At some point a buyer and supplier must discuss pricing; it might not be the first thing they talk about but it almost certainly is top-of-mind and one of the last—and potentially most volatile—things on the table before the “deal” is signed.
Simply put, trying to negotiate the fairest price for a product or service for all parties is difficult and frustrating. Why? I submit the primary reason is that the process for establishing pricing between buyers and suppliers is broken. A pattern of misalignments, misunderstandings and suspicions often creeps into the negotiation, muddying the entire discussion around pricing.
A fresh approach to pricing is needed. This approach is described in detail in the White Paper, “Unpacking Pricing Models: Make ‘you get what you pay for’ Real for Business Relationships” produced by the
University of Tennessee Center for Executive Education and the Sourcing Interests Group.
Let’s briefly explore the key themes presented in the white paper.
Understanding the Fundamentals of “Price” vs “Pricing Model”
It’s vitally important to know the difference between a price and a pricing model and to understand when to use one or the other. A price is how much pay for something, such as a latte at Starbucks. Companies should use a “price” when the business exchange is simple, predictable, and there is no opportunity to create value beyond simply acquiring the good or service. In essence a “price” is the right tool to use when you want to exchange value at a point in time. “I’ll give you a dollar for a widget”.
A pricing model is fundamentally different; it includes mechanisms to determine the optimum monetary exchange between a buyer and a supplier over a dynamic business relationship. The parties “model” the outputs relative to the input components to determine a fair way to pay for goods and services over time. A good pricing model equitably allocates risks and rewards.
A pricing model uses progressive techniques. Rather than simply setting “the price,” a pricing model sets the tone for a realistic and fair pricing strategy that allow for dynamic (and fair!) adjustments on how a buyer and supplier structure the economics of their relationship as “business happens.”
In addition, a pricing model often features incentives that seek to align the buyer’s and the supplier’s objectives. For example, a buyer might be keen on reducing its cost structure or improving efficiencies; this might result in a pricing model with an incentive where the supplier is rewarded when the cost structure goes down.
Think about it. The less a supplier uses, the more profit they would make.
Another example might be to reward a supplier for making asset-specific investments that drive a competitive advantage for the buyer. Let’s say the supplier was able to develop a patent specifically for the buyer. What is the value of the benefit of that innovation? And how do you fairly reward a supplier for taking risks and investing in making the buyer more competitive?
A general rule of thumb is that companies should shift to a pricing model when the work is more complex, variable in nature, and there is a higher likelihood of creating value by working more closely with suppliers (e.g. reducing costs, innovating).
Align the Appropriate Sourcing Business Model with the Pricing Approach
At the heart of pricing misalignment and misunderstanding is the fact that conventional sourcing business models typically use a transaction-based approach and establish a “price” (price per unit, per hour, per call) per transaction.
A key premise of the white paper is that organizations should seek to understand and pick the most appropriate sourcing business model (transaction-based, performance-based/managed services, or Vested) at the onset of a sourcing initiative – and definitely before entering into pricing discussions.
(Refer to the white paper Unpacking Sourcing Business Models for additional details). Knowing which sourcing business model is the most appropriate for a sourcing initiative is key, because then you can align the right pricing approach to the appropriate sourcing business model.
Using the wrong pricing approach with the wrong sourcing business model is like trying to put a square peg in a round hole; it simply doesn’t fit and causes friction. Unfortunately – and all too often – it happens; many companies say they want their supplier to be “strategic” and “invest” in “innovation,” but the they bring in professional negotiators to commoditize (and often over-commoditize) what the supplier is doing into a transactional price.
A good rule of thumb is that the more complex and strategic a sourcing initiative is, the more a company should shift to an outcome-based sourcing business model (performance-based or Vested) and these sourcing business models should use a more a collaborative, flexible “pricing model.”
Negotiating Pricing with a Different Lens
Understanding sourcing business models and price vs. pricing models is a good start, but it’s also important to understand the other “tools” that are available. The white paper outlines four techniques that you should use for strategic sourcing initiatives—those requiring you to look beyond a price per transaction/commodity focus.
Each is discussed briefly below:
TCO/Best Value: Understanding only some of the costs will result in a poor decision. A Total cost of ownership analysis will help you look beyond the price and get to the heart of the cost structure and cost drivers.
A Clear View with Transparency: Information is power, but to truly develop great pricing solutions, access to data from both the buyer and supplier is required.
Seek Mutual Gain Through Cooperation, Not Competition: The merit of creating true “win-win” approaches are coming to the forefront with the notoriety of Nobel Laureate Oliver Williamson and popular books such as
The Evolution of Cooperation and Vested: How P&G, McDonald’s and Microsoft are Redefining Winning in Business Relationships.
Expand the Agreement Zone with Smart Risk/Reward Allocation: An expanded agreement zone encourages the buyer and the supplier to take on smart risks in exchange for incentives if they achieve success against mutually defined Desired Outcomes.
The Bottom Line: You Get What You Pay For
The next time you find yourself frustrated with a supplier (or client) over misaligned pricing, stop and think about your grandma’s words of wisdom when she told you, “You get what you pay for.” Then, ask if the root cause is a pricing model mismatch where you are using the wrong pricing approach with the wrong sourcing business model.
For those that sense frustration, we suggest downloading and reading the complete Unpacking Pricing Models white paper—it’s free;
Kate Vitasek is an author, educator and business consultant. She has been lauded by World Trade Magazine as one of the “Fabulous 50+1” most influential people impacting global commerce and is an international authority for leading the University of Tennessee’s award-winning research efforts on the Vested sourcing business model for highly-collaborative relationships, Her practical and research-based advice for driving transformation and innovation through highly-collaborative and strategic partnerships is profiled in five books, including
Vested Outsourcing: Five Rules That Will Transform Outsourcing, Vested: How P&G, McDonald’s and Microsoft Are Redefining Winning in Business Relationships and
Getting to We: Negotiating Agreements for Highly Collaborative Relationships. She can be reached at