Know the Rules of Procurement

Elta (the electronics arm of Israel Aerospace Industries) put out a competitive tender for the development of subsystems for an electronic warfare system, for a big and important customer abroad. The main competitors were Rafael (Israel's state-owned defense developer) and a young plant that was willing to "go kamikaze" on every project.

Whoever won the tender could look forward to a huge future production deal, both in terms of years of work and in terms of money.

The relevant engineering department at our plant analyzed the RFQ and submitted its inputs, which showed that development would cost around $350,000, and each of ten prototype units (a pre-production run) would cost about $12,000.

The unit price in future production (there was talk of a very large production run that would go on for years) was expected to be around $5,000.

I submitted a quote along those lines and followed up closely in all sorts of ways, including frequent visits, each with a different purpose.

The plant's management and all the senior people involved understood how enormously important this project was for us. I'll never forget the worried looks that greeted me every time I came back from a visit to Elta and stepped out of the elevator. It's hard to exaggerate the weight of responsibility on the shoulders of a single sales manager who has to secure the livelihood of everyone at the plant.

At one point I was urgently summoned to the office of the CEO at the time, and he told me that Elta's purchasing manager (a very senior, very experienced man) had just called to let him know that an order had gone to that young plant at the following prices: development, $250,000; each of the first 10 units, $9,000; and each unit in future production, $4,000.

For us, that was below cost...

The purchasing manager also made it clear that Elta intended to place a parallel order with a second Israeli supplier (a second source), but since both were Israeli, he couldn't pay even one dollar more to either of them. He put it flatly: if you can submit an offer identical to what we agreed with the competitor, submit it and you'll get an order. If you go over by even one dollar, don't bother, and we'll place the order with Rafael.

In those years Rafael was a unit of the Ministry of Defense. Budgets and profitability were not exactly at the top of its list...

We were prepared to lose money on the development and the prototypes, just to get a share of the big production run later.

I asked the CEO for approval to go down to the competitor's prices, and he agreed.

As I got up to leave his office, he said something like: "I know you, Peled. Are you really planning to go down to the competition's prices??" I told him I had an idea, but if there was no choice, I'd have to give in.

The truth is, I didn't trust that CEO's grasp of the sales world. A pleasant, friendly man, a veteran in the industry, but with a purely engineering background and no connection to sales whatsoever. To be on the safe side, I called Elta's purchasing manager myself, to make sure he hadn't been pulling my CEO's leg. But I found that he was very serious and his numbers were accurate.

I offered to come over, discuss it, look at alternatives... but he was adamant: send an offer identical to the competitor's, or don't send anything.

I printed two quotes. One was identical to the competitor's prices and terms, in case my plan didn't work. In the second, development was priced at about $320,000 and each of the ten prototypes at $10,000. The estimated unit price for future production was the same as the competitor's. To this offer I added a condition I had planned in advance, one I would have to "sell" to the decision makers at Elta.

With all kinds of excuses, some stranger than others, I managed to avoid sending either quote (that would have been a recipe for failure) and set up a "meeting to clarify the figures" with the right people at Elta.

On Elta's side, the meeting was attended by the purchasing manager and his deputy, and the project manager and his assistant.

After a little small talk, I turned to my hosts and asked what the chances were that Elta would really land a big production order for this project.

The purchasing manager answered: "As we sit here, Elta's marketing people are sitting with the customer, closing a production contract. There's no doubt there will be production. The quantities are clear too, since it's a requirement of the foreign army behind the order."

I put the same question to the project manager: "Is that your impression too?"

"No doubt about it," he told me. "We at Elta wouldn't have gone into this development adventure without a commitment to production either. You don't make money on development. You make money on production!"

Given how certain they were, I turned to them and said: "You say there will definitely be production, and I believe you. But look how absurd the situation is. You're the ones who know exactly where the project stands, yet you're trying to roll all the risk onto us... You expect us to absorb development costs now, based on future production potential we have no control over. Why don't you share the risk with us?"

"What do you mean?" they wondered.

At this point I pulled the higher quote out of my briefcase and declared: "If there's series production and we get a minimum order of 100 units (about a quarter or a fifth of the project, as far as I remember), you'll immediately get a credit for the entire difference between our prices and the competition's!"

There was a moment of tense silence, and then the project manager smirked at me: "Peled, you sell high-tech the way they sell used cars in America!"

"How do they sell used cars in America?" I asked, and he explained: "They hang a big sign on the car: $10,000. Then they cross out the number with a big X and write $8,000 underneath... So the price is really $8,000, right?"...

Only then did I relax. He'd taken the bait.

In the end we got an order at prices higher than the competitor's. Prices we could live with.

If for any reason Elta didn't win the production contract, we'd still been paid in full.

If the competing plant completed its development successfully and we didn't, we'd still been paid in full. And even if Elta decided, for whatever reason, to send the entire production order to the competitor, once again we'd been paid in full for the development and the prototypes.

But the most important thing of all: if there was production, and Elta wanted the credit for what it had overpaid us, it would find itself married to us for at least 100 production units. In a project that size, there's no difficulty paying back the credit agreed for the development.

WIN WIN WIN.

By the way, the production unit price wasn't fixed at that point. It was only a budget estimate...

The moral:

Just as in a classic sale you have to size up the buyer, read his personality and "tailor" your approach to him, in institutional sales you have to understand the rules and the procedures a purchase goes through.

You need to know all the "players" well (the DMU, the decision making unit), how much weight each carries in the decision, and how they operate.

In a large organization, the purchasing manager can't approve a deal with a particular supplier on his own say-so, especially when there are cheaper suppliers available. He has to attach a "justification form" to his decisions, so he won't be suspected of favoritism, accepting kickbacks or the like.

The credit equal to the difference between our prices and the competitor's is what made the deal possible.

Now think about it: what purchasing manager will one day give up a credit that was the very basis of a deal he approved...

I have to admit that a few years later I tried to set up a deal with the same purchasing manager using the same idea, but this time it didn't work.

I guess the penny had dropped.