Final Assignment on International Business Negotiation

L

Negotiation on Oil Contract

$1.$Background Information

The Central Oil Company $($CO$)$ was founded in $1942$ as the Fortune Oil Company. It was also one of the largest and best known worldwide producers of industrial petrochemicals. Through growth and acquisition, the company expanded rapidly. It developed extensive oil holdings in North Africa and the Middle East, as well as significant coal beds in the western United States. Much of the company's oil production was sold under its own name as gasoline through service stations in US and Europe, but also it was distributed through several chains of independent gasoline stations.

One of the company's major industrial chemical lines was the production of vinyl chloride monomer $($VCM$).$ The basic components of VCM are ethylene and chlorine. Ethylene is a colorless, flammable, gaseous hydrocarbon with a disagreeable odor, it is generally obtained from natural or coal gas, or by "cracking" petroleum into smaller molecular components. As a further step in the petroleum "cracking" process, ethylene is combined with chlorine to produce VCM$,$ also a colorless gas. VCM was the primary component of a family of plastics known as the vinyl chlorides. Polyvinyl chloride can be converted to an enormous array of consumer and industrial applications: flooring, wire insulation, electrical transformers, home furnishings, piping, toys, bottles and containing, rainwear, light roofing and a variety of protective coatings.

In $1969,$ CO established the first major contract with the J&R Corporation for the purchase of VCM$.$ J&R was a major industrial manufacturer of wood and petrochemical products for the construction industry. J&R was expanding its manufacturing operations in the production of plastic pipe and pipe fittings, particularly in Europe. The use of plastic as a substitute for iron or copper pipe was gaining rapid acceptance in the construction trades, and the European market was significantly more progressive in adopting the plastic pipe.

In $1976,$ negotiations began to extend their $1969$ contract.

However, at this time the market projection for VCM had changed $($see Table $7-2).$ While the market was currently "tight"$-$the favorable supply situation that had existed for CO when the J&R contract was first negotiated, the supply of VCM was expected to expand rapidly over the next few years. Several of CO's competitors had announced plans for the construction of VCM manufacturing facilities that were expected to come on line in $20$~$30$ months. Table $7-2$ Projected Demand and Supply Situation

Year

Demand$($in million pounds$)$

$1972$

$5,127$

$1973$

$5,321$

$1974$

$5,572$

$1975$

$5,700$

$1976$

$5,900$

$1977$

$6,200$

$1978$

$6,500$

$1979$

$7,000$

Supply Capacities $($in million pounds$)$

$6,600$

$6,600$

$6,600$

$7,300$

$8,450$

$9,250$

$9,650$

$11,000$

CO had a rated capacity of $1,000$ million pounds a year. J&R$,$ CO's

second largest customer, took about $20\%$ of CO's capacity. The

largest customer took $23\%.$ The left took between $10\%$ and $3\%$ of CO's capacity. If all the projected new capacity for the industry was completed and customers foresaw declining demand, CO would have difficulty selling enough VCM to run its plant profitably. In an oversupplied market, CO's plant utilization of capacity could vary from $50\%$ to $90\%.$ At long term average prices, CO broke even at $70\%$ of rated capacity. CO must allow $10\%$ of its rated capacity for maintenance, breakdowns and variations in product mix. Since most costs were fixed, profits rose and fell very rapidly: each $1\%$ increase in capacity utilization, from $70\%$ up to $90\%$ of capacity, contributed $5\%$ of the total profit that CO would earn at $90\%$ of capacity. Each $1\%$ decline in utilization, from $70\%$ down to $50\%$ of capacity, contributed $5\%$ of the total loss that CO would incur at $50\%$ of capacity. Below $50\%$ of capacity, loss was so great that it did not pay to keep the plant running. CO was now running at $87\%$ of capacity, including $4\%$ to the spot market.

You are negotiating a supply contract with representatives of J&R$.$ Because of your concern about the J&R negotiation, you have

started to explore alternatives. You estimate, from discussion with prospective customers, that you could replace $100$ million pounds of J&R$\text{'}$s $200$ million pounds VCM demand a year by selling to four small, new customers. To get these replacement sales in today's market $($June$,1977),$ you would have to make price concessions which would reduce revenues by an estimated $$1$ million a year below your provisional agreements with J&R$.$ Also the replacement sales would increase CO's operating and administrative costs $$150,000$ a year for three years. At present, CO would have capacity for new customers only if J&R or other customers decreased their takes. Historically, during periods of industry over$-$capacity large buyers were tempted to split their purchases among suppliers and then played them off against each other to get lower prices. To control wide swings in plant utilization, producers generally would not sell quantities of $50$ million pounds a year or more to one buyer without a long$-$term contract.

CO could sell VCM in the spot market where prices and amounts available varied considerably from week to week. You prefer to sell on a contract basis to assure that your plant capacity is fully used. The spot market can be highly volatile. Spot prices can swing plus or minus $50\%$ around the long$-$term trend.

Although the trend of spot prices appears to be under downward pressure, $50\%$ of the new VCM capacity projected for $1974-1977$ nevertheless has come in place. Producers can postpone new plant constructions or shut down under$-$utilized capacity if they believe supply will be too far above long$-$term demand. Most producers, however, resist postponing new construction for fear of losing market share when demand increases. They resist shutdown when demand declines unless they foresee heavy, long$-$term losses, or imminent bankruptcy.

The cost of your pipeline to J&R will be fully recovered by the end of the current contract. Sales to buyers without a pipeline are delivered by truck or railroad tank cars. Customers without a pipeline must allow an order lead time of one week to six months, depending upon CO's order backlog and the availability of trucks or tank cars. For annual volume of $50$ million pounds the costs of a pipeline amortized over $8$ years equal the costs of non$-$pipeline transportation. At higher volumes pipeline costs are recovered more rapidly. Pipeline maintenance and operation costs are less than $5\%$

of non$-$pipeline transportation.

CO's average contract price for large volume buyers like J&C was $15$ cents$/$lb$.$ in $1976,$ up from $10$ cents$/$lb$.$ in $1974.$ Actual contract prices are computed by a complex formula: Product price$=1($Feedstock$)+2($Labour$)+3($Energy costs$)+4($Crude oil commodity costs$).$

Each is a negotiated coefficient. Prices have been rising primarily because of increases in crude oil commodity costs and feedstock prices. Predictions are that these costs will continue to rise because of OPEC. In the past $12$ months spot prices of VCM have been as high as $24$ cents$/$lb$.$ and as low as $12$ cents$/$lb$.$

J&R buys a large quantity of VCM and CO is geared to supplying product to J&R$\text{'}$s quality specifications. Interruptions in supply due to unacceptable quality or delayed shipments can force a customer like J&R to cut back production or shut down in two weeks. Although there are specific American Chemical Society product standards, the quality delivered can vary substantially across suppliers. When there are quality disputes, the parties may negotiate a settlement, agree to arbitration or$,$ as a last resort, sue. CO has an excellent reputation as a reliable, high quality supplier. $2.$Negotiation for the remaining issues

Party A: Assume that you are in CO negotiating team, which consists of the V$.$ P$.$ Marketing$-$Europe, the VCM Marketing Manager$-$Europe, and the Assistant VCM Marketing Manager$-$Europe. You will be meeting with

Party B: the J&R Corporation negotiating team, which consists of the J&R V$.$ P$.$ Europe, the Purchasing Manager, and the Assistant Purchasing Manager.

Time has passed since your last meeting and it is now June $24,1977.$ If neither party gives notice of termination$($that is$,$ by June $30,1977)$in $180$ days, the "evergreen" clause takes effect. Evergreen means that after December $31,1977,$ the contract will be renewed annually with its present terms unless either party gives notice of termination. CO had agreed to make changes on the original contract. Both sides had reached the provisional agreement on price, minimum quant it ies, and length of new contract $($three years from date of signing$)$ and metering. Three issues are still in dispute: $(1)$Most favored nation's clause $($MFN$)$; $(2)$ Meet the competition$($MTC$)$; $(3)$ Right to resell the product $($RTR$).$

Price: The formula price would be adjusted downward by approximately $0\mathrm{.}85$ cents per pound.

Minimum quantities: J&R suggested minimum quantities of $205$ million pounds in the first year of the contract and $210$ million pounds in the second year and $220$ million pounds in the third. CO considered the minimum quantities were ridiculously low, however, they agreed to the purchase schedule.

Length of new contract: The two sides agreed to a three$-$year contract renewal instead of suggested five years by CO$.$

Metering: J&R stated that the pipeline sending the product was leaking. If the new metering system could be installed they would feel infinitely more comfortable. Finally CO agreed to remeter the pipeline.

The remaining issues:

$(1)$Most favoured nation's clause. If CO negotiated with another purchaser a more favorable price for VCM than J&R was receiving now, CO would guarantee that J&R would receive that price as well. $(2)$Meet the competition. CO would willingly meet any lower price on VCM offered by a competitor, in order to maintain the J&R relationship.

$(3)$Right to resell the product. J&R wanted the contractual right to resell the product if it could not use the minimum amount. Requirement for the Negotiation

Organize your negotiation teams according to the roles in the case. Work out your negotiation plan, including each other's interests, negotiating power, the most wanted interests and interests you can make, concession, other options and best alternatives.