Friday, June 3, 2011

Agree on the Decision Principles Early

My family just bought a puppy.

My daughters are both crazy about dogs, something they may have inherited from me.  When Morgan, our youngest, was not quite two, my wife Trish ended the constant requests with a promise: we would get a dog when Morgan turned five.  Both girls accepted this and have been talking about it regularly ever since.

With Morgan's fifth birthday approaching we had to get serious.  Jade has a slight allergy and Trish's key interests were "not too big" and "no shedding".  After some research we decided that a mix of poodle and cocker spaniel (known as a cockapoo) was our ideal dog and we identified a good breeder within driving distance.  Trish and I went out to meet the breeder and then brought the girls to pick out their new puppy.

There were two dogs available when we went out.  Within minutes it was clear to me that one of them was the right choice.  He was energetic and affectionate and spent the whole visit going from person to person, getting attention, licking hands and then going to the next person.

It was also clear that we might have a problem on our hands.

The other puppy was very shy and quiet.  He didn't seem to want much attention and didn't go to any of us.  He was, however, born on March 11, which happens to be Jade's birthday.  Jade had picked him up and was holding him in her lap and was quietly falling in love with him.  I didn't think he was the right choice, but it looked like Jade might be heartbroken if we didn't pick him.

Then Jade gave a wistful smile and said, "I love this one.  But I think that one loves our whole family.  He's the one we should take home."

What happened?

For years we've been talking with the girls about getting a dog and we've told them over and over that the most important rule for getting a dog is to let the dog pick you.  At bedtime I would tell the story of how I got my first puppy because out of the whole litter he was the one who walked right over to me.  They both agreed on how we would pick out our dog long before we actually met any puppies.

As time got closer, Jade and Morgan began imagining their dog.  Morgan has a brown stuffed dog that she sleeps with and announced that she wanted a brown dog.  That worked for Jade, too.  Sometimes they wanted a boy and sometimes a girl.  Trish and I knew that the puppies we were going to see were both black males.  We went back to our rule and we also had the girls list everything they wanted in a puppy.  Once they had that list (which we made sure included "loves us" and "friendly and playful") we asked them which ones were really important.  They quickly agreed that color, sex and whatever else was secondary.  We would let the puppy pick us so that we got one who loves us and is friendly and playful.

Without that background I'm pretty sure Jade would have wanted the puppy who shared her birthday.  I'm sure it would also have been a fine dog, but I'm very glad Jade was committed to the idea that the puppy chooses us; it got us a fantastic dog, and without any heartbreak, tantrums or fights between the sisters.  (Morgan wanted the one we chose from the start.)

This story illustrates an important process step for negotiations.  It is often much easier to reach consensus on details of a negotiation if the parties first agree on the principles that will be used to decide.  The agreement should be as specific as possible; if, for example, you want to use a principle of fairness you should define what fairness means and get consensus.  If you don't you may find yourself disagreeing over what's fair, with each party honestly believing in a definition of fairness that favors them.

In this blog post I discussed the problem of fairness and discussed a negotiation simulation I did at Harvard.  Let's look at it in more detail here and see how important it was that we agreed on decision principles up front.  In the case two subsidiaries of an industrial conglomerate (probably based on General Electric) had to negotiate how to share a new magnet technology.  One subsidiary (mine, in the exercise) had developed the technology for its own use as a component in devices it manufactured.  It owned the product and could manufacture it for its own use but by the rules of the company only the other subsidiary (that produced industrial magnets) was allowed to sell it.  Since the market potential was much larger than the value of using it solely as a component, we needed to make a deal.

In addition to royalties (i.e. how much the magnet subsidiary would pay us) we had a huge range of options about exclusivity, both in terms of length and whether exclusivity was total, limited to other sister companies or limited to our product line.  It was clear that finding the "right" exclusivity terms was key to maximizing the value of the deal -- as we discussed here the key goal is to create the biggest pile of money possible, rather than to "win" exclusivity terms that were more favorable to us but which cost the other side more than we gained.

This exercise came at a point in the course where trust among the participants was high and where we all shared an understanding of the importance of value maximization.  As a result, both three-person teams in our simulation independently decided to suggest a "full disclosure" approach.  By fully sharing the relative cost/benefit of each of the possible exclusivity terms we would identify the best possible deal and then split the value.

Before we got started, however, I wanted to make sure we agreed on what defined the value of the deal, i.e. what exactly we would be dividing.

Let's use the "pile of money on a table" analogy.  Suppose that, by cooperating, you and another person are able to create a pile of $1,000 on a table to divide.  Is it fair to divide it evenly so each of you takes home $500?  What if the table started off with $300 of your money and $100 of the other person's money so that $600 was added?  If you split the whole pile you gain $200 (the difference between $500 and $300) and the other person gains $400.  If you split the money that was added you each gain $300 over where you started; you take $600 in total and the other person takes $400.

Before we began the analysis I said we thought that the value to be divided evenly should be the value created by the deal, rather than the total value of the deal.  (In the table example this is the $600 rather than the full $1,000.)  Thus, once we maximized the size of the pie we would subtract the value we each began the negotiation with (i.e. our BATNAs) to determine how much had been created.  Then we would structure the deal so that we each improved on our BATNA by half of the value.

After some discussion, mostly to clarify that everyone understood, the other team agreed to that principle.  With full disclosure of information we quickly figured out that the best deal was worth a total of $150 million.  Our BATNA (the value of producing the magnet solely as a component) was $50 million.  Their BATNA (do nothing, since we retained the product) was $0, so the value created by the deal was $100 million ($150 - $50 - $0).  They paid us a royalty that brought our total value to $100 million and theirs to $50 million so each of us was $50 million better off than our BATNA.  We all left happy.

Now let's imagine how things might have gone if we hadn't agreed on exactly what was being split.  We'd have arrived at the $150 million total value and someone from the magnet subsidiary would have said, "OK, so now we just work out the royalty we pay you so that each of us gets $75 million in value."  We reply that the deal only created $100 million in value so the correct split is $100 million to us and $50 million to them, since they came in with nothing and we came in with $50 million.

That discussion would be likely to produce two bad (for us) results: less money (unless we were very persuasive we would almost certainly have to meet in the middle) and frustration and lost trust on both sides.  Instead we got full value out of the deal and everyone involved felt they'd gotten a good deal.

It's important to note that this isn't just about everyone leaving the table happy or reducing the risk that negotiations break down and a value-creating deal is lost.  Taking the initiative on decision principles can be an important part of controlling how a negotiation is framed and thus capturing the most value possible.  I do think that the method we chose is "correct" but it was also favorable to us compared to splitting the entire value of the deal.

When we returned to compare results it quickly became apparent that many groups had looked at how to divide the value far differently than we had.  For some groups it seemed that "my" subsidiary had created $50 million and the other subsidiary was now creating $100 million more so they should get the larger share of the pie!  Most groups in fact reached a deal that gave more than half of the total value to the magnet subsidiary; our team got the highest score for our subsidiary, averaging perhaps $30 million more than our counterparts.

Thus, what seemed like a small detail was arguably the cornerstone of a very successful negotiation.  It streamlined agreement on the final details, avoided potentially costly and trust-eroding arguments and positioned us to capture far more value than we might otherwise have.

Obviously a real negotiation over $150 million would involve lawyers and contracts rather than a simple discussion and calculating and verifying deal values becomes very complex.  The fundamental point, however, remains valid.  It's much easier to reach agreement if all parties have a shared understanding of the decision principles when negotiations start...whether you're negotiating a business deal or picking out a puppy.  And thinking about those principles ahead of time so you can shape them can be instrumental in getting the result you want.


  1. Thanks for this. I come to your blog via BGG, but negotiation is a large part of my non-gaming day, and I find your insights and anecdotes enlightening and helpful.

  2. Glad to hear it! If there are any particular topics you'd like to see covered, please let me know.

  3. Hmm. Were you making sure that the selection criteria favored "friendly and playful" over "shy and quiet" because that was your own personal preference, or because you thought you knew that was what your children would want even if they didn't know it, or simply because you wanted to have some predetermined criteria to make the decision easier?

  4. I don't understand the magnet example. Why does it make any difference at all how much one subsidiary pays the other subsidiary? Are they both wholly owned by the parent company? It seems completely irrelevant, so why even bother to negotiate it and why would you as a participant care about getting a higher royalty payment rather than a lower payment? It seems like the kind of thing that in practice would be determined by tax considerations.

  5. Hi David,

    Sorry, I missed your comments until just now. On the puppy, it's a bit of both. I think the girls (and the family in general) will be happier with a playful and outgoing puppy and choosing that way avoids the risk that a seemingly-shy puppy is actually timid/scared because of something that happened to it.

    In the magnet example, many conglomerates are managed such that division CEOs are expected to maximize divisional profits (and divisional profits substantially determine their bonus). The assumption, right or wrong, is that losses due to local optimization are more than offset by benefits of that approach. Thus, for the purposes of the negotiation, what each party cared about was the profit that accrued to their division rather than the total earned by the consolidated entity.