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Winning in Russian Roulette Type Negotiations
Managing Pricing Opacity in Business Markets

March 2009 Pricing, Selling

Templeton would go into the customer’s negotiating room with a metaphorical gun on the table.  Customers would force him to place the gun against his head and ask him to drop prices or pull the trigger.  Templeton didn’t know if the gun was loaded or not.  For four years, Templeton managed this challenge, and the bullet never fired.  Templeton’s method of managing this struggle over prices reveals a key to pricing in opaque business markets.

(For the sake of preserving privacy and maintaining active relationships, we have changed the name, company, and industry in this story, yet the challenge, method, and results accurately reflect a true story.)

Industry Makeup

Templeton’s company, Silicon R US, provided a key silicon chipset to a handful of hardware component customers.  Their market was highly concentrated, yet not small.  Five hardware component customers held 90% of the market and purchased roughly $300 MM of the key silicon chipset per year.  Three silicon chip manufacturers supplied a majority of the chipsets; while one other held a negligibly small market share.

Competitive Dynamics

The first stage of the competitive game is pure engineering execution.  The core design of a new chipset would involve over three years of research and development prior to application engineering.  Once developed, another six to twelve months would be spent in close interaction between the hardware component manufacturer and chipset supplier to improve yields and deliver the functionality sought.  Each chipset supplier faced the same engineering horserace to bring a new product to market.

Once in production, the dynamics shifted towards yield management and price reduction.  Chipset prices would be negotiated every quarter.  Hardware component manufacturers faced a market requirement to decrease their product component prices by 8 to 10% year on year.  In turn, they would seek chipset price reductions on that same order of magnitude.

In this second stage of the game, suppliers were forced to play Russian Roulette.  A new chipset might have a six month leeway in the market at best.  Once launched, component manufacturers would push other chipset suppliers to make a competing product, partly for supply stability and partly for price compression.  Each quarter, prices would be negotiated and Templeton would be under the gun.

Pricing Dynamics

In the interim time between product launch and competitive entry, it might be tempting for a chipset supplier to raise prices.  After all, they have a somewhat locked-in market until a competitor can meaningfully enter.  A prior executive at Silicon R US undertook this move, but ended up seeing a mountain peak only to walk off a cliff.  In raising his price for the chipset, the customer at first asked “Are you crazy?”  Though the customer swallowed the price increase at first, within months they had developed a relationship with another supplier.  For three years after that, the customer refused to do business with Silicon R US.  Once the price raising executive had moved on, Templeton had to re-cultivate their trust.  Successful, Templeton eventually won 100% of their business, but it was hard work.

For Silicon R US, it is far more profitable to capture and hold a key position on the hardware component manufacturer’s printed circuit board and then expand to supplying other silicon chips to that board, than it is to raise prices in one quarter and destroy all future business.  (From a theoretical perspective, one would say that the long-term Nash Equilibrium in this game is higher when chipset suppliers avoid short-term price taking.)

Information Driver

When Templeton first took responsibility for sales and marketing in this chipset business, he faced a serious information deficit.   Customers would demand a price reduction in every negotiation under threat that they would take all of their business elsewhere, even if they had no intention of following through.  Purchasing managers were rewarded for the size of the price concession gained and, subsequently, were known to fight viciously for each basis point.  At one point when Templeton didn’t provide the price reduction sought, the customer called Templeton’s boss to have him removed.  Fortunately, Templeton had kept his boss in the loop and termination was avoided.

For Templeton, this was a real pressure cooker situation.  The gun would be on the table.  The customer would tell him to put the gun to his head and pull the trigger, or give in to price demands.  Templeton knew he had to develop a strategic solution.

The advantage that customers have in business markets over suppliers is pricing opacity.  If customers can keep suppliers in the dark, suppliers have nothing but their emotions to guide them.  Under the threat of complete business collapse, it is hard to restrain the emotional pull to cave-in to customer demands.

Templeton needed to level the information playing field.  He needed to determine if a competitor was able to supply a similar product and, if so, at what price.  He also needed to know the yields a hardware component manufacturer was attaining with his competitors, as yields are a key driver of profits in high-volume manufacturing.

Seeing Clearly Through Opaque Glass

During the development cycle, Templeton had developed tentative relations with some of the supplier’s pre-production engineers as a necessary part of the process of adapting a chipset to a manufacturer’s production process.  As Templeton nurtured these relationships with engineers, he gained information.

Though he could not get at his competitor’s exact prices, Templeton could uncover the quality of his competitor’s products and relative price range.  The hardware manufacturer’s engineers were also able to share with Templeton the functionality and yields they were attaining with his chipsets and comparable alternatives.

Armed with information about the status of competitors’ products in the pipeline, Templeton was able to check the gun for bullets before sitting down at the negotiating table.

Results

For four years, Templeton managed customer relations for Silicon R US.  Though Templeton still had to grant price concessions, he didn’t have to completely cave-in to customer demands.  During that time, he continually nurtured relations, managed information, and captured market share.  In 2001, Silicon R US held a 20% market share in that chipset market.  By 2005, Templeton had improved the market share to a whopping 70% with a profit from operations at 40%.

Business markets are opaque when it comes to pricing.  For companies like Silicon R US, creating strategic information sources are the solution for managing prices and capturing market share.  In Seagull Markets with higher transaction volumes, the appropriate methods are price waterfalls and net price bands.  But, for Hawk Markets with few suppliers and customers like those in which Templeton competed, cunning is required to keep from taking a bullet to the head.



About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

Tim J. Smith, PhD
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