Using Criticality Grids to Determine Negotiation Strategies
Lee Buddress, Ph.D., C.P.M.
Lee Buddress, Ph.D., C.P.M., Portland State University, Portland, OR 97207, 503/725-4769, firstname.lastname@example.org.
Alan Raedels, Ph.D., C.P.M.
Alan Raedels, Ph.D., C.P.M., Portland State University, Portland, OR 97207, 503/725-3728, email@example.com.
83rd Annual International Conference Proceedings - 1998
Abstract. Purchasers acquire products ranging from industry standards and commodities to patented products and those containing proprietary technologies, with usages ranging from very low to enormous. The criticality grid helps to classify purchases based on importance of internal use and external market structure. This tool enables purchasers to develop different negotiation strategies for different levels of internal and external criticality.
Introduction. Purchasers often are assigned responsibility for the acquisition of many different products or commodities. They may be required to perform a wide array of activities from daily spot buys to the negotiation of long term contracts. One of the more difficult tasks is the development of appropriate negotiation strategies for the various products or commodities, each of which may have a very different internal importance and external market structure.
The Criticality Grid. A criticality grid is a 2 X 2 matrix which has two variables on two dimensions. On the vertical dimension, external market criticality for a purchased product or component is defined from low to high. The horizontal dimension describes the internal criticality of that product or component to the purchasing firm, also from low to high. Please refer to the final page of this paper for an example of a criticality grid.
Market Criticality. There are several dimensions in which market criticality may be viewed. From an economic perspective, supply markets may range from monopolistic on one end to nearly perfect competition on the other. The majority of markets in between are forms of oligopoly - multiple firms with varying degrees of market control.
Another view of market criticality is in terms of operational control. A highly critical market might be one where the product is patented or contains proprietary technology. On the other end of the scale are commodities and industry standard products, where most competitors' offerings are interchangeable. This dimension may also include consideration of a product's life cycle position. A patented product early in its life cycle may evoke a different negotiation strategy from the same product toward the end of the patent life.
A third critical dimension might be defined as market difficulty. Is the supplying firm difficult to deal with, inflexible and intractable? Are employees of the firm difficult to work with? Alternatively, are the firm and its employees highly 'customer service' oriented?
Internal Criticality. The horizontal dimension of the criticality grid assesses internal criticality - criticality of the purchased product to the purchasing firm. Again, there may be several dimensions to this measure. First may be volume. Very low volume requirements may suggest low criticality, while high volumes indicate increasing importance. Keep in mind that the grid focuses on only one product at a time. Another dimension of internal criticality may be value. If the product is low priced, criticality may be low even if volume is high. The opposite may be true of high value goods.
Pervasiveness of the purchased product is another dimension. Even if the purchased product is used in small quantities, if most of our products require it, even in small quantities, criticality may be high. A fourth dimension is future use. If forecasts or future plans call for significantly increased consumption, either due to new product introduction or growth of existing products which use the purchased item, criticality may be high even if current use is small. The next step is to place the product in question in its quadrant on the criticality grid.
Negotiation Strategy for Low Internal/Low External Criticality. Products classified as having low market criticality include commodities and industry standard products. Included in this category are such things as office supplies (copier paper), electrical supplies (switches and outlets) and fasteners (standard nuts and bolts). If volume requirements of these goods are low, perhaps the best strategy may be to use blanket orders or phone quotes and spot buys to meet requirements. A goal for purchases of goods in this quadrant should be to minimize administrative costs of acquisition. These goods are typically of relatively low value, readily available from many suppliers and of little criticality to the purchasing firm. This could be called the Routine Quadrant.
Negotiation Strategy for Low External/High Internal Criticality. Goods in the lower right quadrant of the criticality grid have the same market characteristics as those above. However, volumes may be significantly greater. Since markets for industry standard products are typically classified as highly competitive, a market driven strategy may be beneficial here. Competitive bids for annual or multi-year contracts are effective. Not only are volumes significant on a period-to-period basis, the aggregation of volumes over longer time periods increases leverage. This is the Contractual Quadrant. Effective tools for this qaudrant are systems contracts, supplier managed inventory programs and other long term contractual agreements.
It should be noted that it is not necessary, nor even desirable to have strategic alliances or formal partnerships with all suppliers. Administration of such relationships is time-consuming and intensive. Given limited administrative resources, efforts such as they require should be reserved for purchases from suppliers whose products help form or define competitive advantage. There may be products which fall in the upper part of this quadrant where future use or technological or market changes suggest moving a supplier from the Contractual Quadrant to the Relationship Quadrant. The location of a product in a particular quadrant may change over time. Reevaluation should be made at each contractual renegotiation.
Negotiation Strategy for High External/Low Internal Criticality. A term for this upper left quadrant of the criticality grid might be "Cautionary". Products in this category are ones for which the buying firm has little leverage, but must buy in difficult markets. Here, it is especially important to look ahead. Is there a likelihood of increased use in the future? If so, perhaps the long term strategy might be to work toward a partnership relationship. If not, this product may be one where engineering should work toward substitution or elimination. Product life cycle is important here, as well. Is this a brand new product, or are competitors beginning to emerge? If the latter is true, perhaps a wait-and-see strategy is appropriate. In any case, this is a difficult quadrant for purchasers. As a means of building volume and leverage, investigate other standard products that might be acquired from this supplier.
Negotiation Strategy for High Internal/High External Criticality. The upper right quadrant is called the Relationship Quadrant. Products placed here are the ones requiring the most attention. These are products which may be patented (sole source), contain proprietary or leading edge technologies, or are critical to the creation or maintenance of the buying firm's competitive advantage. These are also required in significant volumes or are pervasive throughout the buyer's product line. Here, the concepts of partnerships or strategic alliances with key suppliers are most applicable. Negotiation strategies for products in this quadrant include long term focus, mutual benefit examination and a separation of costs from margin. It is mutually beneficial to attempt to divorce discussions of supplier's profit margin from an analysis of the cost drivers for this particular product. Margins are subject to negotiation, but cost elements in a close, collaborative buyer-supplier relationship are to be jointly attacked.
Criticality Grids and Supply Chains. The typical application of criticality grids is to the negotiation between a buyer and a seller to help purchasers better understand the critical internal and external situational issues that will define negotiation strategy. It is also useful for purchasers to apply these same concepts to their supply chain partners - suppliers and customers.
Having used the criticality grid to formulate a negotiation strategy with a supplier, it is beneficial to take a new grid to asses the supplier's probable position. How does the supplier view the marketplace for the products under negotiation? Where does the specific product fit in the supplier's product line? What is the purchaser's best assessment of the product's criticality to the supply firm? What is the supplier's view of its supply markets for key components? What is the purchaser's assessment of the supplier's view of the purchasing firm's need? In short, try to use the grid from the supplier's viewpoint to assess the supplier's potential strategic focus. If, for example, the buyer classifies the supply market as highly critical, one negotiating strategy may emerge. If, however, the purchaser realizes that the sale of the product may be critical to the supplier, a different strategy may evolve.
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The same approach is useful when looking up the supply chain to customers, as well. How do customers view the criticality of the product or component they purchase from us? How does the customer view the marketplace from which they purchase our product or component? How important do they think it is for us to make the sale?
Conclusions. A criticality grid is a useful tool to assist purchasers of many different products in diverse markets. It facilitates formal recognition of internal and external conditions that define appropriate negotiation strategies. The criticality grid discussed here is of the 2 X 2 form. As purchasers become more familiar with its use, it can be expanded to a 3 X 3 form where rows and columns defined as "moderate" may be introduced between "low" and "high". Deciding just which approach to take to a negotiation is difficult in most situations. Criticality grids are important tools for use in that decision-making process. Determination of perspectives of others up and down the supply chain is likewise aided by the use of criticality grids.