[This is a summary of one topic within a white paper prepared for a client. With their permission it has been summarised and reproduced here.]
When negotiating with a vendor to take on their product (either a one-off payment or a recurrent charge) there is a bigger picture concern that is often missed. Let's construct an example and work forwards...
A vendor provides a product to your trading desk users, let's say you have six potential users. The vendor proposes a pricing model that looks like this:
Flat charge = $x/month
Per user charge = $y/user/month
Per feature fee = $z/feature/user/month
Data storage fee = $a/GB/month
Market data = Vendor-of-record model pass-through of exchange fees plus management charge per exchange
Very quickly it's possible to disappear down the (white) rabbit-hole of looking at each of these fees and trying to establish a "fair" price.
We propose a different model:
Split the charges into:
those that involve external payment - so market data and data storage in this example
those that are internal only - such as a per user charge
Establish what value you believe the system brings to your trading desk.
Identify what, if anything, the vendor has that is unique and valuable
Extraction Cost (your option)
If a decision is made to rip-and-replace the vendor product what would that cost?
Extraction Cost (vendor option)
If the vendor decided to stop supporting the product what would that cost?
If you want on-site help, that costs more than local help which in turn costs more than nearshore or offshore.
Vendor Size Consideration
What percentage of overall vendor revenue and profit is supplied by your firm?
Relative Size Consideration
What is the relative size of your firm and the vendor?
Use these metrics as the input into a different question:
What is the value of this relationship?
And the answer to that question is how much you should be paying...