How to Negotiate a Cap on Annual Increases

Have you ever had a supplier ask for annual fee increases during negotiations? It's a typical demand from suppliers. And most organizations simply meet them half-way by agreeing to a cap on annual increases.

But in many cases, allowing annual increases is like allowing the supplier to rip you off.

Watch this week's video to learn why annual increases make no sense and how you can use this clause to get better deals in negotiations with suppliers:

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Video Transcript

Do all of your agreements - at least the ones for technology - have a limit as to how much a supplier can increase costs year over year?

If so, why? I don’t mean “why” as in “why do you have a cap on annual increases?”, but "why do you allow increases at all?"

Over the last several years, I’ve seen this growing trend with suppliers - especially software suppliers - where their starting position in their contract is that they can increase costs every year. The customer then usually asks for some kind of a limit as to how much they can increase it

The customer then usually asks for some kind of a limit as to how much they can increase it and they come back with something ridiculous like 5% or 10%. And that typically gets negotiated down to the lesser of or greater of some number and CPI, which is an index that measures inflation.

But why any increase at all? Just like termination for convenience, I will ask suppliers to give me a valid reason for why they should have the right to increase our costs. Most will say that the increase is to allow them to

Most will say that the increase is to allow them to continue to innovate and improve the product, which is ultimately to our benefit. But that’s what we pay maintenance is for.

If your agreement states that you have to pay annual maintenance, spend some time clearly defining what maintenance fees mean.Maintenance should not only cover support calls, patches, and fixes and updates.

Maintenance should not only cover support calls, patches, and fixes and updates, but also upgrades and new releases to a product - because good software that you’ve paid a lot of money for shouldn’t require a lot of support calls or patches or fixes.

So the tens of thousands of dollars that you’re being asked to pay for maintenance are already being used to used to innovate and improve the product. And any additional increase to that amount is just double-dipping by the supplier as far as I’m concerned.

The other argument suppliers will make is that the increase is due to inflation. Now, if I’m buying lumber or gas or some other consumable, I can see the logic in that. But when it comes to technology, the only impact of inflation on your supplier is that they may need to give their employees a raise.

In fact, the next time you’re negotiating a cap on increases, ask the supplier if they’ll agree to lower their costs every year to account for the fact that you need to give your employees a raise. I’ve actually asked that question a few times. Interestingly, no supplier has agreed to it yet.

At the end of the day, most organizations will allow for some annual increase, but it doesn’t mean you have to give it away for free.

I’ll fight tooth and nail for no annual increase and then I’ll concede the point towards the end of the negotiation for something that’s more important to me.

Here are a couple more points on annual increases:

Always make sure the increase is tied to some measurable index like CPI. And if they’re gonna add another number, make sure that it’s the lesser of that number and CPI Less Energy.

Now some of you are probably wondering what “CPI Less Energy” is. CPI is the Consumer Price Index that measures price change of consumer goods and services. The energy portion of CPI is the increase in the price of gas.

I’ll tell suppliers that I’ll agree to an overall increase due to inflation, but I’m not going to pay for your employees to put gas in their car just so that they can drive to work.

The reality is the difference between CPI and CPI Less Energy is so small that it’s probably not going to have a huge impact on the overall increase.

But when you have such a specific measure for calculating increases, it’s less likely that the supplier’s going to spend the time and effort to figure out what that increase is going to be rather than just send you an invoice which is the same as what they sent the previous year.

So I hope that was helpful. And I hope you’ve had a chance to check out our free video course on the 7 Skills of an Elite Negotiator at oneviewnow.com/negotiator

Thanks for watching and we’ll see you next week when we’ll talk about Limitation of Liability.