Thursday, March 24, 2011

Up front investments

One area where negotiators spend a great deal of time in discussion software contracts is sizing the up-front investment, or commitment, each company is making to an alliance. Often, this is shrouded or overtly captured in subjects like: Pre-payment, up front payment, initial royalty, Non-Recurring Engineering (NRE) charges, and so forth. But, in general, each is a measure of what one company expects the other to "commit" to the relationship in exchange for a special license, commitment to resources, preferred market position, time to market, corporate focus or other less quantifiable "stuff".

As an example, a company may be seeking a preferred (e.g. source code) license and associated set of (e.g. engineering, marketing) services from a software supplier in order to achieve market advantage. In exchange, the supplier must commit resource and an implied single-mindedness to the relationship due to its magnitude or complexity.

For some negotiators, it is hard to get past the size of the financial commitment requested by the supplier (in my example) in exchange for the required license and resource commitments. How do I justify charging "millions" to my potential strategic partner? I find it useful to break down the kinds of value that a supplier is offering in order to come to agreement on the figure.

There are several items that might be embedded in that up front $ figure. Often, the figure was originally based on a need to supplement company revenue (caution!), but the supplier probably doesn't want to share that with its intended partner;-) So, it is helpful to justify the amount on a business level.
I find it useful to consider the following list of components that may be included in that figure. First, value the concrete items such as:
  • NRE - Committed engineering labor at fully-burdened cost
  • "Buying down" the royalty % from standard rates
  • Specilaized ongoing support and maintenance

And, less quantifiable things like:

  • Scale (the partner's needs necessarily require you to limit efforts elsewhere)
  • Special (e.g. Source code) licenses
  • Extended term of a license
  • Market exclusivity for a period of time (a scary topic, but this can actually be valued!)
  • Cross-licensing of collaborative efforts

To achieve the optimum outcome, the supplier's negotiator should use their skills to break apart the desired financial commitment into one or more of these, and demonstrate to their intended partner the value being delivered for the required commitment. It should help!

More on this over time. Enjoy the spring - the trees and flowers are blooming in Texas!



No comments:

Post a Comment