In a previous article, I stressed the importance of knowing your cost. I am here again to stress that point, but now for a different reason – cost negotiation.

In cost negotiation, how well you use the knowledge of your costs is critical in creating value for yourself, your clients, and your business partners.  A business owner needs to be sensitive to the long-term effects that a poorly negotiated deal could have on their business. Paying more for products or services could significantly rob their business of its true earning potential. For example, a business owner poorly negotiating a property lease stands the risk of losing a significant amount of money throughout the life of the lease. A three- to a five-year lease with an annual increase of 3-4% could leave you with a huge bill.

Negotiating costs is a very important part of delivering value to your customers/clients and your business partners. However, there are many moving parts associated with this type of negotiation.

What are you negotiating?

The first thing to establish is the cost of the item of negotiation, fixed or variable. Knowing your cost is critical and cannot be overstated. Second, identify the cost of your subject item in your negotiation. For fixed cost items, the two most critical aspect of your negotiation will be time and cost. The thought would be, ‘how long will the business be locked into this contract and what are the penalties to be incurred if you broke the contract?’  Remember, your property lease is a fixed cost because its cost does not depend on the volume of your sales. So why is this important? Because you will be tied to a specific amount per period and for a specific time. Now relate this to your overall expenses to see its impact.

Another example is when a business owner goes to renegotiate contracts concerning inventory, which falls under variable costs. The results from a renegotiated contract could have a serious impact on your working capital funding gap. The funding gap is the time between when inventory is paid for and when the company receives payment for goods sold. If after negotiating prices for inventory, your customers take longer to pay, your funding gap increases, which means your working capital increases. You always want to reduce the amount of time that your customers take to pay, ideally without too much discounting. You need to be aware of what you are negotiating and how it impacts your business.

It is important to note that small businesses can negotiate “non-negotiable” items in the contract. By simply raising an issue or concern does not damage your contract. It creates an opportunity for discussion and possibly renegotiation. So never be afraid to raise issues after the fact. You may be surprised at the result!

Planning and strategizing around your topic of negotiation.

In addition to the dollar value of the negotiation, identify the other non-monetary items that affect your deal. The non-monetary items include the relationship you have with the person you are about to negotiate with and the quality of the product or service. What are your alternatives? After considering your relationship with the other party, the quality of the product or service and your alternatives, you then strategize. You’ll also need to keep the other person’s alternatives in mind, which may require some guesswork. Don’t assume the other party is too big to negotiate or give something up for your business. Sounds simple enough? Let’s dig in.

Knowing Your BATNA

Roger Fisher and William Ury coined the term BATNA in their 1981 bestseller Getting to Yes: Negotiating Without Giving In. BATNA stands for ‘best alternative to a negotiated agreement.’ I would observe my mother using this concept all the time at the farmer’s market. While at a farmer’s station she knew she could purchase a pound banana for $0.45, the lowest price, from another farmer. Meaning, the $.045 was her best alternative to a negotiating agreement. By nature, we are programmed to look for the best price when shopping or spending our money. This is the premise of a BATNA, if the negotiation fails, what is your next best option. In my mother’s case, if the farmer insisted on a higher price, she would then go to the other farmer who had the bananas for $0.45. For the business owner faced with an increase in their property lease, their BATNA might include a new, similar location at a comparable cost.

Now that we know what BATNA is, how do we identify it? Harvard Law School: Program on Negotiation suggests the below four-step approach.

  1. List your alternatives. Think about all the alternatives available to you if the current negotiation ends in an impasse. What are your no-deal options?
  2. Evaluate your alternatives. Examine each option and calculate the value of pursuing each one.
  3. Establish your BATNA. Choose a course of action that would have the highest expected value for you. This is your BATNA—the course you should pursue if the current negotiation fails.
  4. Calculate your reservation value. Now that you know your BATNA, calculate your reservation value—the lowest-valued deal you are willing to accept. If the value of the deal proposed to you is lower than your reservation value, you’ll be better off rejecting the offer and pursuing your BATNA. If the final offer is higher than your reservation value, you should accept it.

Translating Your BATNA: The Reservation Value

While translating your BATNA, you want to either think win-win or win-lose. Are you in a situation where both parties can benefit? Meaning, you can collaborate with the other party to find a solution, win-win. Or is the situation a little more competitive, so it is a win-lose situation.

Using the above business owner example, for him/her to be successful he/she needs to flesh out all aspects of their BATNA and the other party’s BATNA. If the store owner’s property lease is about to increase by 4%, this could be too much for the store owner. This increase could be significantly eroding to the store owner’s profit margin. The business owner now needs to ask, ‘What are the elements of value in this situation?’ A big element in this example would be the location. What does your current location offer your business compared to your BATNA? Which location offers the highest level of convenience, while causing the most traffic? Is another business ready to take your spot? What is the cost of relocating? These are some of the questions a business owner would have to answer and then rank. After ranking the items of both options then you will know whether to accept your current deal or not.

Other things can affect your reservation value. However, it is important not to change your BATNA while negotiating. Getting emotional can lead to unfortunate consequences. Be prepared.

Tying it all together at the negotiation table.

So while waiting for negotiations to begin, you mull over all the important pieces of your negotiation. What are you negotiating and how critical is it to the value you offer your customers/clients? How does it impact the profit margin of your business? These are some basic questions to have a clear answer to before your negotiation. After identifying how critical the item is to your negotiation, strategize. Use the four steps outlined above to define your BATNA, then translate your BATNA to your negotiation situation. Whether your negotiating environment is win-win or win-lose, these are key concepts to grasp and act on to ensure you win.

About the Author(s)

 Rodger  Hamilton

As a UCONN MBA graduate, Rodger Hamilton has a wealth of innovative ways to address current business issues. In his professional experience, he has been able to help companies resolve operational, and marketing challenges. More recently he has been engaged in addressing more financial business issues. In addition to being a member of Greater Hartford SCORE, Rodger is an active part of the US...

Creating Value Through Effective Cost Negotiation