Negotiating in Times of Uncertainty: How to Manage Risk

Businesses around the world have faced heightened uncertainties of late: about interest rates and consumer sentiment, in volatile markets, and with increasing risks of trade wars and supply chain disruptions. But they still need to deal with customers, with suppliers and with other business partners. The question is, how do you negotiate deals under risk and uncertainty?

Managing risk is a core part of most commercial negotiations. But as we've all experienced, risk comes in many forms; it is not just a question of whether there is, or is not, risk. Risk is generally defined as the probability of some bad thing happening times the magnitude of the impact if it does. If they are both high, then the deal is often deemed too risky to do; if they are both low, we typically worry a lot less about the issue. But when we face the combination of low probability of a hazard but very high impact if it does occur, that's when we get concerned and start looking for cover.

When parties perceive significant risk in a deal, the most common negotiation move they make is to try to push the other side to bear it. Redlined documents fly back and forth as parties try to shift liability caps, indemnification provisions and what constitutes force majeure. The lawyers spend a lot of time arguing about who will be held accountable for which failures in the expected outcomes and what might excuse one side or the other from responsibility for the costs.

While it may be appealing as a business leader to step back from the negotiation at this point and let the lawyers argue about the risk clauses, that approach to negotiating risk is entirely zero-sum. It assumes there are only two possibilities: You bear the risk or they do. But if we take risk as another business problem and break it down into its component parts, then we can see that there may be things I can do to reduce the probability or prevent the hazard, and there may be other things I can do to reduce the magnitude or mitigate the impact of the hazard.

Those are two possible sets of moves that are not only about who can be required to pay for the consequences; they also involve operational and business stakeholders. And in most commercial deals, there may be things that your counterpart could do to prevent or mitigate; that’s two more sets of moves.

And there are often ways we might be able to collaborate on prevention or mitigation by leveraging our different resources and capabilities. That gets us to six different avenues for dealing with risk in a deal, other than deciding in advance that if it happens, it’s on their dime (or ours).

In an IT services deal, for example, the provider might agree to help reduce the probability of a data breach by including enhanced security measures in their scope or providing data privacy training to employees. Or in an industrial supply contract, a large customer might offer to help a small, but important supplier mitigate the impact of supply chain disruptions by agreeing to pre-purchase buffer stocks for critical components. Those and other measures may be better bulwarks against significant risks than a contractual provision that may ultimately require costly litigation to enforce.

I've found that it's far more productive to collaboratively work our way through a list of risks to understand their likely causes and who can best prevent or mitigate them (and how) than it is to argue about exclusions to an indemnification provision. But that approach to negotiation does require a strong working relationship built on a foundation of trust. Building that working relationship, whether with an existing business partner or during an initial negotiation, takes work and requires a real commitment to understanding and helping solve for a counterpart's interests, as well as our own. I’ll come back to that topic in the future and share some practical do’s and don’ts for building productive relationships as we negotiate.

Building that kind of relationship might also serve you well if, instead of managing down your risk, you actually want to use risk and uncertainty strategically. Have a perspective on the likelihood of an outcome that you would like to lean into and bet on? You can offer to bear more of that risk and structure your agreements so that you also capture the upside if the uncertainty resolves the way you expect.

Have other exposure to some specific risk that you want to hedge against? Negotiate for more significant cover for that one instead of the other risks you already have under control elsewhere in your value chain. (As a side note: I’ve seen some negotiators be tempted to use uncertainty to try to game or outsmart counterparts. It can work, but my advice is to make sure you’ve thought it through from their perspective as well. If they don’t fully understand what they are signing up for, that contract you thought provided you with a financial hedge or mitigated a supply chain risk might be worth nothing more than an expensive and time-consuming right to sue for breach, rather than representing a real boon.)

Next time you are negotiating a contract with a client or supplier, instead of just sending over language that puts all the risks on them and bracing for their response, consider engaging them in a discussion about the potential risks and their possible causes, who can best prevent the problem from occurring and how you can work together to mitigate any impact if it does. It won't work every time, but you can always revert to arguing about exceptions to liability caps later.

Originally published by Forbes.