Never Let Vendors Be a Single Point of Failure

“In a perfect world, these relationships would appreciate that this venture is your vision and would never take advantage of the fact that they are the only source. Unfortunately, you must accept that some resources will leverage this knowledge to your disadvantage.” 

This is hard. In early stages, you want to create relationships with companies that will ride the wave with you. Companies that will see your vision and take a flier on it. Unfortunately, more often than not, companies understandably protect their self-interest. This is not to say that all constituents will do that. If you are fortunate enough to find constituents that share your common vision and are willing to invest in it, so be it. Until that happens, however, you must not expose your vulnerability. While the preferred solution will always be to have a back-up plan, you never should communicate that a potential relationship is your single source. Individuals and companies who understand that they are in a competitive environment are likely to perform better and provide better terms.

Take the example of a vendor. With vendors, you are often looking for partners who are willing to take below market or other creative compensation (e.g., equity) in exchange for performance. In these cases, you develop a relationship with these vendors and share information with them. You might have one company bidding to be your manufacturer. You might have one software vendor bidding for your technology business. When your business matures, you will have the ability to mitigate your risk with multiple or backup vendors. You’ll have the ability to create contingency plans. Early on, you don’t have the capital or management resources for that.

Many vendors who realize they are your single source, will use that fact to extract a higher price or to put you in a position in which your negotiating leverage is minimal. We have all heard stories of the contractor working on your house, is seventy-five percent finished and suddenly communicates that the price is going to be fifty percent higher than expected. You are left with two bad choices—pay the additional fifty percent or fire them—and end up with seventy-five percent of a house. It’s not a coincidence that despite having built hundreds of houses this major price issue didn’t arise until the job was seventy-five percent done. They understand that they are the single source of the solution.

What are some of the tools you can use to minimize this risk? Here are a few tips:

• Create a Bidding Process. Conduct a bidding process and communicate to your vendors that you will be considering their bid against other bids. The bidding process can be formal or informal. Communicating that you are accepting proposals from multiple vendors will cause vendors to act accordingly.
• Be Careful Sharing Information. When your balloon is full and you build a relationship with constituents like vendors, you tend to share the gory details of your business. While this can let air out of your balloon, this can also be detrimental to the business. When vendors hear a sense of desperation or a risk to your business, or know there is a customer deliverable in two months, some may use this information to alter pricing and terms or use this leverage to create relationships that are not balanced. Vendors should earn your trust by performing. At that future time, you can share more with them.
• Have Alternatives. Even when you hire vendors, make them aware that you are constantly looking for ways to improve and always keep alternative vendors on call. It is like having a bench when it comes to employees. This keeps vendors on their toes.

Your job is to act in the best interest of the business. Of course, you would like to strike a vendor relationship that turns into a close one in which you ride the tide together. This is rare, especially since the early vendors who make sacrifices expect to be treated differently as the business grows. Like early employees who make sacrifices, early vendors who work for below market prices expect preferential treatment. The same rules apply to employees, customers and investors. When investors sense that they are the only game in town, they have leverage to negotiate more preferential terms. If a candidate knows they are the only one for the job, you may be faced with higher compensation demands. If a customer knows that they are your only prospect, you may be faced with pressure to lower your price or expand your offering to win their business.

This rule is not groundbreaking, but given the frequency with which early stage companies have single sources and minimal back-up options, it is a key one to follow. It is never about being dishonest. It is about acting in the best interest of the business. Think of it this way, if you asked a customer, “Are we the only vendor you are considering?” Even if you were, do you think they would tell you?