October 26, 2006
dan twing on the winner’s curse
Dan Twing writes an excellent piece about squeezing outsourced vendors on price. He starts by citing a study by the London School of Economics, although he could have just called me:
Clients do not win by squeezing outsourcing vendors on price to the point that they cannot deliver good results and still make a fair margin.
(A London School of Economics) study found that one in five IT outsourcing deals are doomed to failure because they favor the client at the expense of the vendor from the outset. This effect, labeled the ‘Winner’s curse’ is a very real issue from my experience as both a vendor and a client.
The main question is, why do we vendors not walk away from terrible deals? Twing proposes an insightful answer:
You might think that vendors would just walk away from deals where the price is too low. So as a client, you can just push for the absolute lowest price that a vendor will accept. It is a bit more complicated than that. The term loss-leader applies to selling behavior in both business-to-business and business-to-consumer marketing.
A very low price is used to get a customer relationship started with the intention of building on that relationship and making additional sales where the ultimate profits will be made. This is not a bad concept when applied with reason, but it can manifest some negative outcomes when it becomes unreasonable.
So, we enter relationships with big companies for ridiculously low prices, counting on the fact that the next project will have great margins. Problem is, there are 20 other firms willing to do the next project for a ridiculous price, hoping for the same thing. But, if the customer is ethical, it can actually work out:
The reasonable form is when a vendor enters the deal knowing margins will be thin, but expects to win more business through great customer service and real value-add to the client’s business. The latter can only happen when the vendor can bring enough resources to the table to do a good job.
When it doesn’t work, we often start gouging our customers:
One form of unreasonable use of the loss-leader deal is when a vendor agrees to any price just to win the deal away from competitors, and then looks to nickel and dime the customer on every out of scope request with change request after change request. The customer will never be happy in this scenario as every question to the vendor spawns another quote for extra work.
