Thursday, June 16, 2011

A "Hidden" Source of Value Creation, Part 2

In my last post we challenged the theoretical assumption that single-issue negotiations necessarily involve a fixed pie, such that the negotiator's only task is to claim as much value as possible.  After looking at examples of price negotiations where a highly "successful" value claim led to disaster and giving away more than was necessary led to a great result we reached the conclusion that in many negotiations the value we receive depends on how the other party views the resulting deal.

Ultimately this is because relationships are much broader than contracts or agreements.  People who are happy with an arrangement and who believe they have been treated honestly and fairly will generally outperform in their promised duties than people who are indifferent or unhappy or who believe they were treated poorly.

Today I want to look at the practical side of this.  How do we negotiate so as to benefit from satisfied counterparts without overpaying?

Step one: Evaluate the importance of their satisfaction

We already discussed a simple asset sale with no follow-up business, such as a typical house purchase.  In those cases you're pretty close to zero-sum, although even then there are reputation considerations.  Act ethically and within the law, but otherwise you want to pay as little (or sell for as much) as possible.

At the other extreme are negotiations with family and coworkers where your relationship is more important than any single issue you're likely to negotiate.  Someone once wrote that if you ever win an argument with your spouse you should apologize immediately; this is not a relationship where you want to defeat the other person (unless you're both game players).  Not only do you want a healthy relationship for very pragmatic reasons but you also (hopefully!) care a great deal about their happiness for its own sake.

Most negotiations fall somewhere on the continuum between these extremes and you can get a pretty good sense of where a particular one lies by asking yourself some questions, like:

  • How might the other party behave differently in the future if they are happy or unhappy about this deal and/or our relationship?
  • Do I expect to do business with them again?  If so, how will this deal affect prospects for future collaboration?
  • Is the other party likely to be an important source of word-of-mouth?  How is my reputation going to be affected by their perception of our negotiation?
  • How important are all these factors?  Remember the example of my lead creative agency for a EUR60 million marketing budget.  With all the constraints we faced, shaving $100K off their fee wasn't nearly as important as being one of their favorite clients.  A similar improvement in the speed and reliability of office supply delivery might not be nearly so valuable.
Once you have an idea of the benefits of happy counterparts you're ready to plan your negotiation accordingly.

Step two: Plan to make them happy

Just as you plan and prepare carefully for other aspects of a negotiation, you should think about what is likely to make your counterparts happy with the deal -- both at closing and over the course of the relationship.

It's tempting to see this in terms of simple generosity, i.e. letting them have a larger piece of the pie than you could get away with, but this is at best an oversimplification and in some cases counterproductive.

First of all, process is often at least as important as outcomes.  If you listen carefully, take the other party's interests into account, treat them honestly and work collaboratively towards value creation (all things you should do even if you didn't care about their satisfaction!) you're a long way towards them feeling good.

It's also not always the case that more money leads to more satisfaction.  Consider a negotiation in which you're selling a business you helped found to a larger company in your industry.  Your reservation price is $3.5 million and based on your research you estimate their reservation price as $5 million.  Having read this blog post you decide to keep the whole ZOPA in play with an opening offer of $5.2 million.

The negotiators for the buyers blanch and explain that that's really too high a price.  They counter with $4.1 million and you're glad to see that they're already above your reservation price.  After some more discussion you shake hands on a price of $4.6 million.  You've gained $1.1 million in value and you suspect that you've captured more than half of the value in the ZOPA.  You're feeling good.

Now imagine that instead they did a double-take at your opening offer and said, "Five point two million?  Done!"  Then, beaming, they stand up to shake hands and say they'll have the contract delivered to you in the morning.

You're better off in scenario two, but most of us are likely to feel better in scenario one because clearly in scenario two we sold for less than we had to.  By the same token, you can often negotiate hard and claim most of the value and shake hands with a satisfied counterpart.

An anecdote from my recent HBS negotiations class illustrates this point well as two important pitfalls.  Our first negotiation simulation involved a book deal, with one person playing the role of the author's agent and the other a senior editor of an interested publisher.  In studying the case I correctly guessed that the initial interest the author had received from other publishers had fallen away and that the author's agent was in a weak position.  Most likely he only had to secure a large enough advance to make his client feel the project was worthwhile.  Thus, even though we were very eager to get the book deal and I was authorized to make an advance of up to $350,000 I opened with a very aggressive offer of $37,000, just over 10% of what I was actually willing to pay.  The agent countered with an offer of $100,000 and we ended up settling on an advance of $75,000 which was $25,000 above his reservation price and $275,000 below mine.

As class resumed, Prof. Bazerman asked for a show of hands as to who felt they got a good deal?  Nearly every hand went up, including my counterpart's.  I'd captured almost all of the value on the table but from his perspective things had gone quite well.  He'd fought off an unacceptable opening offer and secured 50% more than what his client was willing to accept.

And now the pitfalls.  Once the results went up and it became clear not only that I'd been willing to pay almost ten times my opening offer but that most other pairs had settled on a price closer to $300K, my counterpart naturally felt less good about the result.  Had ours been an real-world negotiation that might easily have translated into bad blood.  (Whether the cost of that would have outweighed the money saved is a business judgment you'll have to make in each case.)

Your counterpart may not know your reservation price during the negotiation, but it's important to ask what information he or she is likely to gain later.  In the 1930s, the Institute for Advanced Studies recruited Albert Einstein to come work with them in Princeton, NJ.  When asked how much salary he would require, Einstein answered $3,000 "unless you think I can get by with less."  The IAS "countered" with an offer of $15,000.

This wasn't necessarily generosity on the part of the IAS!  They simply recognized that Einstein had no knowledge of the salary he and his peers commanded in that context but that he would certainly learn it over time.  Better to start him off with an appropriate salary and build trust in the relationship than to save a few thousand dollars and erode that trust or lose the relationship altogether.

Pitfall number two could have come into play if I'd badly underestimated his reservation price.  What if his client had told him only to make a deal at $250,000?  That would imply a ZOPA of $250K to $350K and $100,000 of value to be had...but it would be a lot harder to reach a deal in that ZOPA without my counterpart concluding that I'd blatantly lowballed him.

What counts as a successful deal varies tremendously based on the nature of the negotiation.  If you're negotiation a service contract from a vendor with essentially one offering it may be enough to be slightly more profitable than their normal contract.  If you're negotiating with your spouse it may be that the only thing that ultimately matters is listening well and showing care and respect.  As with so many other aspects of negotiation, put yourselves in their position and think about what would make you happy.

Step three: Explore and ask

You've done your homework and you've identified a good path to your counterpart's satisfaction.  Just as you ask questions to test other assumptions you should test this one as well.  Ask them to tell you, without giving away specifics, what metrics they use to evaluate the success of a deal?  Not only will this help you ensure that they're happy with the end result, it can be a useful part of learning their priorities for more traditional value-creating tradeoffs.

Finally, in cases where you're explicitly looking to give your counterpart a larger-than-necessary share of the pie because of the value you expect to get back as a result it can be worth saying so.  After settling on price with the partner at Mother, I had a quiet conversation with him about the upcoming year's work.  I explained that I was glad he was happy with the price we'd agreed and that I'd set out to make sure our contract offered his agency a good margin, but that in return I was counting on them delivering things that a contract couldn't cover -- the sorts of intangibles that a "best client" gets.  Too few people are as straightforward in their dealings (especially when they are doing something unusual, like looking out for their counterpart's interests as an end in and of itself), and I find it's rewarding far more often than not.

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