Episode #135: Request for Proposals: Avoiding the Winner’s Curse

“Never forget that your weapon is made by the lowest bidder.” –Law Number 20 of Murphy’s Laws of Combat

Simply put, don't do them

We at VeraSage recommend that you do not do RFPs, because they subsidize dysfunctional buying behavior, often being used as a club to extract concessions from the current provider by customers who have no intention of changing suppliers. 

Or they are used by price sensitive customers you do not want anyway. We also suggest you charge for an RFP. Why not? The customers are asking you to compete, which has value in and of itself. 

If you charged for an RFP, like charging for admission into your firm, it might actually be a process that created some value, rather than merely reciting deliverables.

That said, many firms have to do a certain amount of RFPs. If you do, you should be well versed with what economists call the winner’s curse.

Avoiding the Winner's Curse

In auction markets, economists refer to the dreaded winner’s curse—whereby the winning bidder is often a loser, because obviously all of the other bidders believed the engagement had less value.

In other words, the only request for proposals (RFPs) that buyers will accept are ones you should not make. One of the ways to avoid the winner’s curse is to bid more conservatively when there are more bidders. Thomas Nagle and Reed Holden explain why in their book, The Strategy and Tactics of Pricing:

The more bidders there are, the more likely you will lose money on every job you win, even if on average you estimate costs correctly and both you and your competitors set bids that include a reasonable margin of profit. The reason: The bids you win are not a random sample of the bids you make. You are much more likely to win jobs for which you have underestimated your costs and are unlikely to win those for which you have overestimated your cost.

The only solution to this is, in effect, to formalize the principle of “selective participation.” You do that by adding a “fudge factor” to each bid to reflect an estimate of how much you are likely to have underestimated your costs if you actually win a bid. Needless to say, adding this factor will reduce the number of bids you win, but it will ensure that you won’t ultimately regret having won them.

RFPs have become more commonplace as competitive bidding has replaced negotiation for price buyers. It is as if dysfunctional buying practices have arisen to counter dysfunctional selling practices.

It is important to have some contact with the economic buyer—that is, the person who can actually make the decision to hire you, rather than just the procurement department. You need to find the person who can say “Yes,” not just the ones who can say “No.”

Establishing relationships and having internal advocates in the customer’s enterprise also helps to ensure your value is being considered, not just price.

Another strategy with RFPs is: No surprises. Your potential customer should know everything in your RFP before you submit it. Gaining an understanding of your customer’s expectations, business model—how they make money—and how your company can add value is imperative to increase your odds of a successful RFP, one that won’t suffer from the winner’s curse.

Co-Opetition
$11.71
By Adam M. Brandenburger, Barry J. Nalebuff

Co-opetition by Adam M. Brandenburg and Barry J. Nalebuff also discuss the following eight hidden costs of bidding that are also worth considering:

  1. There are better uses of your time.
  2. When you win the business, you lose money.
  3. The incumbent can retaliate.
  4. Your existing customers will want a better deal.
  5. New customers will use the low price as a benchmark.
  6. Competitors will also use the low price as a benchmark.
  7. It does not help to give your customer’s competitors a better cost position.
  8. Do not destroy your competitor’s glass houses.

Other RFP strategies

  • The RFP is not about your firm, it is about the value you will add to your customer—focus on how they will change, not your firm’s history and processes.
  • What is your competitive differentiation? If you do not have one, do you expect to be successful with this RFP?
  • Always submit options, at various value/price points, with any RFP.
  • What would justify the customer paying a premium price?
  • Are you dealing with the economic buyer? If not, you probably should not waste your time with an RFP.
  • Is the organization using the RFP process as “column fodder”—that is, to beat up its existing firm?
  • How you sell is a sample of how you solve—be creative, innovative, and different.
  • RFPs do not sell, people do.
  • Never submit an RFP to people whose criteria for judging your success are unknown.
  • What does the customer expect from their firm? How will you exceed those expectations?
  • Do not let the RFP be the first time you “test” your price with a customer.
  • Do not be constrained by the customer’s “budget.” As the opening email of this Appendix confirms, budgets are elastic, and if the economic buyer understands the value, the money will be found from somewhere else in the budget.
  • See if you can propose on a greater share of the customer’s business.
  • Consider charging for your RFP to test the customer’s seriousness, providing a full (or partial) credit if your firm is selected.
  • If you win this RFP, what will be the impact on the firm’s self-esteem?
  • If you have a 25 percent market share, you should be losing 3 out of 4 of your RFPs. In other words, do not worry about losing more RFPs than you gain.
  • Once you submit an RFP, you lose all control and leverage, leaving you asking “Have you made a decision yet?” If your RFP is innovative and surprises the customer, you will change the standard operating procedures.
  • Put a deadline on the price. No price should last indefinitely. Three weeks is a good rule of thumb.
  • Copyright all your RFPs so the firm retains the intellectual property rights (especially for advertising agencies).
  • If the customer asks you to match a competitor’s lower priced bid, be sure to understand the scope of work that the lower price is based on.
  • If your RFP is rejected based upon price, ask the economic buyer:
  • Do you not believe the value we discussed is accurate?
  • Do you not believe that we will be able to create that value?
  • Or do you think you will be able to acquire that value from another firm?

Recognizing not all customers are created equal, should be charged the same price, or accepted, or proposed for, in the first place, is essential to avoiding Baker’s Law: Bad Customers Drive Out Good Customers.

Comment

Ed Kless

Ed Kless joined Sage in July of 2003 and is currently the senior director of partner development and strategy. He develops and delivers curriculum for Sage business partners on the art and practice of small business consulting. Courses include: Sage Consulting Academy, Business Strategy and Customer Experience Workshops. Ed is the author of The Soul of Enterprise: Dialogues on Business in the Knowledge Economy, a compendium of a few of the episodes of his VoiceAmerica talk-show The Soul of Enterprise: Business in the Knowledge Economy with Ron Baker, founder of the VeraSage Institute where Ed is also a senior fellow.