

55
47
30

t-25

30

r.35

(%)

lOOo/o

loo
95

9a%
95
85

7a

70
58

60
55
46

40
33
20

ll

204

If the historical bid frequencies in Exhibit 8.3 are used withoui adjusi
ment as the probabilities of underbidding ihe opponents, ihe probability of

winnin8 a job with a bid ratio of 1.2 ifhcn bidding against opponents A
arld

B and

two peripheralopponents is as follows:

P*-(1.2) = .ss x

.60

.4u- =

.0s3

o/

5.3%

I{ managmni is uncerialn whther opponenis A or B *-ill bict, it

weights the bids of the specific opponents by the subjective probabiliiy ihat
each one would bid. If the company is mcertain about the number of pe
ripheral opponnts who wor d bid, it weights th calculation of underbid
ding xactly as shown for the average opponeni approach.
The winner's curse
Competitive bidding is notorious for causing ihe winning bidders to
lose money.'' In fact, rcsearch shows ihat even biddcrs who use sophisticated models and formalized techniques often losc money." The reason is
ihe winner's curse. To understand the curse, imagine first thai )rou are one
oI iwo bidders and you win a bid with the lowcr pricc. You will probably
be quit happy. Now imagine thai you are one of ten bidders and you be

lieve that youl competilors are sophisiicated businesspeople who know

how io bid a job. Again )'ou win. Are you siill as happy? What does it
mean ihat yor bid below nine othe. knowlcdgcable bidders? Perhaps it
means that yor were willing io take less profii on the job. On the other
hand, it could also mean thai you underestimated ihe cosi to complete th
The more bidders ihere arc, the more likely you *,iLL losc money on
every job you win, cuz, if o alrenEe you esti nte .,sts catrcctlv atld bath VoLt
and yout conpetitarc set bids thnt include n rusonabl? nnryin af prcfit . 'lhe rca
son: The bids you win are not a random sample of ihc bids you make. You
are much more likely to win jobs for which you have undcresiimatc.l your
costs and are unlikely to win those for which you have overestimated your
cost. Consequently, the cxpectcd profiiability oI a.job, candilia al on the fIct
lturt lau haoe uron it, is much less than the expctd profitability belore $.in
unconditional probabili
ning. The difference beilveen the conditional
'ind
ties jncreass widl the number of.omPetitors against whom you mustbid.
The only solution to this is, in effect, to for alizc the principlc of "scleciive participation" described above. You do thatby addtug a "tudgc factor" to each bid to refleci an estimate of how much you are likcly to havc
underestimated 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 cnsure that youwon't ultimately regret having won them.