Sign on the dotted line

In our free enterprise system, would you willingly agree to give up your rights to engage with a competitor, or if you do, agree to a penalty for doing so? Absolutely not! After all, that is the entire basis of our economy.

Wrong… you do it all the time. Think about your mobile phone plan. You sign yourself up for one to two years and agree to an early cancellation penalty. Other agreements may require some period of notice before you can cancel. Try paying off your mortgage early. Some loan agreements have nasty early termination clauses. The fact is, locking out competitors is normal. Since it is clearly legal, can you use such a technique in your own business?

What happens when we agree to work under such contracts is that we trade our right to switch to a competitor at no cost for some other benefits. This may be a lower per minute charge on our mobile phone, a free handset or free weekend calls to nominated phone numbers. We avoid some set up costs on our mortgage if we agree to a termination payment. You would normally sign up for a software maintenance and support contract for a year and forgo a refund if you opted out early, but you do get a lower monthly rate.

Many businesses work to secure long-term commitments from customers and in return give them something in return. A manufacturer might agree a reserved capacity for a minimum annual order level. A wholesaler might agree to hold a specified level of inventory for a guaranteed monthly purchase order. A services company might agree to locating a consultant on-site in return for a longer term support contract.

What you need to work out is which risks you can mitigate or negate of your customer by changing your commitment to them and then what do you want in return. You need to move to a cooperative engagement where both parties gain something by entering into a longer term commitment. On your end, you may offer price discounts, reserved capacity, time to respond, minimum inventory levels, custom design, access to internal information, interfacing of systems across company boundaries and so on. What would you like in return? Most suppliers are looking for certainty in their forward customer orders. The greater the certainty of sales forecast, the easier it is to plan workloads, staffing levels, finance requirements and so on. Both parties have much to gain by entering into a preferred supplier/customer agreement.

There can be no question that this is a competitor blocking technique. Once you have the customer locked in, they won’t be dealing with your competitors during the period of the agreement, although you still have to deliver your end of the agreement. However, remember that your competitors may be doing the same, so you really do have to offer something the customer needs to get them to sign up. The need for a strong competitive advantage doesn’t go away but you might be able to buy some time to improve your own.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia.