Monday, August 8, 2011

Your Bad BATNA is Your Own Fault

Everyone, even professional negotiators, sometimes find themselves forced to negotiate with a bad BATNA.  In another post I looked at some of the ways you can still negotiate effectively with a bad BATNA but today I want to focus on the fact that our BATNAs, good and bad, are generally self-created. I'll go through some examples and then talk about how you can develop good BATNAs long before you even know you're going to be negotiating.

Walking the Dog

We recently got a puppy.  In order to keep the option of day and half-day trips to places Jordan can't come we found two local companies that offer dog-walking and "doggy day care" services.  One of the companies was well-established and the owner was a friend of a friend.  We knew several people who used her service.  The other was a relative newcomer.

I met first with the owner of the established company.  We had a good conversation about how her service worked and what they offered, and she a contract to fill out at my convenience if I wanted to hire them.  I always think you can learn a lot about a firm by the contracts they offer, so I skimmed through it as we talked and found several "interesting" terms.

As you can imagine, one problem a dog walking service has is preventing "poaching" by walkers.  The firm hires and trains young workers and then introduces them to clients, in exchange for which it keeps a significant cut of the walking fees.  The value provided by the firm is largely up front -- once the walker is trained and has met the client the client doesn't lose much by paying the walker directly so they split what the agency would normally get.  In order to avoid this problem, the owner had come up with a creative solution -- a $1,500 "referral" fee the client would pay if he or she hired one of the agency's walkers other than through the agency.

Another problem she must have had was collecting, and she had another solution -- a clause that said that the client was responsible for any legal fees the agency incurred in order to enforce the terms of the contract.

It's likely that if we hired that agency nothing would ever go wrong.  I have no interest in poaching and I pay my bills.  But disputes do happen, even in relationships where they seem unlikely.  When you sign a contract you need to ask how the terms of that contract will affect the resolution of disputes in the event that they do happen?

Let's say a couple of years from now I'm taking Jordan for a walk and we meet a college kid who mentions that he walks dogs to make some extra money.  Unbeknownst to me, he once worked for this agency -- or perhaps he actually walked Jordan once but I forgot.  The owner thinks that we're "poaching" and demands her fee.  Can I negotiate?  Not very effectively -- instead of a mutually unpleasant BATNA of going to court, the pain of court is all on my side because I'd have to pay her expenses.  She could even make my BATNA worse by mentioning that if we do go to court her attorney happens to be from a premium firm (i.e. very expensive for me)!

Inability to Tolerate a "Normal" BATNA

In discussing how to negotiate with a bad BATNA I mentioned my work with a healthcare non-profit that wanted to negotiate higher reimbursement rates.  One of our biggest challenges in those negotiations was that the organization's balance sheet was weak, meaning it couldn't easily afford the lost revenue that would come from temporarily refusing to accept any of the major insurers.  Put simply, their BATNA was weak and for purely internal reasons.

Sometimes it's not that your BATNA is all that bad but that you're unable to bear the costs of a moderately bad BATNA that is normal for the negotiation you face.  If a union can't afford to strike, a person can't afford to go to court or a client can't afford to change providers for a key service then their negotiation position is weak for potentially unnecessary reasons.

Creating Our Own Problem

All too often we create our own bad BATNA out of whole cloth.

For a vendor, two of the most beautiful words in the world are "switching costs".  Switching costs are expenses a customer needs to incur in order to change service providers, and companies work hard to build them in.  Some switching costs are natural.  If your company contracts out key services it's likely that any new provider would require at least a learning period before they provided as good a service.  In some areas, particularly involving software or services that are tightly intertwined with one's core business, switching costs can become prohibitive.  In extreme cases, a company can have no viable alternatives at any bearable cost.

Switching costs occur regularly in day-to-day life as well.  Loyalty programs are designed to create a benefit (e.g. miles) that loses some or all of its value if we don't continue to buy from that company.  Switching costs can be non-financial, too. My main email address, that I've used for many years, ends in the name of my cable company rather than and as a result there would be a non-trivial switching cost for me if we ever decide to change cable providers.

It's not realistic to avoid all switching costs, but excessive switching costs can be disastrous, especially if protective measures (e.g. a maximum annual fee increase) aren't built in.  If you can't afford to switch you have a terrible BATNA in any negotiation about pricing.

Avoiding Bad BATNAs

To reduce the number of situations in which you have a bad BATNA, the following steps are useful:

  1. Get used to thinking about the potential for disagreement.  Most people dislike conflict and in particular most people dislike thinking about future conflict at the start of a relationship.  At the same time, we recognize that disagreement, conflict and divergent interests exist in even the healthiest relationships.  (Just ask any successful business partners or happily-married couple!)  Get in the habit of asking yourself what the context for future disagreements is likely to be.  If it's tilted against you, the start of the relationship is the right time to act.
  2. Look forward, reason back.  At the start of any long-term relationship, imagine yourself (and, more importantly perhaps, your counterpart) in the future.  Does one of you have undue leverage over the other?  Are your interests diverging?  In my post about negotiating with a bad BATNA I gave the example of a homeowner who had some custom moulding made for his house and found himself with a bad BATNA when he wanted a small amount of additional work done using the same moulding.  He could easily have avoided that if he'd asked, "What will happen if it turns out I want some more work done?" and asked the contractor to agree at the start of the original job that any future work using that moulding would be done at a comparable rate.
  3. Build trust, social capital and mutual need.  There is a world of difference between negotiating with someone where you need them and where you need each other.  Similarly, integrated organizations can avoid painful games of brinkmanship if they develop social capital and norms that make such behavior unacceptable.  This is generally even more effective with individuals.
  4. Develop your BATNA before you need it.  If you're in the habit of looking forward and exploring the potential for future disagreements you can prepare for those disagreements by strengthening your BATNA so that if and when they arise you're in solid shape.  As a by-product, your strong BATNA may prevent disagreements from occurring at all, since your counterpart's incentive to force a renegotiation may not exist absent your weakness.

Above all, remember that your BATNA isn't something you're stuck with.  You can affect both how it starts and how it develops over time.

Friday, August 5, 2011

How to Create a Scoring Matrix

After my last post I got an email from a reader who said that a scoring matrix sounded like it could be really useful but that she had no idea from what I wrote how she should go about making one.  This post will walk through the creation of a simple scoring matrix and then discuss some practical ways one might use it beyond evaluating competing offers.

Let's take a common life decision, leaving one job for a new one.  In our hypothetical case, Jane has a job she's happy with but after exploring the market she identified some other interesting opportunities.  After pursuing them she's in final interviews with two other companies (we'll call them A and B) and is doing her homework to negotiate in the event any offers come through.

The first step is to set her "utility currency".  This is what you'll use to score each component of your offer.  For this exercise we're going to use money, but for someone for whom money wasn't a key motivator that might be the wrong way to go -- you could use generic points instead.

Jane currently has a salary of $100,000 and last year she earned $20K in performance bonuses.  She's having a good year this year and expects a bonus closer to $35K and a raise to $110K, so her BATNA has a compensation of around $145K.  She'll evaluate competing offers accordingly.

Jane identifies the following criteria as important to her decision:

  • Growth potential.  Jane's current company is large but it's also a family business.  Some non-family members have reached high levels within the organization but Jane is concerned that she may not be able to accomplish as much as she'd like there.  Company A offers more normal growth potential and Company B is particularly exciting because she'd be reporting to a woman who was a longtime client and who has an excellent reputation as a career mentor.  Jane estimates that the improved growth prospects are equal in value to $20K in salary at Company A and $40K in salary at Company B.
  • Commute.  Jane's commute currently takes over an hour each way and combined with long work hours has been taking a toll on her outside life.  Company A is only ten minutes away; Company B, unfortunately, is almost an hour and a half away.  Jane estimates the commute difference as worth $30K in salary at Company A and -$10K in salary at Company B.
  • Vacation time.  Jane's family has two traditional events each year, both of which take up a week of vacation.  Jane is also passionate about travel and really values the five weeks of vacation she has at her current job.  The HR representatives at A and B have told her that new employees only get three weeks of vacation.  Jane is very concerned about this; she would rate four weeks salary as -$15,000 and three weeks is almost a deal-breaker.  She reluctantly puts it as -$50,000.
A real job evaluation would likely consider more -- possibly many more -- factors than this.  How many you include depends on personal preference but you should try to include all significant factors.  Once you have a list and start scoring them you may decide to drop some.  For example, Jane might have included "quality of nearby lunch options" and then realized that this only scored at $500 which would be rounding error compared with other factors.

Jane's scoring matrix now looks like this:

Company A
Company B
Offer - $145K
Offer -$145K
Offer - $145K
Offer - $165K

The total line is how much better (or worse) an offer is than staying put.  From this Jane can tell that any offer above $145K from Company A or above $165K from Company B has a positive score and thus seems better than her BATNA of staying where she is.  More importantly it's a useful tool for negotiating with her new company and for creative problem-solving on her own.

Let's start with the commute.  Once Jane has it down on paper that she'd give up $30K in salary to shorten her commute she might think about moving.  There aren't any places she'd like to live that are closer to her current company but there's an attractive neighborhood close to Company B.  Rent is likely to be $15,000 a month higher but that's still a net improvement of $15,000 ($30K value of short commute less $15K in higher rent) instead of the negative $10,000 if she were to stay where she is.  Thinking through her priorities thus led her to realize that what looked like a drawback could be converted into a positive.

Fully understanding her interests might lead Jane to improve her BATNA as well.  Either before or after she gets an offer, Jane may decide to talk to her manager and explain that limited career prospects are playing a significant role in her considering a different firm.  It's possible that they'll want to keep her and will find a way to give her confidence that she can advance there.

Then there's vacation.  Jane really cares about her travel time; going from three weeks to four is worth the equivalent of $35,000 in salary to her and a fifth week is worth another $15,000!  Recognizing that should guide her in her negotiation but it also suggests a possible solution if the three week policy is indeed firm -- her contract could include two weeks of unpaid leave.  If her compensation is roughly $3K per week, then taking two weeks of unpaid time costs her $6K compared with her current job, which is much better than $50K.

Assuming Jane gets an offer from Company B, this problem solving suggests a different scoring matrix:

Company B (original)
Company B (revised)
Offer - $145K
Offer -$145K
-$6K (assuming 2 unpaid wks)
Offer - $145K
Offer - $84K

One last point.  A scoring matrix is only as accurate as the assumptions used to make it.  It should be reviewed and challenged and you should never forget that it's a tool.  For example, if Jane gets an offer of $90K her matrix gives that a positive score but such a significant drop in salary might indicate that her new firm sees her playing a less important role than she anticipates.

Thursday, August 4, 2011

Create Your Scoring Matrix

If you've ever taken a negotiation class or read an MBA negotiation case, you've probably noticed one major difference between a case and the real world.  A typical case provides a scoring matrix that converts any deal into a value that can be compared with other deals.

For example, in the Harvard Business School case, a television production studio negotiates with a local TV station to sell syndication rights for reruns of a popular show.  The central issue is price, but the worksheet in the back of the case also tells you the dollar value of being allowed to do four, six or eight "runs" (essentially how often you can show each episode) and exactly how much to discount cash received in future years.

These matrices are extremely helpful in finding value-creating tradeoffs.  In it costs the production company less (in lost value) to allow eight runs than it gains the TV station (in higher ad revenue), so four or six runs are dominated by eight.  Up front payment also dominates any delayed payment because the production company has a higher discount rate, so it costs them more to delay being paid than the TV station benefits.  (To say term A is dominated by term B means that for any deal with A it is possible to find a deal with term B in which all parties are better off.)  Figuring this out is trivial if the parties share information openly, but isn't hard even if they don't, provided the parties really know what the various options are worth.

Professor Max Bazerman says probably the most common criticism he hears of cases is precisely that in the real world you aren't provided with a scoring matrix.  His response is perfect:
In the real world, it's your job to create your scoring matrix as part of your negotiation prep work.
People often enter negotiations with only a general understanding of their own interests.  If you're contracting an addition to your home it's trivial to know that you'd rather pay less than more, that you'd rather pay later than earlier, that you'd rather have the work finished earlier than later, etc.  That's not enough to answer a question like, "Would I rather pay $50K to have the work done by September or $60 to have it done by June?"

In order to evaluate alternatives you need to know all of your interests and how important each of your interests are to you.  Start by brainstorming and getting a rough sense of priorities, as well as any trigger point.  (For example, if you have a major family reunion planned at your home in September, that may mean that any finish later than August is a deal-breaker.)  Try to formalize your list into a set of utility values that can be offset against each other.  (This is sometimes easier to do when the central factor is money, but even in a non-financial negotiation you should be able to say that X is about +20 and Y is -5.)  Write it down and then test what you've written by comparing your reaction to hypothetical offers to what your scoring system says.  Make sure you know the score value of your BATNA so that in addition to comparing offers A and B you also know whether and by how much each meets your interests better than your no-deal alternative does.

Finally, test your scoring system with other people.  If you're the only stakeholder (e.g. you're single and you're negotiating a job) a friend who knows you well may be able to identify interests you haven't considered or help you see scores that don't mesh with what she knows about you.  If you have lots of stakeholders, this step is even more important because it's not just your scoring system.  The more buy-in you have, the more flexibility you'll have to make value-creating trades and the less chance you'll find that you have to backtrack from what seemed like a promising proposal.

Monday, August 1, 2011

Debt Ceiling Deal

It now looks like we have a deal on the U.S. debt ceiling.  While the deal hasn't yet passed, it seems very likely that it will for two reasons.  I don't think Obama, Reid, Boehner and McConnell would be endorsing it unless they already had a pretty good sense of the vote.  More fundamentally, prior bills failed because one party or the other was 100% against them so all the yes votes had to come from the other side.  Even if Tea Party Republicans vote no on this compromise the bill can still pass since some number of Democrats in the House will vote in favor.

I usually blog about one specific idea, but today's post is going to move about a bit as there are a number of really interesting things to discuss about the negotiation and the deal, so I'm going to move around between them.

Agreement at the Last Minute

As has been widely noted, this negotiation came down to the wire.  This is very common and is seen not only in negotiations but in complex auctions as well.  Until the deadline (or final round) approaches, a lot of activity is kept on hold.  There are some good reasons for this and some bad ones but recognizing it is important when we consider our own negotiations, especially those in which we have some control over process.

There is some research that suggests that a willingness to wait to the last second helps capture value.  In one study of negotiation exercises conducted between Americans and Israelis, for example, the Israelis captured more value and the main factor seemed to be their comfort in waiting.  The downside is that reducing the amount of constructive negotiation time and keeping cards close to one's vest are both harmful to value creation.  As we've discussed, in many deals the potential to do well by increasing the size of the pie outweighs incremental gains in one's share of the original pie.  Negotiators should consider how much value creation potential they see, and if it's high they should consider working against the "deadline" phenomenon.

The greater the amount of brinkmanship involved (and this deal had a lot), the more likely it is that real progress waits until the last moment possible.  Trust and a mutual commitment to value creation are essential if major progress is to be made throughout a negotiation.

Deal within a Deal

The current deal accomplishes a modest amount of deficit reduction now and empowers a 12-person group (nicknamed the Super Congress) to propose further deficit reductions.  If it fails to do so, or if those reductions are blocked by Congress (difficult, but theoretically not impossible) then further spending cuts are automatically triggered, divided between defense and domestic programs.  Thus, the main consequences of this deal are not fully known at this time and will depend on which members are chosen for the committee.

The Wall Street Journal notes this and says
While the "trigger" includes no revenue increases, the committee itself could agree to raise taxes to meet the $1.2 trillion deficit reduction target. This means GOP leaders Mitch McConnell and John Boehner have to be especially careful in their choice of appointees. No one from the Senate Gang of Six, who proposed tax increases, need apply. The GOP choices should start with Arizona Senator Jon Kyl and House Budget Chairman Paul Ryan, adding four others who will follow their lead.
We don't know, however, whether the membership of the Super Congress has already been agreed.  Nor is it clear that Boehner and McConnell would choose six hard-liners.  The whole purpose of creating the Super Congress is to make it more likely that politically difficult deficit reduction decisions will be taken, both by reducing the number of people who need to reach agreement and by providing political cover to members of Congress who might otherwise have trouble supporting it.  Republicans were able to hold firm on tax increases in the initial agreement but at the cost of being seen as unreasonable according to many polls.  Continuing to hold that hard line carries real political risk, so the Super Congress may be a "golden bridge" (to borrow terminology from William Ury) that lets them compromise on some tax increases.  From the perspective of internal politics it's also likely that Republican leaders don't want to give too much power to the element of their party that was the least tractable.

Deliberately Creating a Bad BATNA

Agreeing on substantial deficit reductions won't happen easily, since each party wants them to happen in different ways.  The initial agreement happened largely because Republicans created a bad BATNA for both sides by threatening to block an increase in the debt ceiling.  The current deal takes a less drastic approach by saying that unless an agreement can be reached the cuts (or shortfall in the event that a partial agreement is reached) will be triggered automatically.  Since half of the cuts would come from Defense and half from domestic programs, it's hoped that members from each party would find a compromise preferable.

Most observers are summarizing this as a situation where Republicans would hate half the cuts (to defense) while Democrats would hate the other half (to domestic programs) but I think there's something more subtle at work.  Creating a mutually painful BATNA works when the negotiation in question has the potential for value creation, i.e. it's easily possible to create deals that are better for both parties than their BATNA.  Electoral politics is very nearly zero-sum.  Thus, from a political perspective, it's hard to see how any particular outcome is damaging to both sides.

I suspect that this structure really aims at creating political cover for, and applying political pressure on, individual members.  A reluctant Congressperson can say, "This proposal isn't perfect but it's what the Committee has agreed on and the alternative means failing to support our troops in the field and cutting medical support to the most needy."  Alternately, any block that attempts to prevent a proposal from being enacted (e.g. because it includes some tax increases) is in a more vulnerable position than when the consequences of no deal being reached are vague or theoretical.

As Always, the Fine Print Matters...and sometimes it's Dominant

The agreement calls for deficit reductions...but from what?  The current CBO baseline (which is what the triggers are based on) seems both obvious and neutral but it includes an assumption that is politically volatile: that the Bush tax cuts will expire in 2013, adding $3.5 trillion in revenues.

This is huge.  Republicans have long insisted that the Bush tax cuts should be made permanent and Obama and most Democrats have supported making them permanent for those making less than $200,000 per year.  Either proposal would mean a bigger change to the CBO baseline than the entire targeted level of reductions.

The WSJ editorial argues that this is such a large increase that the Super Congress is unlikely to consider any further increases, but this is pretty simplistic analysis.  The Super Congress is likely to want to ignore the Bush tax cuts altogether in its proposal, since any change would make their task monumentally more difficult, and their timeline theoretically makes ignoring the cuts easy.  Obama, however, can use his threat to veto a later extension of the cuts to pressure Republicans to accept some tax increases as part of their overall deficit reduction recommendation.  Obama has some real leverage here, as the cuts expire after the 2012 election, giving Republicans limited recourse against a veto threat.  It's entirely possible that a two-prong agreement will be reached, with some tax increases being part of the Super Committee's recommendation in exchange for concessions on the Bush tax cuts.

More fundamentally, it means that this deal should be seen as just one salvo in an ongoing struggle.  A small agreement has been reached with a medium-sized negotiation scheduled through November but a larger issue remains very much on the table and barely discussed in the context of the current deal.  Regardless of where you fall on the political spectrum, we continue to live in interesting times.