The Infrastructure of Negotiation
All negotiations are exchanges, but not all exchanges are negotiations. Exchanges and negotiations allow you to trade your current status, position, or solution for a new one. In an exchange, you swap your current status quo for a new one that you prefer, but neither party tries to alter the preset terms of the exchange. For example, in a typical exchange, the seller sets the price and the buyer agrees. In contrast, one party may make a first offer, which is only a starting point in a negotiation. Moreover, while you may simply accept the offer—in which case we would consider it an exchange—you may reject it by making a counteroffer, thus starting the negotiation.
In most exchanges, value is created for both you and your counterpart. (The exceptions are involuntary, coercive exchanges, such as a robbery—something we will not address in this book!) For example, you buy a loaf of bread for $5; this purchase creates value since you care more about the bread than you do about the $5, while the baker values the $5 more than the bread. Thus, value is created because you each received something that you value more in exchange for something that you value less.
To establish how much value is created in an exchange, we need to know each party’s reservation price; that is, the most the buyer is willing to pay and the least the seller is willing to accept. For example, assume that you value the bread at $6.50 (that is, you would be just indifferent between paying $6.50 for the loaf of bread and keeping your money). Similarly, the baker is unwilling to sell the bread for less than $2.50. An exchange would then create $4.00 of value, $1.50 to you ($6.50 − $5.00) and $2.50 ($5.00 − $2.50) to the baker.
Now add a negotiation component to this exchange. The baker has set a price of $5. You want the bread, but believe you could do better, hoping to get it for $2—your aspiration price—and so you counter the baker’s offer at $2. If a deal is eventually struck, the agreement will be somewhere between the baker’s offer of $5 and your counteroffer of $2. Suppose the baker reduces her price to $3. Relative to the original exchange, no additional value was created in this negotiation, but you claimed an additional $2 in value that the baker lost when she agreed to reduce her price. This is value claiming. Your negotiating resulted in your getting the bread for $3 rather than for the initial offer of $5.
Of course, all of this is based on an important assumption—you and the baker value dollars equally. What if you and the baker do not value dollars equally? Assume she values each dollar more than you—maybe you derive pleasure from the experience of eating fresh-baked bread, while the baker is concerned that her start-up bakery be a success. If she values dollars more than you, more value is created for the exchange at the higher the price. Going from a price of $3 to a price of $5 is worth more to the baker than the cost to you of paying the additional $2. Yet because there is only a single issue—the cost of the bread—there is no incentive for you to pay more, even though you value the incremental dollars less than the baker.
This situation would change if there were an additional issue that were valuable to you and that the baker could accommodate. Perhaps it is the fresh-baked aspect. If you were willing to pay $3 for a loaf of bread, what would you be willing to pay for a loaf of bread that just came out of the oven? If the baker valued dollars more than you and you valued the aroma and taste of just-out-of-the-oven bread more than it cost her to customize your bread, then you could offer to pay more—say, $5—if she were willing to bake a loaf of bread for you right now. In this case, she would get what she valued more: the dollars; and you would get what you valued more: the experience of eating fresh-baked bread. This is value creation through negotiation. The benefit of the fresh-baked bread is worth more to you than the additional $2 you agreed to pay for it. For the baker, the cost of custom baking the bread is less than the $2 she gets for her just-out-of-the-oven bread. You and the baker each got what you value more: she—the dollars; you—the freshly baked bread.
To move from the value created by an exchange to realizing the value that can be created within a negotiation requires you to interact thoughtfully and strategically with your negotiation partners. One way to claim more value is to create more value within the negotiation; by creating more value, you may be able to claim more. But be careful. One does not guarantee the other. In fact, if you were not thoughtful, you might claim less even when more value is created because the information you reveal when creating value can make it easier for your counterpart to claim more. Your counterparts can use this additional information to their advantage (see Chapter 4).
How much value is created or claimed depends on the negotiation. What you want is a good deal, one that not only meets your goal but is also better than your alternatives, exceeds your reservation price, and is as close to your aspiration as you can get. In the next section, we consider a systematic approach to establishing what you want to achieve; then, we will determine the contribution of each of these parameters to your overall success in a negotiation.
IDENTIFY YOUR GOAL
Negotiators can have different goals, even multiple goals. For example, when you negotiate the purchase of a new car, you typically focus on paying as low a price as possible. In other negotiations, your goal may be to beat your counterpart or to reach an agreement as quickly as possible. In yet other negotiations, you may want to improve your relationship with your counterparts even if that comes at some cost to your short-term interests.
It may seem obvious that negotiators should have their goals clearly in mind before commencing a negotiation, but many don’t abide by this most basic rule. Many negotiators start the process before identifying precisely what they wish to achieve, much less how to achieve it. Moreover, unless you have a very clear understanding of what the goal is, you run the danger of becoming confused in the excitement of the negotiation. Indeed, negotiators often lose sight of their original goal and either focus only on getting more than their counterpart or resort to a quick agreement to avoid an uncomfortable situation.
As mentioned in the preface, negotiators have an affinity for reaching agreements, yet agreements do not always equal success.1 Indeed, a successful negotiation is one in which you get more of what you want—not one in which you just arrive at an agreement. If your assessment of a good deal shifts to one where you simply reach an agreement with your counterpart, you have not only redefined success, but also put yourself in a position where you may end up with less of what you want. Once your counterpart recognizes that you merely want to reach an agreement, he will have a great advantage, primarily because it will allow him to claim a larger amount of any surplus created in exchange for your highly valued outcome: an agreement. We strongly advise you to guard against such a shift during the negotiation.
To avoid losing sight of your original goal and simply negotiating to reach an agreement, you need to know what a good deal is—and what it is not. This means that you must understand and value the issues that you consider important. You must establish your reservation prices and your aspiration. And you must do so in a manner that keeps you from losing focus on those goals, reservation prices, and aspirations.
ESTABLISH THE PARAMETERS OF YOUR NEGOTIATION
To begin to define the parameters of the negotiation, you need to determine the worst possible outcome you are willing to accept. This is your reservation price. It is the point where you are indifferent between saying yes and taking your alternative. Obviously, to determine where that tipping point is, you must also assess your alternatives; what will happen if this negotiation ends in an impasse.
The most obvious (and common) alternative is the status quo—what your situation was like before you started the negotiation. However, your alternatives can also be other deals with other negotiators. Collectively, your alternatives represent your safety net, or what you will get if you walk away from the present negotiation, and rationally, you should not agree to an outcome that is worth less than your alternatives.
Obviously, the better your alternatives, the more willing you will be to walk away from the negotiation and hence the more—on average—you will be able to claim if agreement is reached. Therefore, one of your most immediate sources of power is the value of your alternatives. In essence, alternatives force your counterpart to “pay” you at least the value of your alternatives to stay in the negotiation. Thus, the single most important aspect of your preparation before entering into any negotiation is to establish your alternative: What are your options if no agreement is reached?
Of course, your counterpart will also have alternatives that empower her to walk away, potentially forcing you to “pay” her to stay in the negotiation. Indeed, research shows that the negotiator with the better alternative—on average—claims more of the value in the negotiation.2
Recall the case of Margaret and Thomas’s reaction to their first academic job offers, discussed in Chapter 1: Thomas had nine offers, while Margaret had only one. Clearly Thomas was in a much more powerful position because of his alternatives! Indeed, he used his power to negotiate while Margaret signed her offer letter as quickly as possible.
THE POWER OF ALTERNATIVES
A good alternative (or alternatives) can dramatically alter your behavior in a negotiation. Consider the following:
In 2000, BusinessWeek released its semiannual survey of MBA programs, ranking Stanford’s Graduate School of Business a shockingly low eleventh, an all-time low. This surprisingly low ranking stemmed from recruiters rating Stanford’s MBAs very poorly, citing their arrogance in interviews. Allegedly, when Stanford MBAs actually showed up for interviews, they would often come dressed casually, more appropriate for a game of golf than a job interview. Two years later, Stanford’s GSB was ranked fourth overall. What accounted for this meteoric rise?
When asked that very question, the dean indicated that in the ensuing two years, he had instituted career management classes focused on conveying the importance of each student representing Stanford. Superficially, the classes seemed to work, as recruiters rated Stanford’s MBAs dramatically higher in 2002.
Consider another explanation. In 2000, dotcom mania gripped Silicon Valley, with the average Stanford MBA receiving more than six job offers. The class of 2002 was not nearly so lucky; with the economy in a tailspin, the average MBA received less than one job offer. It seems possible that the difference arose not from these career management classes, but rather from the number and quality of their alternatives; with worse alternatives, the students had less leverage in their interviews, which likely caused them to present themselves more respectfully. You decide!
The quality of your alternatives also has an impact on how you behave and how you are perceived by your counterpart. Good alternatives change the intensity of your negotiating behavior. Negotiators with great alternatives often come across as aggressive and competitive, while negotiators with poor alternatives come across as cooperative, warm, and friendly.3 Thus, analyzing your counterparts’ behavior can help you triangulate their alternatives. For example, if your counterpart behaves more aggressively than you expect, that may indicate that his alternatives are better than you had thought.
Alternatives can also change people’s behavior even when they are irrelevant to the situation at hand. Think about how a good-cop/bad-cop strategy works. Because people assess value through comparisons, the good cop makes the bad cop seem worse, and the bad cop makes the good cop’s offers seem more attractive. However, there is a third alternative: don’t take either offer. Therefore, from a rational perspective, the offer by the bad cop is whatever it is, and its value is not dependent on the offer of the good cop and vice versa.4
Once you have identified your alternatives, you can set your reservation price. The reservation price is the highest price a rational buyer will pay, or the lowest price a rational seller will accept. It is your true bottom line. At the reservation price, you are indifferent between your accepting counterpart’s offer or walking away and accepting your alternative; the better your alternatives, the more extreme your reservation price.
Naturally, the lower bound of sellers’ reservation prices is set by their alternatives, while the upper bound of buyers’ reservation prices is set by theirs. However, some sellers lower their reservation prices (or buyers raise theirs) as the negotiation drags on, because they factor in the effort that has already gone into the negotiation. This is a mistake known as a sunk-cost fallacy. Alternatives do not change because a negotiation is taking longer than expected, so reservation prices should not change either.
Reservation prices represent the last bastion, your resistance to the siren call of agreement. So think of your reservation price as a red line—a standard that you have the discipline not to violate. Imagine that you are considering purchasing a theater ticket from a scalper. You have considered your alternatives and decided that you are willing to pay no more than $30 for the ticket, but the scalper wants $60. After some haggling, the scalper has come down to $31 dollars: $1 more than your reservation price. You believe that this is the lowest that he will accept for the tickets. How should you respond?
Most people will accept his offer, violating their reservation price. To do so, they create excuses as to why the $31 ticket was actually a good deal, despite violating their reservation price of $30. “I got him to concede $29 dollars on his initial ticket price,” for example, or “just a dollar more than what I was willing to pay, and my time is worth at least that much, and I have heard this is really a great show …” These are not explanations; these are excuses. You already knew the value of your time before you started the interaction, and you also knew how good the show was. And by that logic, you should be willing to pay even more had the scalper first demanded $90 dollars for the ticket. You learned nothing new after setting your reservation price; you merely violated the boundary of your reservation price so that you could say yes.
But are you really going to walk away for only one dollar? From a psychological perspective, it seems silly. What is one dollar, more or less? After all, you surely value the time you spent negotiating at more than one dollar. If you have an alternative from which you could extract as much pleasure as the play and which costs exactly $30, then the reservation price of $30 could have some real sticking power.
Yet it’s not merely a question of the dollar. Violating your reservation price creates a slippery slope. If you were willing to accept $31, you should also be willing to accept $32 (only one more dollar), $33 … $35. And if you accept $35, you are likely to accept $40. Where is the point at which you would walk away? Perhaps that point is $60, the original asking price of the ticket. But then, why bother negotiating at all?
This is a question of discipline: If you accurately set your reservation price at $30, then you should say no to the offer of $31. Of course, it’s possible that your reservation price was not accurate, that $30 was an underestimation of your reservation price, or that you failed to assess your alternatives. But if not—if you learned nothing new in the course of the negotiation that you could not have known prior to the negotiation—then your reservation price should not change. Your reservation price is a standard against which you judge the lower bounds of the acceptability of a proposal; it is not something you modify to justify accepting a proposal.5
Note that we are not suggesting that you never adjust your reservation price. If, in the course of the negotiation, you discover something that you could not have known when you calculated your reservation price, then there is room for revision. However, exercise caution when you consider revising; be sure to do so only because of new information, and not simply as a way to justify getting an agreement.
The closer you get to the reservation price, the harder it becomes to resist the powerful allure of “yes.” But resist. Having the discipline to honor your reservation price is one of the best ways to insure that the deals you accept meet or exceed your status quo.
Your alternatives and your reservation price are important parameters for any negotiation, but if you focus only on them, you will systematically underperform in your negotiations. Rather than setting your sights on at least meeting your alternatives (your safety net) or using your bottom line as a standard for what is good enough, consider setting your expectations at a higher level. Because expectations drive behavior (see Chapter 1), you need to define them clearly at the outset of each and every negotiation.
Your aspiration is an optimistic assessment of what you could achieve in a given negotiation. And because aspirations are optimistic, they inevitably enhance your expectations for—and, as a result, enhance the outcome of—the negotiation.
Setting and focusing on your aspirations represents an often overlooked advantage in negotiation. Aspirations provide psychological leverage that makes you focus on the potential upside of a negotiation, rather than on your downside protection (your alternative) or your bottom line (your reservation price). This increases the likelihood that you will achieve better results. Indeed, research shows that the more challenging your aspirations, the better you will perform.6 Even if you do not meet your aspirations, they will motivate you to perform better than if you had set more modest goals.
Your aspirations should be set independently of your alternatives. Alternatives offer a safety net and shouldn’t get mixed up with your goals for a negotiation, but many negotiators treat them as a standard of performance.7 Negotiators with poor alternatives often set their expectations lower, causing them to accept less. This result goes hand in hand with the general notion that better alternatives produce better outcomes, and worse alternatives produce worse outcomes.
In fact, your aspiration is the antidote to your natural focus on your alternative. Just because you may have poor alternatives does not mean that you should be pessimistic in setting your aspiration. Be mindful that the quality of your alternative plays a powerful role in enhancing or diminishing your performance, independent of your actual negotiation skill.8
Focusing on aspirations can make you a better negotiator, but it won’t necessarily make you happier with the outcome of your negotiation. Consider a study in which researchers encouraged some participants to focus on their aspirations in the negotiation, while encouraging others to focus on their alternatives.9 Once the participants completed the negotiation, the researchers assessed both their performance and their satisfaction with those outcomes. As you may have predicted by now, those who focused on their aspirations achieved better outcomes than those who focused on their alternatives. However, the aspiration group was less satisfied with their objectively superior outcomes. (See Figure 2.1.) Counterintuitively, you tend to get more but are less satisfied if you focus on your aspirations, but you feel more satisfied with a worse outcome if you focused on your alternatives. The alternative-focused negotiators got less, but they exceeded their alternatives, which satisfied them. By focusing on their alternatives, that alternative became the goal, the mark to beat. By contrast, the aspiration-focused negotiators got more, but less than they aspired to, which frustrated them.
FIGURE 2.1 ASPIRATIONS VERSUS ALTERNATIVES
This is the dark side of aspirations. Specifically, while optimistic aspirations lead to better negotiation outcomes, you will be less satisfied with your objectively better outcome. Consider the following example:
For decades, the World Value Survey identified the Danes as the happiest people in the world. Over the last thirty years, more than 67 percent of Danes have reported feeling very satisfied with their lives. What is the secret of this happiness, a secret they evidently have not shared with their Scandinavian neighbors? It appears to be low expectations.
Negotiators often act like Danes, who seem to set their expectations low about everything, including their happiness—and, as a result, feel content with their lives. Negotiators tend to focus on their alternatives, and when they exceed them, it makes them much happier than they would have been if they’d focused on their aspirations and failed to achieve them.
So focusing on alternatives means sacrificing performance for good feelings. This suggests that your subjective measure of getting a good deal is whether or not you’ve exceeded your alternative. Paradoxically, having lower goals and subsequently lower performance gives you greater satisfaction.
To cope with this paradox, you must determine before any negotiation whether your goal is performance or satisfaction. If you prefer satisfaction, you should focus on your alternatives, but if the overall value of your outcome is a more important measure, you should focus on your aspirations (while knowing full well that you will likely be less satisfied with the outcome). You will not likely achieve your aspiration, but having high aspirations makes it more likely that you will get a better outcome. Additionally, if your goal is getting more, you should determine your alternatives and your reservation price, and then put it aside and instead use your aspiration as the standard to anchor your assessment of your performance. During the negotiation, you should focus exclusively on your aspiration price. Only after you have negotiated the best deal possible, and just before agreeing to it, you should compare the value of your alternative and your reservation price, and accept the deal only if it meets or exceeds both of these parameters.
Once you have established your reservation and aspiration prices, the next step is to figure out how to achieve a deal that will approach your aspirations. Where are the opportunities for you to claim value? For that, you need to think about the structure of the issues over which you could be negotiating.
TYPES OF ISSUES IN NEGOTIATIONS
Issues can be classified into three types: congruent, distributive, and integrative. Congruent issues are those over which the parties have no dispute. For example, in an employment negotiation, both the candidate and recruiter may favor the candidate joining the same division. Similarly, the buyer and the seller may prefer an early delivery.
Some issues—price, for example—are not likely to be congruent. Although there may be issues about which the negotiating parties are in agreement, the parties may be unaware that they each prefer the same outcome. Identifying the congruent issues should therefore be one of the goals of the information exchange.
Identifying congruent issues can provide you with a strategic advantage if you know which issues are congruent but your counterpart does not. For example, the knowledgeable negotiator can benefit by offering to “concede” on the congruent issue in exchange for preferable terms on another noncongruent issue.
Distributive issues are those where the two parties have opposing preferences, often valued with equal intensity. That is, parties value each unit of the issue (for example, price paid, or days of delivery time) equally. Price is the most typical example of a distributive issue; the buyer prefers to pay less, while the seller prefers to receive more, and each incremental dollar benefits one party by the same amount as it hurts the other.
Most people think of negotiations almost entirely in terms of distributive issues, which is why negotiations are often characterized as battles to determine who gets what out of a fixed pool of resources.
Integrative issues are those where the parties have opposing but asymmetric values. All integrative issues have these two essential characteristics: first, the parties have opposing preferences; and second, the benefits and costs are not equal. For example, the benefits for the party that prefers more of the issue do not equal the costs to the party that prefers less of the issue. For instance, the number of vacation days offered in an employment negotiation could represent an integrative issue. The candidate likely prefers more vacation days, and the employer would prefer to offer fewer (hence opposing preferences), but the candidate may value each incremental vacation day more than the company wishes to avoid them. Such an issue offers an opportunity to create value by trading concessions on vacations days for an issue that the employer values more.
Trading integrative issues can make both parties better off. The exchange of information in a negotiation should therefore help identify integrative issues and assess their differential valuations so as to create value. Therefore, it is not only important to identify which issues are integrative but also to discover how the preferences differ in intensity; this will provide you with a strategic advantage (see Chapter 6).
Let’s consider a real-world example in which each of these types of issues plays a role in setting up a negotiation.
SNOOP INC.
The sole proprietor of a business asked Thomas to serve as her advisor in valuing the company and devising the strategic approach to negotiating its sale. The value of its primary service of providing hiring organizations with background checks of potential employees had grown with the increased security concerns in the wake of September 11. With the vast majority of her personal net worth tied up in the company, the owner hoped to divest her stake to diversify her assets and to provide her with sufficient liquidity to pursue other opportunities.
After discussing the company with the owner in detail, Thomas identified three issues to serve as the basis for the negotiation: price, risk, and the owner’s future involvement. It became clear that each issue featured a high level of complexity. For example, the issue of selling price had two components: cash upon closing (dollars today) and an ongoing equity stake in the business (dollars in the future). Thus, these two issues not only differed in the timing of the amount to be paid/received but also in the risk (the first being certain, the latter uncertain). Second, her future involvement in the company was not a binary decision, but could fall anywhere along a continuum from the CEO’s walking away the day after the sale to a much longer, more involved transition plan. In between those two options lay countless variations, where the selling CEO might stay on for a predetermined time as a consultant.
This example reveals an interesting overlap between distributive and integrative issues. While the selling price would likely be a distributive issue—the seller values getting more money for the company and the buyer values paying less—the exact nature of the payment could be integrative. That is, while the owner wanted to receive more of the total selling price in cash up front to reduce her risk and allow her to diversify her holdings, she also valued future cash payments, albeit less than dollars up front. The buyer, on the other hand, valued future payment more than current payments because it tied the owner to the business, allowing the buyer to benefit from her expertise. In addition, shifting payments to the future and making them contingent on the subsequent performance of the business (a so-called earn-out) shifted some of the valuation risk to the owner who knew better what the business was actually worth. Because buyer and seller did not value the earn-out equally, it was an integrative issue.
The owner’s desire for an ongoing involvement in the business was clearly a congruent issue; both parties wanted her to remain involved. However, they differed in their preferred length and extent of her involvement. From the owner’s perspective, if she remained too involved, she would not make much progress toward her long-term life-style goals. She was willing to remain highly involved immediately after the sale, but she wanted to disengage gradually from day-to-day operations within two years. The buyer preferred a longer, more consistent involvement—a logical preference, given all the expertise the owner had gained building the company from the ground up.
Once he had identified these issues, Thomas tried to understand each one from both the owner’s and the buyer’s perspective. The owner’s alternative in this negotiation was straightforward: Because there was no alternative buyer on the horizon, the owner’s alternative was the status quo, in which she could continue to own and operate the company. Using the existing business plan, Thomas valued Snoop Inc. at approximately $230 million from the perspective of a well-diversified investor. However, the owner had virtually her entire wealth tied up in the business (her only other major asset was her private residence). Thus, changes of the value of Snoop would have a very large impact on her well-being. To take this very high specific risk into account, Thomas increased the discount rate accordingly, which resulted in a lower value of Snoop Inc. to the owner. This adjustment resulted in a reduction in the value of the firm to $150 million. That is, while Thomas estimated that Snoop Inc. was worth $230 million to a well-diversified investor, in his assessment, taking the fact that virtually all of the owner’s wealth was concentrated in Snoop Inc., the owner should be indifferent between keeping Snoop Inc. (high risk) or $150 million (low risk), which was Thomas’s assessment of the owner’s reservation price.
Next, Thomas established the owner’s aspirations. Based on discussions with the owner, he estimated that combining Snoop Inc. with the buyer’s existing business could generate synergies of approximately 40 percent or $92 million, resulting in a corporate value of $322 million ($230 million + $92 million). The owner hoped to capture 60 percent of those synergies or $55.2 million. Thus, the owner’s aspiration price was $285.2 million ($230 million + $55.2 million).
The CEO was pleased with the work that Thomas had done—but despite their careful planning, other factors disrupted what might well have been a productive negotiation for both parties. The initial meetings were scheduled to begin in November 2008, just weeks after the Lehman Brothers bankruptcy filing, when capital markets froze, mergers-and-acquisitions activity plummeted, and almost unprecedented economic uncertainty cast a chill over the whole economy. The subsequent tightening of the credit markets prevented the buyer from successfully arranging the financing necessary to complete the transaction. The last time we checked, the CEO was still running the company, waiting for another suitor to appear.
SUMMARY
As negotiators, you must consider the unique aspects of your negotiations while recognizing that most negotiations have considerable commonalities. First and foremost, you must clarify your goals. Do you want to extract as much value as possible, or consummate a deal quickly to minimize risk and transaction costs? Would you prefer to enhance the relationship between you and your counterpart, or do you want to feel victorious?
With your goals defined, you must then identify the characteristics of a good deal:
• You need to know when to say yes, and when to say no; that is, you must know your alternatives. Consider the other options, partners, and opportunities you have.
• Once you understand those alternatives—and ideally, those of your counterpart—you must establish your reservation price or bottom line, the point at which you feel indifferent between taking the deal and walking away to take your alternative.
• You must also determine an optimistic assessment of your outcome: your aspirations. This should be significantly better than your reservation prices, sufficiently extreme as to challenge you to achieve more.
• Once you have identified your alternatives, reservation prices, and aspirations, you must understand the issues in the negotiation and their underlying structures; are they distributive, integrative, or congruent?
Later, in Chapter 5, we will walk you through a process that helps classify these types of issues in your negotiations. In the next chapter, however, we consider the value created by a negotiated exchange in which the issues are distributive: a situation that many people think of when they hear the word “negotiation.”