A date with your supplier at Pebble Beach, and five other mistakes you can't afford to make

The following is a guest post by Justin Castillo, a partner with our law firm affiliate, Levine, Blaszak, Block & Boothby, LLP.

Many economists are warning that the current downturn could last into 2011 or beyond. Until it ends, enterprise customers are facing a once-in-a-generation decline in their businesses, while carriers are trying to economize by cutting capital expenditures, reducing headcount, and driving harder bargains with their customers.

Over the next several years there is a very real possibility that your enterprise will face one or more severe challenges, including layoffs, plant/store closings, divestitures, and mergers/combinations (either voluntary or forced). These challenges will test the ability of telecom managers to manage their service providers. The lesson for anyone about to embark on a telecom procurement is to assume that your company will be under economic pressure for months, if not years, and negotiate accordingly. Pursuing the traditional strategy of relieving short-term financial pressures by securing an average, if not mediocre, deal that yields enough upfront credits to get you through this quarter is no longer an option.

We have all heard stories of the carrier account team from hell, but it is important to note that often the customer is equally to blame for a deal that is mediocre (or worse). Let's see how that happens and find ways to avoid it.

Short-term thinking. Reduced competition and a stagnant economy mean that much of the "low-hanging fruit" is gone: the virtually automatic 10% annual price decreases of the last decade are a memory, and users now have to wrestle for better pricing and for terms that will protect them from the risks of a protracted downturn.

Some companies will keep trying to score easy wins. They may reap modest price breaks and/or credits by agreeing to diminish their leverage, but they are setting themselves up for disaster in the coming years because once their leverage is gone, they become captive customers of their primary carrier, unable to pursue competitive options.

Failing to look beyond price. Looking beyond price went out of fashion early this decade. During the past five years, for example, large customers often believed that they did not have to worry about business downturn clauses because the economy was strong and overall demand was rising. As the recession batters budgets and reduces demand, some customers are confronting the very real possibility of a shortfall, which gives new relevance to business divestiture, early termination, and shortfall provisions. Customers who agreed to the carriers' boilerplate in this area (among others) are in for a shock as they discover that those clauses offer little in the way of real protection because they don't entitle the customer to anything more than a conversation.

In the current economic climate controlling risk has taken on new importance, and terms and conditions matter more than ever.

Losing control of the procurement process. Procurements work best when the customer is in control of the negotiations. Controlling a network services procurement means having leverage -- the ability to go somewhere else if you aren't offered a good deal -- and having the time to take advantage of those options. All too often customers lose control of procurements because they run out of time, usually because they either didn't allow enough time in the first place, or chewed up months on internal negotiations before going to the market. That puts the vendor in the drivers' seat -- the conversation starts to focus on how much in savings the customer is losing every week by not agreeing to the vendor's latest offer.

The only thing dumber than not allowing enough time to complete negotiations is telling the selected carrier up front that the deal has to be done by a certain date, which pretty much guarantees vendor non-responsiveness as the clock winds down.

Creating a credibility gap. Enterprises that want the best deal need to maintain credibility with their vendors. That requires discipline, internal coordination, and knowing your traffic. It also means maintaining a clear message internally and reminding the vendors that you know what you're doing.

Vendors are always looking for higher-level executives who will weigh in even when they know little. If they find a CIO who blusters and does not know what he or she is talking about (the kind who wants "Most Favored Nation" clauses from all of the telecom vendors), they'll pounce -- and you'll end up trading $1 million in savings over three years for $100,000 in unattainable credits and a trip to Pebble Beach.

Confusing cost and value when compensating advisors. All too often customers try to save money on procurements by agreeing to an uncapped contingency fee with outside advisors. Such arrangements nearly always overpay outside experts, especially when (as is often the case) the terms of the fee agreement are not clear. Will the contingency fee be based on total savings? Over what time period? Do you have to pay if the advisor's projected savings involve migrating to a carrier that you don't want to use? In addition, these arrangements can incent advisors to structure deals that maximize fees by surrendering the customer's long-term leverage for short-term savings.

If you want to do a contingency fee deal (usually because the project won't be approved if there is any out-of-pocket expense), at least take steps to protect yourself. Cap the fee at a reasonable level, reduce the contingency fee after it reaches a predetermined figure, and count only one year of savings when computing the fee.

Failing to recognize the primacy of leverage. The biggest mistake that enterprises make is failing to maintain leverage. Many companies think that negotiating requires giving up leverage: improving pricing, terms and conditions requires, say, increasing the commitment from 65% of total spend to 80%. Over the long term, this approach is self-defeating because as leverage declines you get less and less from the vendors.

Leverage matters because buying telecom services is not like buying many other kinds of services: they are mission-critical, purchased for multi-year terms, and it is difficult and expensive to switch vendors. The only way to keep your primary vendor honest is to be able to credibly threaten to move traffic if you are not treated appropriately. Customers who squander their leverage become beholden to their primary carrier -- guaranteeing above-market rates (and often sub-par service).

The key is to use leverage without eroding it, primarily by pitting the primary vendor against one or more competing carriers. Keeping the customer's traffic "up for grabs" yields steady pricing improvements over the contract term.

While we are on the subject, maximizing leverage by pursuing "no commitment" deals sounds great, but in practice, decent pricing in telecom requires a commitment of one kind of another. Those who think they got something by avoiding a minimum annual or term commitment often find that they have minimum commitments for each and every circuit -- which is much more onerous. Negotiating network services agreements is never easy, but the need to control risk and improve deal economics makes that task even harder. In short, there is no room for error. Enterprises that avoid the mistakes described stand a much better chance of conserving their leverage and getting the deal they need to meet the challenges of the coming years.