Oct 2, 2018
How I Think About Negotiating Contracts
During my senior year at Carnegie Mellon I took a course titled Statistics in the Law. It was taught by Jay Kadane, one of the world’s foremost experts in Bayesian statistics and a much sought-after expert witness. Kadane always published a scientific paper of his work after each court case concluded, ensuring transparency and sending a message to the statistics community about the importance of ethics in expert witness testimony. Each week he assigned one such paper for us to read; the following week we’d discuss the paper and court case as a group.
The experience was fascinating and sparked in me an interest in the law that continues to this day, where one of my responsibilities at Smartling is to oversee the legal function. As is the case for many B2B companies, we usually have a flurry of new customer and renewal signings in the last week of each quarter, which means the topic of contract negotiation has been on my mind. I’ve negotiated over $200 million in total contract value, which is to say I have a fair bit of experience. Although there are no hard and fast rules, I’ve found the following guidelines to be reliably beneficial.
The intention of these guidelines is threefold:
- Build trust between buyer and seller. All prospects lie, all the time. Overzealous sellers are mostly to blame for this. At a minimum, sellers should take steps to avoid perpetuating this distrust.
- Establish the right internal checks and balances. At most companies, sales is incentivized to sign new customers but not necessarily to ensure long-term success. Clearly defining the relationship between sales and legal helps to make sure that only the right deals are signed.
- Accelerate the negotiation and signing process. Time kills all deals. If you don’t know what this means, you’ve probably never done sales. I’ve had a champion be fired the day after signing a contract. (The reason for his termination had nothing to do with the contract.) Think it would have been signed if the negotiation had taken a day longer?
The Relationship with Legal
Here’s a not-so-secret secret: outside of the narrow envelope of ensuring compliance with applicable law, there’s no such thing as “legal”; everything that legal does is commercial, i.e., helping the business to understand and manage risk. Rarely is legal empowered to make decisions; usually, legal is an enforcer of decisions that have already been made. That said, legal will sometimes act on behalf of finance, e.g., regarding payment terms, or on behalf of operations, e.g., regarding service commitments.
Given this:
- Don’t ask legal to negotiate on your behalf. It isn’t legal’s job to overcome one last objection; that’s your job. Stick your legal with responding to a discount request at your own risk.
- Don’t try to get legal to change its mind in public. It’s unbecoming. It’s also unlikely to work, because as I wrote above legal is rarely empowered to make decisions. And the prospect/customer is likely to use what you say as leverage in the negotiation.
- Even worse, don’t contradict legal in public. You instantly go from being viewed as fighting on the prospect/customer’s behalf to being just another overzealous seller.
Want to avoid these (sadly) frequent pitfalls? Align ahead of time on who will say and do what, and use common sense.
Hold 10-Minute Orientation Calls
It’s a misconception that cloud software necessarily is simpler than on-premises software. The reality is that today’s cloud software is far more powerful than yesterday’s on-premises software, and customer requirements are more advanced; at the same time, there are new pricing models, complex data protection considerations, and growing concerns about information security with which to contend. These forces combine to make purchases more challenging to complete.
Prospect/customer procurement and legal teams aren’t experts on their company’s requirements or on your solution, and you shouldn’t assume that your champion has briefed them sufficiently, if at all. In my experience, a 10-minute orientation call goes a long way to avoiding unnecessary back-and-forth. You know the typical negotiation issues better than anyone — for example, exactly what personal data your service collects, and how it’s used — and can avoid obstacles by front-burnering them.
Give Everything You Can and Nothing You Can’t
Much of the distrust between buyer and seller stems from two things:
- Information asymmetry. One party always knows more about something than the other. For example, the buyer knows its budget, which may be more — but is never less — than what the seller has been told. Similarly, the seller knows how the proposed price actually compares with what similar customers are paying, which is often more and rarely less.
- Over-negotiation. Both buyer and seller develop an obsession with getting the most (or the least, situation depending) of everything. For example, the buyer’s procurement exacting its pound of flesh after a pricing negotiation is said to have been completed, or the seller giving its first-but-not-best response to a redline request.
You want to be remembered for three things: how many customers you sign, for how much money you sign them, and how quickly you sign them. Pretty much everything else is irrelevant. I’m not suggesting that you cave on everything other than price; rather, I’m observing that deals slow and sometimes die when one party or the other wants to try giving an inch before agreeing to give a foot — even though that party would be perfectly fine giving the foot in a later round of negotiation. Nothing valuable is gained through this approach, yet it happens all the time.
My solution to this problem is deceptively simple: give everything you can at the first possible opportunity, but nothing you can’t. Look for ways to say yes as quickly as possible. And if the answer has to be no, say it early and firmly, and explain why that’s the case.
Contracts Should Mirror Reality
Sometimes buyers will ask for language that seems innocent enough. Here’s one of my favorite redline examples:
Each month, Vendor will send to Customer a report detailing its performance under this Service Level Agreement.
Seems reasonable, right? You’re committing to an SLA and the buyer just wants to know that you’re adhering to it. Why would you reject this redline, especially in light of what I wrote earlier in this post?
My problem with this redline is that it doesn’t solve a problem for the buyer, yet it creates an unnecessary obligation — and therefore a potential problem — for the seller. Assuming the seller has a track record of adhering to its SLA (which is a reasonable assumption; if it doesn’t, the deal would almost certainly be dead already), wouldn’t both parties rather the seller’s time be spent making the customer successful, rather than checking an SLA compliance box? Consider the following alternate language:
Upon written request, Vendor will send to Customer a report detailing its performance under this Service Level Agreement.
This gives the buyer the protection it desires (access to SLA performance reporting) without an unnecessary burden having been created.
If a redline would require a party to do something unnatural, it probably doesn’t belong in the contract.
Leave a Dollar on the Table
Especially with a subscription business, what matters most is that a customer stays with you forever. For this reason, I’ve found that it’s best to “leave a dollar on the table” during negotiation, or put another way to sell your service for one dollar less as opposed to for one dollar more. Doing so buys a lot of goodwill, which you can almost certainly leverage to get that dollar back — plus many more — through future expansion. On the other hand, not leaving that dollar on the table can leave a bad taste in the customer’s mouth, one that lingers for months or even years.
Yesterday was the start of a new quarter — traditionally the busiest for B2B companies. I hope these guidelines will be helpful.
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