Too many companies and managers discount the value of having good data and experienced people. Here’s an example of contract negotiations where knowledge and experience paid huge dividends.
Steel Resale and Scrap Revenue Sharing Agreement
Several years ago I worked for a supplier who needed to get the parts they produced put on their Customer’s Steel Re-Sale program. For a long-time this company was able to buy steel on the open market for less than the price they quoted, which led to higher profits. However, as time went on, the price of steel increased and became more volatile. By the time we approached the customer about going on their steel resale program, prices on the open market were about 25% higher than the quoted cost, and my company was losing a lot of money as a result.
By going on the Steel Resale Program, we would be able to buy steel at a fixed price, regardless of the market price. This eliminated the upside when steel prices were low, but it also eliminated the risk and losses when steel prices were high, like they were at the time.
There were some conditions to going on the Resale Program. The biggest obstacle to going on Steel Resale was that we would have to sign the Scrap Revenue Sharing Agreement (Scrap Agreement). The Scrap Agreement required us to share the revenue we received for the scrap steel we sold. The scrap steel was a byproduct of our manufacturing process; and it generated over $2 Million per Year in revenue. If we wanted to stop our losses from the high price of steel, we were going to have to share some of the revenue from our scrap sales.
There was something unique about our business though. The company I worked for was a pioneer in the use of offal, which amounts to taking the scrap material from one part and using it to produce a different part. In other words, we were like the people who figured out you can also use the donut holes, not just the donuts.
The offal complicated things. Some parts we produced 100% from offal, but for other parts we didn’t have enough offal so we also had to buy new, virgin steel. This meant the customer’s scrap agreement formula (gross blank weight – net part weight = scrap weight) didn’t really work for us. Additionally, some of the parts we also helped design, investing significant engineering and development resources, to enable the use of offal. Our process wasn’t patented, but it was intellectual property; and ownership felt strongly that this entitled us to some extra compensation.
The ownership strategy for the scrap revenue sharing agreement was to negotiate a higher sharing threshold – for example, instead of sharing everything above $.06 per Pound, like the Customer wanted, we would only share if the price of scrap went about $.10 per Pound. The other variable in the agreement was the percentage of sharing: The customer wanted 100% of everything above the threshold and they were not accepting less than 85%; and we wanted to give them 0%, but we were dug in at 70%.
I previously negotiated the same agreement with the same customer a few years before, when I was with a different company, so I knew the sticking points. They weren’t going to go above a certain dollar ($) amount in terms of the sharing threshold; and they weren’t going below a certain percentage (%) of revenue sharing. The Customer’s position was that if we didn’t want to agree with what they offered then we could buy our steel on the open market and suffer the losses.
The end of year deadline was closing in. We had been negotiating this for a few months, but we were stuck. Each side had drawn a line in the sand and wasn’t budging. During a one-on-one conversation with the Buyer, he confided in me that getting all suppliers on steel resale and scrap share was one of their objectives for the year, and we were the last ones. In other words, our Buyer’s bonus was partly tied to getting this agreement done; an so was his Management’s. They were motivated, but they still weren’t moving on the sharing threshold or percentage. He also made it clear that he wouldn’t be looking to do us any more favors in the future if we prevented him from meeting his goals. We needed him to be an ally, not an enemy!
I had an idea. I wanted to see how it would look if we agreed to the variables the customer would accept, but got language added to exclude scrap sharing on all parts where there was a parent-offal part relationship. When I got back to my home-office, I revised the data to reflect the customer agreed parameters on the sharing threshold and percentage with the parent-offal parts excluded. Based on my calculations, using economic conditions at the time, this revised agreement benefited us by almost $30,000 per month, or roughly $350,000 per year over the scrap agreement parameters we were dug in at.
After my figures were confirmed by our Controller I was authorized to make this new, revised proposal to the customer. When I gave the proposal to our Buyer, he wasn’t sure how to respond. He didn’t have the knowledge and information I did; and he may not have been able to figure it out even if he wanted to. However, he didn’t want to crunch all that data; he and his Management just wanted to get this deal done and get their bonuses.
He took our proposal to his management and legal team, then came back a week later with the revised agreement that included our language. We promptly signed it. When I sent it back to him, he said; “I’m not sure what exactly we just agreed to, but I know you’re one of the best negotiators I’ve ever dealt with.”
This agreement was especially sweet for ownership, because at the same time I was concluding these negotiations, they were preparing to close on the sale of the company. The purchase agreement for the company called for the owners to be paid the value of the assets, plus 3x (three times) EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization, which represents the company’s cash flow. By negotiating a deal where we came out $350,000 ahead of what was budgeted for the year, not only did the owners receive the benefit of that year, but they also received over $1 Million more ($350,000 x 3) when the Sale of the business closed, based on the 3x EBITDA multiplier.
Never underestimate the value of having knowledgeable and experienced employees!