Don't Give Software Vendors the Upper Hand

By Jeff Vance

(Back to article)

During an acquisition a few years ago, company A reached a deal to acquire company B. However, much of the value of company B was tied to technology services, many of which were outsourced. The principals of the deal, therefore, believed that establishing good terms for the acquisition depended on negotiating a reasonable deal with the outsourced technology service provider.

“The technology outsourcer brought terms to the table that were not just untenable, but also downright rude,” said Matt Podowitz, executive director, of Business Advisory Services at Grant Thornton LLP.

“Unfortunately, the negotiator for my client believed that the only option was to negotiate a deal with the outsourced technology provider,” he added. While the negotiator wasn’t going to accept the terrible terms, he took a defensive position when looking at alternatives.

The situation was eventually resolved. Company A brought its CEO to the table. The CEO had taken the time to prepare alternatives. When the outsourcer restated its ridiculous demands, the CEO laid out an alternative deal with another company that he was ready to accept. In less than a minute, the outsourcer caved and proposed agreeable terms.

The lesson here is that the CEO was not emotionally invested in the negotiation, nor was he blind to alternatives. However, Company A eventually walked away from this deal anyway. This wasn’t immediate―the outsourcer was retained for a few months, until the acquisition was successfully completed―but the outsourcer’s behavior at the negotiating table had so poisoned the deal that company A dumped them at the first opportunity.

The Importance of BATNA

Much of the trouble in the above negotiation could have been avoided if company A had taken the time to develop its BATNA, or Best Alternative to a Negotiated Agreement. BATNA is a Negotiating 101 concept. However, with technology, organizations tend to lose sight of this fundamental principal.

“Never negotiate with just one vendor,” advised Brian Sommer, president of TechVentive. “While this is incredibly obvious, companies routinely make several mistakes on this one point alone.”

For instance, if you don’t control what is communicated and by whom to vendors, they will have an information advantage over you. “Tech sellers continuously poll their prospects. They’ve got several people on the sales team, pre-sales demo people, third parties, and more, coaching them daily as to the status of the negotiations. If the prospect can’t close off this information flow, then there can be no negotiation,” Sommer said.

If the vendor knows they are the “preferred” choice, they know they have a strong hand to play. Worse, if the vendor finds out that they are the “winner” after a list of alternatives has been whittled down to one, the winner will dig in its heels and concede little if anything of value.

“However, smart negotiators know how to use this to their advantage as they can intentionally leak out information that is intended to keep the vendor engaged in negotiations but unsure of their outcome,” Sommer added.

Leaking the threat of a walk-away is a solid negotiating ploy, but only if the threat is real. Not only must you have alternatives in hand, you must also put enough effort into researching alternatives that they are credible.

“Most fail in two areas: identifying their alternatives (or walk-away plans) and valuating their alternatives,” said Michael Rosenthal, CEO of Consensus Group. For instance, when buying a car, people know where to look for benchmarks and comparisons. Classified ads, Kelley Blue Book, AutoTrader.com, other dealerships, etc. all offer useful information.

With technology, it’s much harder to ferret out information. Often, getting actionable data requires direct contact with another vendor―often to the point of entering into another negotiation. It’s a lot of work but that doesn’t mean you shouldn’t do it.

“The advice we give our clients, and practice ourselves on behalf of clients, is to develop multiple alternatives early on. In this case, explore other vendors, get their pricing, compare apples-to-apples, and determine how much it would cost and the timing involved to develop a similar solution in-house,” Rosenthal added.

With the proper research in hand, you can ask such loaded questions as, “It seems that the market rate for your service is less than what you are asking for. Why should I pay more than that to go with you?” If you don’t get a good answer, you can walk away assured that your alternatives are indeed better.

In the Details

While BATNA is essentially your walk-away point, many technology deals are so complicated that it’s hard to come up with an apples-to-apples comparisons.

James C. Roberts III, managing partner at The Global Capital Law Group, counsels his clients to understand wiggle room and horse swapping. “We try to go through the major elements of an agreement and get a client to articulate the core elements, the must-have’s, and then those elements that are in two or three lesser priorities. We then seek to calibrate the wiggle room for each such element. Then we figure out the horses to swap, based on the wiggle room.”

For example, when negotiating with a hosted service provider, you could agree to a lower uptime in exchange for less planned downtime and higher response times. However, if you don’t go through the trouble of valuing various elements in the proposed contract, it’ll be tough to strike deals like these.

Roberts recommends creating an internal “term sheet” to help guide negotiations. “Clients often view a term sheet as complete once the business terms are included but that is not the case. The term sheet should include everything including positions on critical legal issues (indemnification, etc.) that will become the basis for negotiations,” he said.

The term sheet then serves as the basis for negotiations. As a result, the term sheet often ends up being longer than the actual agreement, but that’s not a problem. The term sheet serves as a blueprint that the lawyers can use to be more efficient and accurate when drawing up the final agreement.

“Remember, though, let the business people negotiate the terms, with input from the attorneys,” Roberts said. “Not the other way around.” You obviously don’t want legal making business decisions for you, but this is exactly what happens in many cases.

Focusing on Value

By now, you’re probably nodding your head at the above points. They make sense. They’re logical, consistent. However, negotiations rarely proceed on logic alone. When a negotiator becomes invested in a technology or in a specific deal, that person can become blinded to the actual value of the deal itself. Whether good or bad, it’s immaterial. The negotiator is too vested to not get a deal done.

Anytime you see your negotiators becoming emotionally attached to a specific deal, alarms should go off in your head. If the other side has kept their cool, they’ll stampede over your negotiator and get exactly the terms they want. To avoid this trap, Podowitz advises his clients to appoint a “value monitor.” The value monitor is someone not directly engaged in the negotiations. The person has no emotional stake in who wins or loses.

“The value monitor need not be technology-savvy,” Podowitz said. “But they should be briefed on the perceived value of the proposed investment and be recognized for putting value first in all of their decisions.”

Equally important, the value monitor should have enough power within the organization to make his or her determinations stick. Usually, the value monitor ends up being a senior business executive who reviews and approves all proposals, counter proposals and responses. With a value monitor in place, you protect yourself from getting a bad deal based on emotions alone.

Finally, the single best way to determine whether or not to walk away is to link the deal to a quantitative value. RIO, TCO and ROCE http://en.wikipedia.org/wiki/Return_on_capital_employed are all values that technologists understand and are used to calculating.

Of course, quantifying something like, say, a social media application, can be pretty difficult. There’s a lot of “soft” value in there. Even so, it’s important to assign a value to it. When the terms of negotiations push your calculations below a pre-defined threshold, it is time to get up from the table and walk away.

Jeff Vance is a freelance writer and the founder of Sandstorm Media, a writing and marketing services firm focused on emerging technology trends. If you have ideas for future stories, contact him at jeff@sandstormmedia.net or visit Sandstorm Media.