I’ve heard many investors and some executives repeat the mantra, “Never offer exclusive deals,” and since this blanket statement is generally bad advice I thought I’d offer the less conventional but I believe more practical version of why exclusive deals can actually be a huge bonus for a startup and why I actively encourage them.
So that we’re speaking the same language I would define “exclusive” as a period in which your company is prohibited from doing business with certain customers or business partners, which is why many incorrectly assume this is necessarily bad. I need to give credit for the topic to PR Malloy who Tweeted me this question. I must admit I discuss this very frequently with portfolio companies but hadn’t thought to write about it.
@msuster looking for an inspired post on when an exclusivity deal (w/ major industry player) works (cons as well) for an early stage tech co
— PR Malloy (@diddly_do_indy) June 13, 2015
The Mother of All Exclusivity Agreements – the iPhone Wouldn’t Exist
Before weighing in on the subject I would point out one thing that should be obvious to many of you – the iPhone was originally launched in 2007 in an exclusive partnership with AT&T and this was vital to both Apple and AT&T and was a hard negotiation throughout 2005 and 2006.
Between the mid nineties until 2007 wireless carriers around the world religiously protected the software that went on to phones and they guarded the end consumer relationship by controlling this software. If a company wanted to distribute software on a mobile device it need to sell via a “portal” (US term) or a “deck” (UK term) of a mobile carrier. As the desk-based Internet emerged it was initially sold through telecom carriers (after players like AOL and EarthLink innovated the market). Although the carriers made a lot of money initially by selling dial-up Internet services, customers never took their software because, well, it sucked. So the value on the Internet went “up the stack” to portals such as Yahoo!, Excite, MSN and eventually Google.
Wireless carriers were sure not to make the same mistake and lose out on the value. So they offered the same kind of crappy software that they tried to impose in the wired Internet era and because you had to get your phone subsidized and purchased through one of their stores and because you had to use a wireless network they had leverage to force customers to use their software.
Apple broke this hegemony (and then later became the toll-keeper themselves when they launched the app store but that’s a different story) and this was no small feat. No carrier in their right mind wanted to cede control of the software but Apple was willing to offer its products exclusive through one carrier in exchange for not having any carrier software on the device. It was a big bet for AT&T but since they weren’t quite Verizon and knew that Apple had recently had a lot of success with the iPods they were willing to bet on letting Apple control the customer experience because they know that everybody who wanted an iPhone would have to sign a 2-year agreement to use AT&T and not Verizon.
THAT is the power of exclusivity. A large, wireless carrier (AT&T) was willing to break it’s traditional rules in order to get access to innovation that it believed (correctly) would help it to sell more contracts and win more market share against its primary competitor (Verizon).
The original agreement was rumored to be a 5-year agreement but had enough “out clauses” that after a couple of years Apple started selling through other carriers. The initial Apple/AT&T deal was of course limited to the geography in which AT&T operated and thus after its initial success Apple had a template for exclusivity agreements in other countries.
Why Exclusivity Matters to Your Customers or Business Development Partners
So now that you’ve accepted (I hope) that exclusivity can be a massive opportunity if crafted correctly, let me delve into the topic. If you’re a start who’s looking to sign small deals with teams that are several levels down in an organization, the concept of exclusivity will seldom come up because your buyer is looking to solve his or her immediate business unit problem with your software or solution and probably isn’t deeply concerned with besting the competition. However, the higher you get within an organization in the sale (and the larger the deal) executives are often looking to “win in the market,” which means growing revenue faster, offering products or services at a lower cost or offering features that their competitors can’t.
So often exclusivity on mega deals is of huge importance to your potential customers or business development partners. If you use this buyer value correctly it can give you a lot more leverage in a negotiation. Of course you’re not going to give them unlimited exclusivity in time or in scope but I’ll come to that in the section on how to craft exclusivity agreements.
Why Exclusivity Gives You Extra Leverage in a Negotiation
Sales is all about knowing the key values of your buyer: What are they trying to achieve in working with you, why do they care about your solution and how will it help them economically? If you know that at senior levels the buyers often have an enemy in mind in each of their big moves in the market you can use that to your great advantage. If you’re negotiating with Samsung you can imagine they have Apple on their minds and if you’re negotiating with Twitter you can imagine they have eyes on Facebook, Google and even Snapchat.
The beauty of these types of buying motives is that exclusivity comes at a cost to the buyer and they often don’t mind paying up to get it. As a startup this is often the one true source of strong leverage in a negotiation to: Get a better price, get a longer-term commitment, get PR commitments and so forth.
But make sure that you understand whether exclusivity is to your buyer and of course you can’t sign hundreds of deals like this so make sure you use it sparingly and for super important deals for you.
How to Craft Exclusivity Agreements
1. Time Bound – The most obvious source of negotiation is time. If somebody was willing to sign a large contract with you, would you be willing to grant them a 6-month exclusive on some basis? Obviously it depends on the deal but it’s worth asking yourself in each negotiation whether or not you’re going to sell enough outside of the exclusive to overcome the “give” you have to agree to in order to win that deal. It’s usually a negotiation in the range of 6 months to 2 years. Your goal is to figure out the relative economic value of the customer win relative to the costs to you of less operating room in the market and how many months that’s worth to you.
But I want to draw extra emphasis on this point: Time-bound exclusivity agreements are often a very easy give for you in order to win important contracts.
2. Named Competitors – Often buyer exclusivity agreements start very broad and your job is to narrow them. I usually try to win the “named competitor” argument because in actuality most buyers usually only really care about a handful of competitors that they’re trying to one-up. If you win this argument then you preserver a whole lot of wiggle room to still sell in your customers general industry. So if you’re selling a service to Virgin America you might start by carving out just Southwest Airlines and JetBlue in your negotiation but be willing to add names as required while avoiding “cannot sell to any US airline.”
3. Industry Bound – Sometimes you can’t win the named competitor argument and the buyer really wants a wider exclusivity agreement. If you can’t get named competitors then I recommend you try to define a really narrow industry grouping, which when coupled with time-based exclusivity, gives you enough comfort. So you might agree exclusivity for the “oil refinery” industry rather than the entirety of the oil & gas sectors . The more specific you can get in your definition the better.
4. Geography Bound – Finally, another natural limiter for you will be geography. You could sign exclusivity for coffee companies in the United States and still give yourself the ability to sell internationally if you choose to. Even if you’re not yet international it’s worth trying to win the point to limit restrictions.
What you want in exchange:
1. Larger contracts – It is very common that in exchange for exclusivity you can argue for much larger contracts, which is one of the reasons I like exclusivity as a seller. If working with your company is very important to your customer or partner and if having a one-up on competitors is equally important then increases in price are seldom an issue.
2. Longer-term contracts – If the price of your product is very firmly fixed or a customer has enough resistance to higher prices then I would always push for a longer-term contract. I would trade a 6-month exclusivity for a large, 3-year guaranteed revenue deal in many instances provided I’m an early-stage company looking for my first big contract win. And often these contracts don’t prohibit you from marketing to competitors so you can often start to build your future pipeline while not immediately selling to the competition.
3. More commitments to success – If there is no way around exclusivity (sometimes customers or partners simply won’t sign up unless they have some degree of exclusivity) you can push for soft benefits in addtion to points 1 & 2 above. You can push for guarantees that the client or partner will appoint a minimum number of staff to rolling out your product, you can ask them to spend hard dollars on co-marketing, you can ask for commitments to case studies or reference calls or PR releases. At the end of they day, if you have to have restrictions on your business operations you need to make sure you’re getting compensated for it.
4. Paid Engineering – One final thing I would often ask for that I see very few others doing is “paid engineering.” Here’s what I mean. Let’s say you have a “customer advocacy” group that consists of your largest customers and they are pushing for you to build a set of features faster than you otherwise would normally commit. I have often asked for funding for this accelerated development. If you could get an extra $250,000 or more in a contract to build 2 quarters faster things you know you eventually need to build then often this is a good trade to make. I’ve often granted 3-month exclusives on the new feature sets to sweeten the deal. The reason I don’t mind is that often it would take 3 months to roll our the marketing and training programs to sign up new customers and giving a small win in exchange for cash is often a trade I’d be willing to make.
In summary, many advisors, board members or executives will steer you away from exclusivity agreements. I understand the logic of this because by definition exclusivity restricts your business operations; however, I have seen exclusivity agreements be used to massive success in the marketplace by increasing contract sizes, getting longer-term commitments and getting many soft commitments to help in your success.
I would encourage you at least to have them in your tool kit for any negotiation and you simply need to be creative in how you structure them and weigh up the pros & cons of each trade.
(Cross-posted @ Both Sides of the Table)