Reference no: EM133219796

Case Study - Stuck in the middle

Otis Henderson is the owner of Perfect Products Ltd (PPL), a manufacturing firm that specialises in sports goods. He recently landed a large contract to produce branded goods for a well-known sports firm. It is a huge contract worth HK$10 million per annum for a minimum of five years. It is highly specialised work for which Otis's firm is a market leader.

The problem has been that some of the equipment that Otis installed specially to deal with the order has not been working properly. As a result some 20% of the goods sent to his client have been returned as 'significantly failing their quality standards'. The client's Purchasing Director, Jose, has requested a meeting with Otis next week at their Head Office to ask him to explain what he is doing to improve the situation. He has also sent a notice to Otis, reminding him that the contract states that the quality of the products must not dip below 95%, and that if it does there are penalties to pay. Jose and his team are keen to make sure their brand is protected as lesser quality goods would reflect badly on their company brand. They are well known for strict enforcement of the quality assurance clause in their contracts.

Otis has had his accountancy team on the case and they have confirmed that currently the damages to pay for an 80% delivery rate are HK$1 million. It is a huge amount of money that would render the project financially impossible. He would almost be better off cancelling the contract - with a cancellation charge of $HK1.2 million.

For his own part, he is aware that the machinery in question is also in breach of performance contract, and he is trying to negotiate with the supplier to give him compensation for all the problems he has had with it. A new one is being installed in its place next week, completely free of charge, and Otis is confident that he can get back on track to near-perfect product lines once it is in place. He is hoping to get a compensation deal of HK$500,000, and has an in-principle agreement from his supplier for that amount to be confirmed once the new machine is installed and working, but that wouldn't touch the million being asked by his client.

The huge investment made to get the new contract has left Otis with little or no capital of his own that he could use, so his only option is to hope that he can negotiate the compensation down to under HK$500,000. Jose is known to be a tough negotiator, and is not averse to using tactics such as shouting abusively in the meeting until the other side gives in and concedes to his demands. He is not known to show any sympathy for his suppliers and demands nothing but the highest performance from them at all times. No excuses.

1. What are the Interests for Jose and Otis in this case?

2. Show the compensation issue for Otis and Jose as a Distributive Bargain.

3. Why could Tradables help Otis to negotiate the compensation with Jose?

4. Give an example of a Proposal Otis could offer to Jose, to resolve this problem.

5. If we imagine Jose's exit price is HK$300,000 and the compensation is agreed as HK$450,000, what would be the buyer's and seller's surplus in this case?