Googler 13

Tuesday, February 1, 2011

Steve’s basic deal methodology

“Triangulating in on Value”

As a self-taught negotiator, I had to come up with my own logic for how to value a deal. One thing that I learned very early (especially on the buy-side- when I was the one with the checkbook), was that the price a vendor first quoted is just a starting place. Often we would end up nowhere near that price. Most of the deals I did at Google (at least on a volume basis) were to license other people’s technology or data for use in our products or services. This included IP geocoding, language translation software, white/yellow page data, etc. The challenging thing from a pricing standpoint was that the way we would be using these things was custom to us. Cookie-cutter rate card pricing was not going to be applicable. The value was ambiguous and we considered it a trade secret exactly what we were doing with their product. Many vendors wanted to participate in the revenue we would receive from whatever service their product was integrated into. I always rejected this concept. As I explained it, its like a supplier of silverware trying to charge more to a restaurant that has $30 entrees versus one that has $10 entrees. My position was that I might pay more for the vendor’s premium offering, but not more for the same offering just because I could monetize well. In addition, I was relatively limited in the intangibles that I was able to offer. We wanted to keep it secret whose technology we were integrating, so we could not allow the vendor to announce that Google was using their products. This made things difficult for me, as vendors were very willing to negotiate down their prices for this ability. The most I was ever able to offer was that they could include us in a list of customers (without disclosing any details of our relationship) in their sales presentation materials (but never on their website).

One thing I learned was that people aren’t always good at understanding the value of their own products and therefore don’t always have good logic for their pricing. As a fundamental analyst, I was always ready to take on the debate. Ultimately, I always came up with the price I was willing to pay, which didn’t always have much to do with the quoted upfront price. Nobody works for free and I didn’t want to drive my vendor’s out of business...but I did want to pay what I believed was fair and equitable.

Here’s how my thinking worked: I always tried to do what I coined “triangulating in on the value”. When I considered how much to pay for something I attempted to discern:

  1. How much money did I expect us to make from our product/service that was integrating the vendor’s product. I needed to ensure that I what I was paying for outside technology was low enough to provide us with reasonable profit. If you pay too much, you can’t make money.
  2. How much profit is the vendor making (much of this was educated guesstimating). I wanted the vendor to make a profit, but not an exorbitant one. I did not want to squeeze the vendor so hard that they ultimately felt cheated and therefore provided poor ongoing customer support for us or difficult re-upping of the contract at the end of the term. "We've never done a deal at that price" is good. "We'll go bankrupt if we give you that price" is bad.
  3. What was the cost of substitute goods. I can’t say that I remember ever dealing with a vendor where they were the only one with the type of product we needed. That being said, there were specifics that made one vendor a better fit for us than the other. If the preferred vendor was substantially higher than another, I made them answer to why, as they were quite familiar with their own competitive landscape. There was never a very good reason, and invariably this question would make them immediately more flexible.
My goal was to land at a price within a range of where those things intersected.

In summary:

  1. Make sure what you pay for outside resources allows you to make a reasonable profit on your finished goods.
  2. Allow for your vendor to make a reasonable profit- but no more.
  3. Know the prices for substitute goods so that you have a sense for the market and negotiating ammunition.


asymtote said...

You said that you can't remember ever dealing with a vendor where they were the only one with such a product. I'm curious, was it a conscious decision to only buy products for which there were multiple alternatives in the marketplace?

The reason I'm asking is that the 2009 Nobel Prize for economics was awarded to Oliver Williamson whose work in the 1970s showed that outsourcing is only efficient if there is either more than one supplier for a particular item or if a simple contract can be written for that item. In all other cases it is more efficient for a company to do the work in house.

In this age of outsourcing companies appear to be blind to Williamson's basic finding. The poster child is of course Boeing and their latest airliner, the 787, which is over 3 years late. Boeing has spent over $1bn buying suppliers who they outsourced work to.


Steve said...

Hi Andrew,
No...the decision to outsource had nothing to do with the # of alternative vendors. It was simply a practical decision which was that the engineering folks simply wanted something that they did not want to build themselves- for whatever reasons. No offense to nobel prize winning individuals...but this is a case of real world vs theory. All other things are NOT held equal when considering a variable decision. We live in a world of resource constraints (limited engineers, personnel expertise, limited schedules, corp priorities, etc). If we dont want to build it and someone else has job was to go get it. Its really that simple. A value exchange is always possible. Thats why people are in business to begin with. Licensing is also possibly a short term (stop gap) measure. If something is truly strategic...ultimately it probably makes sense to hire the right people to build in-house or acquire another company with these competencies/solutions. Google is first and foremost an engineering house- doers/makers. I cant speak to Boeing. Perhaps its a house of managers?