In recent history, the dominant procurement strategy boils down to this: Use your economic power to strip margin from your vendor.
It’s been argued that GM went bankrupt because it stripped margin from its supplier base. GM took that strategy so far that many suppliers went out of business. As a result, GM was forced to buy parts at a premium, or accept lesser quality, or less reliable delivery. All along, GM thought it was getting better prices.
I’ve personally witnessed such a debacle, when I worked for a service provider that accepted a no-margin contract. After the contract was in place, the client used its economic power to force price concessions. My company stayed in the game, believing the prestige of having that client would help it win more clients. It didn’t work out that way. The service provider went bankrupt, giving the client almost no notice. The client suffered damage to its reputation when a substantial portion of its supply chain vanished, almost overnight.
And on the way down, the service provider used every method it could find to cut the cost of its services. Those cuts affected quality. The pressure to extract margin from the business resulted in behavior that bordered on the unethical. At best, it was passive aggressive. At worst, people lied. Of course they would do this. The service provider was in the business to make money, and their investors, just like the client’s investors, demanded profits. The gamesmanship was unsustainable.
Everybody lost.
What drove the client’s behavior was a culture of intimidation. They were convinced that collaborating with the service provider, working together to achieve a common goal (including profit growth), was a bad idea. They were openly dismissive, calling it “playing nice.”
Professor Robert Axelrod of the University of Michigan has science and evolutionary biology that shows they were wrong. He pioneered research into what’s become known as The Prisoner’s Dilemma, and proved that collaboration is the best strategy. It’s not about playing nice. It’s about playing smart.
The classic illustration of the Prisoner’s Dilemma is this: If I rat out my co-conspirator and he rats me out, we both get five years. If I rat him out and he says nothing, he gets 10 years. If I say nothing and he rats me out, I get 10 years. If we both say nothing, we both get six months.
To have a shot at the best possible outcome – only six months – I have to say nothing and pray the other guy says nothing too. But if I say nothing and he rats me out, I get 10 years! We’re not allowed to talk to each other. Can I trust him to not screw me over? How well do I know him?
What would you do?
In negotiating an outsourcing relationship, we have a different scenario. Unlike the two prisoners, we can talk to each other. And if the two prisoners are allowed to talk to each other, they would of course collaborate.
Professor Axelrod has spent his career applying his research in business and international diplomacy. Some credit him with the thinking that allowed us to survive the Cold War and prevent nuclear devastation. He has shown that a strategy of collaboration, combined with a willingness to retaliate, produces the best long-term outcome.
The willingness to retaliate? Yes. In your negotiations with your outsourcing partner, you should be quite open about how you will respond to violations of your trust. Talk frankly about the fact that you must make a profit. For the sake of illustration, if the client company tries to extract margin by forcing a price reduction, the service provider will respond by cutting quality in order to protect margin. If the service provider tries to boost its margin by cutting quality, the client will retaliate by terminating the contract.
If we take margin from our vendor, they will find a way to get it back. They will do it openly, by generating enough scale that they become the 900-pound gorilla, or they will do it quietly, through passive-aggressive behavior. Either response amounts to retaliation. And we will always come out worse off. Both of us.
How to use collaboration to maximize profits for both players is what Vested Outsourcing is all about. Just as Professor Axelrod used research to demonstrate the power of collaboration, so have co-authors Kate Vitasek, Mike Ledyard and Karl Mandrodt used research to show HOW to create, document and manage a successful collaborative outsourcing relationship. Read about it in their book, “Vested Outsourcing: Five Rules That Will Transform Outsourcing.”
It’s not about playing nice. It’s about playing smart.
To hear Professor Axelrod discuss his research, visit RadioLab.
For resources to implement a successful collaborative agreement, visit Vested Outsourcing.
