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Negotiation and Alliance Development for Services Compared to Materials

Author(s):

Larry R. Smeltzer, C.P.M.
Larry R. Smeltzer, C.P.M. Professor, Arizona State University, Tempe, AZ 85287, 602/965-6824, larry.smeltzer@asu.edu
Anthony Nieves, C.P.M.
Anthony Nieves, C.P.M., Vice-President and General Manager, Hilton Hotels, 9336 Civic Center Drive, Beverly Hills, CA, 90210, 310/205-4558, antony.nieves@hilton.com

84th Annual International Conference Proceedings - 1999 

Abstract. Both extensive purchasing management experience and research results indicate that substantial differences exist between buying services and buying materials. The primary differences are: nature of the product/work specifications; the ability to evaluate performance; simultaneous delivery and consumption; and variances in production processes. Strategies for managing these differences are presented.

Introduction. The acquisition of services is a major component of the total buy in most large organization. A study sponsored by the Center for Advanced Purchasing Studies (CAPS) found that in a cross section of 116 large organizations, 54 percent of the purchase dollar were spent for services (Fearon and Bales, 1995). And the purchasing department is now assuming a larger role in the purchase of services (Dobler and Burt, 1997). To quote a popular article, companies are discovering in services "....a lost, lush continent for cost reduction." (Tully, 1995).

Differences. Personal experience, conversations among purchasing managers and journal articles indicate that differences exist between purchasing services and purchasing materials. Although a number of directly address purchasing services, strong implications are made. For instance, Siferd, Benton and Ritzman (1992) analyzed the differences between service and manufacturing operations.

Although these researchers were investigating operations and not purchasing, they identified some 25 characteristics that differentiate between the two processes. The important point here is that materials result from a manufacturing process while services do not. Accordingly, it could seem that the purchases of services and materials would differ because they are outcomes from different processes. In addition, Wyckoff (1992) investigated how quality is perceived and measured differently with services than with materials. Again, the differences in quality measurements between services and materials have ramifications for purchasing services.

To directly investigate the possible differences between purchasing services and purchasing materials, 11 focus groups were conducted with a total of 82 purchasing who had an average of 9.8 years of experience. These groups concluded that differences exist. Although the managers cited a large number of differences, four major themes emerged.

The first difference was that product specifications were much more comprehensive and detailed for materials than services. This allowed the purchasing managers to know specifically what was expected with purchasing materials. On many occasions, however, statements of work were rather general, lacked specificity and relied on subjective interpretation. In turn, this means that the service deliverables may be questioned.

The second difference was that planning was different for services than for materials. This difference is highly related to the third difference which is the difference in the ability to replicate and standardize production processes.

These differences are demonstrated with the purchase of management consulting compared to hard drives. Hard drives can be stored, inspected and returned if they don't meet extremely specific specifications. But management consulting cannot be inspected prior to delivery; it cannot be stored for inspection and retained if found unsatisfactory. A major difference is that consulting cannot be precisely replicated as can a material such as a hard drive. Consulting is consumed as it is delivered. Hard drives are used after they are inspected. These second and third differences mean that the scheduling and planning are different for the two purchases.

Source selection is probably the greatest difference here. Material production can be mechanized; therefore, the processes can be thoroughly analyzed, qualified and certified. But with services, human variability is much greater. As a result, the purchaser must "trust" the reputation and reliability of the service provider.

The fourth difference is evaluation. Because the product specifications are much more specific and comprehensive for materials than services, standards of performance and measurement is different for the two types of buys. Services are generally more subjective and require individual expertise while materials require precise measurement.

The research indicated that in many instances, evaluation of services was entirely dependent on one individual. If this individual changes positions, confusion results.

Negotiation and Alliance Development Strategies. As a result of these differences, negotiation strategies should match the buy. In addition, different approaches are required for effective alliances. The first difference relates to outcomes. With materials, the physical characteristics of the purchase may be measured; however, services require outcomes. These outcome based evaluations may be extremely difficult to measure. For instance, how can the outcomes of management training be measured? It is important to advance beyond the measurement of reaction; rather, the measurement of performance should be the goal.

Services may require more creative measurement procedures and these procedures may become part of the negotiation strategy. For instance, a company was buying a health wellness program. During the negotiation, the buyer asked the supplier to create specific performance measurements. As a result, the goals -- number of participants -- was negotiated into the contract.

The second strategy is highly related. Alliance goals must be established. These goals should specifically state what is expected in terms of performance outcomes, cost reductions, or innovation. In other words, the services must be translated to bottom-line results and a gainsharing approach might be considered.

An example of an alliance with gainsharing is provided with a large cafeteria service. A manufacturing facility with 8000 employees developed a long-term alliance for cafeteria services. During the negotiation an arrangement was established whereby the profits from the service would be shared between the service provider and the manufacturing company.

How can these result expectations be developed? The answer leads to the third strategy: extensive communication and collaboration between the buyer and supplier. With materials it may be possible for the buyer to send specifications to the supplier. With services, it is probably more important for the buyer and supplier to collaboratively develop the specifications. This will assure that the two parties agree on the expected outcomes. This is demonstrated with the previous example.

A team-based Statement of Work is important for services. Oftentimes material expectations can be derived from specifications that were developed over time from objective standards. Service SOWs are often subjective so teams can help develop an objective standard. The teams can be made-up of both the supplier and buying organizations. During negotiations or alliance development, the parties can work together to develop the ultimate statement of work on which both parties may agree.

Because subjectivity is frequently an issue with services, several cost strategies deserve attention. Too frequently, annual market trends or CPI are the only indexes used with services. But cost analysis can be used with services similar to materials.

An example of cost analysis, rather than market pricing, was used for the purchase of legal services. The supplier had historically provided the buyer with market trend data when requesting an annual price increase-that was always granted. But the buyer decided to use competitive bidding of legal services and ask for fixed and variable costs. This was a dramatic change but it resulted in a major price reduction. A totally different cost analysis was the basis for the subsequent negotiation.

The next strategy is highly related to cost analysis: benchmarking. Too frequently buyers don't consider benchmarking when purchasing services. But the correct application of benchmarking enables the buyer to determine if the price and performance measures for services are competitive. Benchmarking, in combination with cost-analysis, assures that professional purchasing standards are being applied to services.

The final strategy is the use of proxy standards. On some occasion it may be nearly impossible to obtain cost or performance measures. For instance, an industrial company hired a magician to assist promoting and selling products at trade shows. Proxy measures were agreed upon by the company and the magician-the service provider. The proxy was the number of potential customers who brought a second potential customer to observe the magician.

Summary and Conclusion. Each of these strategies may be used to develop a negotiation or alliance development plan. Many of these strategies directly relate to facts: cost, measures, price, benchmarking. Purchasing managers too frequently mistakenly believe that fact-based negotiations cannot be conducted with services.

Facts should be at the core of service negotiations and alliances just as they are with services. If conducted correctly, the processes may be slightly different with services and materials, but the outcome should be the same. The outcomes should be based on performance measurements and cost measurements that are based on objective criteria. These facts should be used in the negotiation and alliance development.

REFERENCES

Dobler, Donald W. and David N. Burt Purchasing and Supply Management, New York: McGraw-Hill, 1997.

Fearon, Harold E. and William A. Bales, Purchasing of Nontraditional Goods and Services, Temp, AZ: Center for Advanced Purchasing Studies, 1995.

Tully, Shawn, (1995) "Purchasing's New Muscle," Fortune, Feb. 20, p. 76.

Siferd, Sue Perrot, W.C. Benton and L.P. Ritzman, (1992), "Strategies for Service Systems," European Journal of Operations Research, 56, p. 291-296.

Wycoff, D.D. (1992), "New Tools for Achieving Quality Services" 2nd ed. Christopher Lovelock, ed. Englewood Cliffs, N.J.: Prentic-Hall, p. 236-249.


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