“Don't tell them your budget" is a common prescription among sourcing professionals and a best practice for IT price negotiations. But how effective is it? That depends. If sourcing is engaged early, the purchase is well defined, and current market data is used to develop the budget, then delivering a purchase target to a supplier may actually have a positive impact in some scenarios.
The Anchoring Effect in IT Price Negotiations
The concept of anchoring is based in psychophysics and has been studied since the 1950s. It is best described as a cognitive bias where an individual depends heavily on an initial piece of information – "the anchor" – during decision making. Once the value of this anchor is set, all future negotiations are discussed in relation to the anchor.
Anchoring plays out frequently in IT sourcing and IT price negotiations. Vendors might begin with a 'suggested list price' and a discount. If so, these two values set the anchor and most future conversations will refer back to these data points. A buyer may counter with their own suggestion for price or discount. In this case, the buyer's data points become what is known as the second anchor. This in turn generally establishes the endpoints between which the final end price will land.
Shifting Leverage in the Buyer’s Favor
Vendors generally have the tactical advantage of establishing the first anchor. Without solid data points to support a dramatically lower counter-offer, the buyer is often 'stuck' having to negotiate based on the established anchor. This is where IT price benchmark analysis can change the course, shift the anchor, and create negotiation outcomes that result in the buyer paying a lower price.
Performing IT price benchmark analysis on a telecom or IT purchase or renewal allows the buyer to identify areas of vendor overpricing and establish data-driven pricing targets that are equal to or better than best in market. This reverses the leverage and re-establishes the first anchor in favor of the buyer. Over the last decade, IT price benchmark analysis has become widely-integrated into many enterprise telecom and IT sourcing processes.
The concept of “resetting the anchor” is nothing new. This is the process behind certain reverse auction platforms for commodity items. The buyer agrees to place an order at a maximum price (the anchor) and suppliers then bid against each other to win the purchase (reverse auctions can accomplish this even without the buyer establishing a target since the lowest cost supplier establishes the anchor after the first round).
Studies have also shown that more precise anchors also establish a smaller adjustment for the counteroffer than a less specific anchor. For example, a license listed at $10 per month creates a bias to counter with even dollar amounts, either $8 or $9 or $9.50. But a license listed at $9.95 per month creates a bias for a smaller and similarly defined counteroffer.
IT and telecom suppliers spend millions of dollars to educate and train their sales teams in how to sell using techniques like anchoring. Understanding the bias created from this technique and how to turn it into leverage is just one tool in a buyers' toolbox as they navigate IT price negotiations.
- Blog: The Art and Science of IT Purchase Negotiations
- Bulletin: 6 Ways to Cut IT Costs Amid Global Economic Uncertainty with Zero Business Disruption
- Bulletin: Which Telecom Cost Control Tactics Yield the Biggest Savings?
- NPI Service: IT Price Benchmark Analysis & Contract Negotiation Intel
- NPI Service: Telecom Cost Optimization Consulting