Wednesday, September 19, 2012

Everything is about Strength?

Mitt Romney's Presidential campaign is dealing with the release of a bootleg video from a private fundraising event in which he spoke in unflattering terms about many Americans.  Naturally the press is focusing on him calling 47% of Americans victims who he can't hope to persuade to take responsibility for their own lives, but as a negotiator there was a different comment that alarmed me:

My own view is that that the centerpiece of American foreign policy has to be strength. Everything I do will be calculated to increasing America's strength. When you stand by your allies, you increase your strength. When you attack your allies, you become weaker. When you stand by your principles, you get stronger. When you have a big military—that's bigger than anyone else's—you're stronger. [Unintelligible.] When you have a strong economy, you build America's strength. For me, everything is about strength and communicating to people what is and is not acceptable. It's speaking softly but carrying a very, very, very big stick.

There's nothing wrong with strength.  One of the first pieces of advice I give to people is to strengthen their bargaining position.  If you can improve your BATNA (and show your counterparts that it's improving) or worsen theirs, this can greatly improve your outcomes.  I agree with Romney that having a strong military and a strong economy are assets in diplomacy.

So why don't I like what Romney is saying?

It's his conclusion -- that "everything is about strength and communicating to people what is and is not acceptable."  That is a negotiating philosophy that could be very dangerous if applied to foreign policy.

Nations, like people, don't like being pushed around.  When long-term relationships matter and when interests and power are complex, the best negotiators use positions of great strength to create a context for cooperation and collaboration.  Romney's instinct (at least according to this talk) is to use his power advantage to force the terms of negotiation.  This can be effective, particularly in a single negotiation, but the natural response is escalation and resistance.

Have you ever had a boss who consistently used his or her power advantage to force your compliance? How loyal did you feel to that boss or to that company?  How motivated were you to help that boss?

Moreover, you can't always have the upper hand.  That may not be obvious to Romney.  One of the ways private equity firms like Bain make money is by identifying situations where a particular stakeholder in a company is capturing more value than their negotiating strength merits.  The most obvious form is when a company's workers are being paid more than alternative labor sources, whether those alternatives are unemployed local workers or overseas.  In those circumstances, the private equity firm can buy the company for what it's worth under the current distribution and then increase its value by renegotiating.  These negotiations are typically not aiming for "collaborative" and instead might take the form of, "We're firing you all, but you can reapply for your jobs with much lower pay."

Whatever you think of this tactic, it's important to note that private equity companies get to choose their battles.  If there isn't a big mismatch between what a company's workers are paid and the alternatives then the private equity firm moves on and looks for a different company to buy.

Presidents don't have that luxury.  Even a nation as powerful as ours will regularly negotiate with counterparts who have significant power with which to advance their interests.  An approach to negotiation based around superior strength enabling one to dictate terms -- our way or the highway -- is a hammer in a world full of non-nails.

Consider the first Gulf War.  Jim Baker's assembly of a world coalition against Saddam Hussein is one of the more impressive diplomatic accomplishments of modern times.  He accomplished it not by dictating terms but by dealing with allies on balanced terms.  Mutual interests, value-creating trades and problem solving were his primary tools; not a big stick that let him tell them what was acceptable.

Finally, some forms of strength have a cost.  Wanting a strong economy is almost an empty statement unless you can find a President who wants a weak one.  Standing by our principles is something I applaud and I'm glad to hear Romney say it.  Having a strong military certainly has its uses, but it also has significant costs.  There's the obvious financial cost, but there's also the policy cost.  History shows that it's extremely difficult to have a dominant military without using it.  Just as Republicans correctly point out that government has a much easier time starting a new spending program than closing one down, our military does not only serve to punish bad actors or to protect our core interests.  It inevitably comes to the forefront of policy options and becomes entangled in our external relations.

Even when we don't use our military, it functions as an implicit threat that naturally invokes resentment rather than trust.  This isn't unique to us; a study of history finds that the neighbors of any great military power tend to view it with suspicion.  If one side arranges things so they always have the option of force, the other sides are having it arranged to that force can always be used against them.

Of course, this is one snippet from a fundraiser, and I'm adding my own interpretation.  Perhaps by "communicating what is and is not acceptable" Romney merely means that attacks on U.S. interests won't be ignored and I should emphasize his discussion of values.  At the same time, I can't help but think that if someone came to the negotiating table brandishing "a very, very, very big stick" I'd start looking for other partners or a stick of my own.  Foreign policy is negotiation; if Governor Romney becomes President I hope he has a broader repertoire of negotiation tools than this one clip suggests.

Saturday, August 25, 2012

Kickstarter and Deal Design

One of my favorite web startups is crowd-funding leader Kickstarter.  The core idea is pretty simple.  You have a project and need funding.  Kickstarter provides a platform for you to promote your project to people who might be interesting in providing part of that funding, either because they love the idea or because of tangible rewards you offer.  (Many Kickstarter projects are funded with what amount to pre-orders of the game, book, film, art, etc.)  If you get funded, Kickstarter collects a commission.

This is a pretty straightforward value proposition.  Kickstarter can be thought of as an intermediary, a virtual place for people who are interested in cool projects to meet with people who have cool projects and need money.  There are all sorts of interesting facets to this site but I want to focus on what we can learn about deal design -- and not just for people on Kickstarter itself.

A key part of a Kickstarter deal is that the project owner specifies a minimum amount they need to raise and all pledges are conditional on that target being met.  If it's going to cost you $10,000 to do your project you can set that as your target.  If your combined sponsor pledges are $10,000 or less then the sponsors are charged and your project goes ahead.  If the pledges are less than $10,000 then the project doesn't go ahead.  (Of course, you're not required to set your target at the cost of doing the project.  More on that later.)

This simple facet offers some substantial benefits.  Most obviously, it reduces risk.  Instead of  investing money up front and hoping to recoup that investment, the seller can pre-sell her project.  Risk is reduced for the buyer, too -- if he sees a project he likes he can make a pledge and then continue to learn about it, potentially increasing (or retracting) his pledge.

A more subtle benefit is the interaction it enables between seller and buyers.  Because a project's sponsorship period lasts for a period of weeks, the seller gets an excellent opportunity to connect with buyers and to customize her offering to their wants.  A conventional product launch requires much more time before feedback from early adopters can be incorporated.  A Kickstarter deal is more like a software project with beta testers providing immediate feedback before the "real" launch.

Third, a Kickstarter approach enables potential customers to see other potential customers.  This can offer psychological benefits for the seller (it's well-documented that people are more apt to buy something that they believe is popular) but in some cases the visibility of other customers creates tangible value in and of itself.

Let's take a step back from the website to see how this approach can be applied elsewhere.  Sadly the deal I'm going to discuss was not successful, but a "Kickstarter" approach increased my chances of success from zero to something reasonable and kept my personal risk very low.

Some years ago I thought it could be very interesting to help young job seekers understand potential career paths.  My concept was to do in-depth video interviews with people at different points along a particular path, exploring the measures of success, the rewards and challenges and how they changed as someone advanced within the company or field.

After consulting with a number of people in the recruiting field I concluded that charging users was a non-starter and that hoping for sufficient ad revenues was dubious and highly risky -- but that companies that recruited a lot of people out of school might pay to be part of the service.  These firms spend millions on recruiting and getting the right people is very important for them.

I refined my pitch and got a meeting with senior recruiting partners at McKinsey and Boston Consulting Group.  I didn't ask them to sign up but rather to explore the concept with me.  They connected me with the right people at Bain Consulting.  Having those three firms interested in the project made it easy to have the right conversations with other leading consulting firms.

During those discussions I got very useful feedback on what each firm wanted.  Each agreed that they wanted a service that included only the best firms their peers.  A small boutique firm could be acceptable if it had an excellent reputation but they didn't want to be alongside second-tier firms.  (This would extend to other fields as well.)  Other wants were varied.  One firm really valued the ability to connect with top students at smaller colleges or graduate programs; another had a laser focus on a very small number of schools and only wanted to increase their presence at those schools.  The service morphed considerably from what I'd first envisioned, becoming potentially more valuable to my clients.

In the end, the project didn't go ahead.  The legal and marketing departments of the firms each wanted a level of control over content that I thought would undermine the project (the recruiters agreed with me) and one of the key firms decided not to go forward.  This was a disappointment, obviously but the approach had made success possible...and all I lost was my time.

In thinking about whether and how to apply a Kickstarter structure to negotiations, consider the following questions:

1. How useful will it be to get indications of interest from potential counterparties?  Are people more likely to be interested if they see that their peers (or rivals) are interested?
2. How valuable do you think feedback will be and how can you set things up to get the most useful feedback?
3. How do you close the deal?

The last question is important, because it's very easy for a Kickstarter-style conversation to keep moving forward but never cross the finish line.  Kickstarter deals with this in the most obvious way; it has a deadline.  Unsurprisingly, projects tend to get most of their pledges shortly after launch and right as the project closes.  Think about how you can convert interest into closure.

Kickstarter within a Kickstarter?

I'm going to end with an anecdote that I think illustrates not only the power of the Kickstarter approach but more generally how useful it can be to think openly about deal design and negotiation.

I was working with a client on raising equity investment for a start-up business.  He had a good team and an exciting initial product that had the potential to be a home run success but also entailed considerable risk.  He had found a group of angel investors that were ready to put up the seed money, but only at a valuation he couldn't accept.  He needed a way to increase the perceived value of the deal.

We discussed Kickstarter and unsurprisingly he was already planning to use it in his launch.  The snag was that Kickstarter alone was unlikely to meet his full funding needs, creating a risk that even a successful Kickstarter launch (say, one that raised a third of what he needed) would create fundraising problems because he would need to raise the rest of the money quickly enough to continue product development aggressively.

My suggestion was to pitch an investment agreement that would be contingent on the Kickstarter launch hitting an ambitious target.  That is, the investors would agree to a more favorable valuation (i.e. get a smaller piece of the company) but their investment commitment would be contingent on a Kickstarter result that would merit that higher valuation.  (Contingent agreements like this are often a good solution to different expectations about the future, e.g. how successful a product or company will be.)

Again, this approach does not have to involve Kickstarter itself.  Imagine a start-up that has received interest from a VC firm and from a few potential big clients.  The VCs are reluctant to invest until the firm has at least one large client but the clients don't want to commit to a service from an unfunded startup.  A contingent agreement might be a natural solution; if the clients know that the VC is in if they are, the deal is much more attractive.  (In practice, of course, VCs will often take the initiative in making this happen.)

Sunday, August 12, 2012

Breaking the Rules

One of my most consistent pieces of advice to negotiators is to break the rules.  By this I don't mean the rules of law or of ethics, but rather the self-imposed rules we're often unaware of that limit our choices.  George Perkins refused to think only about the terrible BATNA facing Teddy Roosevelt's campaign and as a result got paid rather than paying out a fortune.  Pat Toomey tried to gain leverage in negotiating the debt ceiling with Obama by changing the no-deal outcome so that it became a credible threat.  Not every move succeeds, but many of the most successful examples of value creation and of value capture involve one or both parties going past the conventional approach.

A reader of the blog sent me the following clip, which absolutely made my day.  It's a perfect example of breaking the rules.  The clip shows the finale of a UK game show called Golden Balls.  During the show the players accumulate money in a jackpot and then in the final round they are presented with a Prisoner's Dilemma.  Each must secretly choose either "Steal" or "Split".  If both choose Split they split the jackpot.  If one chooses Split and the other chooses Steal then he takes the whole jackpot.  If both choose Steal, they get nothing.  Before they decide they get 30 seconds to talk about what they're going to do.

Let's break down what happened.

First, let's review the incentive problem that a Prisoner's Dilemma creates.  Imagine that you're one of the players and you know the other person is going to choose Split.  You can then either choose Steal (and get the whole thing) or Split (and get half).  You're better off choosing Steal.  Now imagine you know he's going to choose Steal.  You get nothing either way.  Thus, Steal can be better than Split but Split can never be better than Steal.  In game theory terms, Steal dominates Split.

Given this, the normal play is to spend thirty seconds persuading the other person to choose Split, presumably with the promise that you're going to choose it yourself.  Each player will pledge to "do the right thing" and then worry that the other one will choose Steal -- and, of course, some of them will choose Steal themselves.

In this case, however, the gentleman on the right broke the rules.  He declared that he was going to choose Steal but promised that if the other player chose Split he would split the money with him after the show.

His move is based on two key insights.  First, the show doesn't have to be the endpoint of the game.  The whole gambit only becomes possible with the recognition that even if the show awards all the money to one player, the players could have a separate agreement to split it.

The second insight is that this particular Prisoner's Dilemma can be broken.  A typical Prisoner's Dilemma requires both players to choose the "cooperate" option (in this case, Split) in order to gain the best combined outcome.  In Golden Balls, however, it only requires one person choosing Split for the full jackpot to be awarded.  This, combined with the ability to offer an after-the-show promise, allowed him to reverse the game theory implication for his opponent.

Imagine you're the player on the left.  You believe that the other player is going to choose Steal.  That leaves you with two choices -- Steal (and get nothing) or Split (and hope that he's honest and will divide the money with you).  Unless you're really angry with the strong-arm tactics or really want to avoid being suckered when he says, "Thanks for choosing Split but I have no intention of sharing the money with you," your best choice is to choose Split.  Instead of the Dilemma pushing you towards a "defect" option, it now pushes you to cooperate.

That leaves one small problem.  People aren't always rational, especially under pressure.  There has to be a non-zero chance that the player on the left will choose Steal either out of anger or confusion or simply because he really doesn't want to be suckered.  Our hero solves this problem by choosing Split in the end!  If his gambit succeeds then the players split the money (which was his intention anyway) but if it doesn't then the other player might decide that he had good intentions all along and agree to split the money as they'd both said they wanted to do.

In my experience, opportunities to break the rules aren't rare -- they are the rule rather than the exception.  The more we can free ourselves of artificial constraints, the more likely we are to find win-win opportunities (or ways to capture value) that would otherwise have gone unnoticed.

Friday, August 10, 2012

Deconstructing an Offer

Today we step out of theory for a bit and look at a very mundane negotiation; the type each of us faces regularly at home and at work.  Hopefully it will be useful for your own negotiations but naturally I'm going to try tying it to a larger theoretical idea.

Part of the renovations of the school next door to my home included putting up a new fence along the abutting side of my property.  At the start of the project there were two fences there; an old chain-link fence on the school side of the line and a wooden one on ours.  The renovation called for the school to replace the chain-link fence with a new cedar fence.

Our fence is both old and, to use a technical term, cheap.  It was already in rough shape and it sustained some damage during the project.  There was an obvious win-win opportunity here; rather than ask the town to fix the damage to our fence we asked them to remove that section entirely so that when the project is complete there is only one fence -- the new wooden one.

As the date of the fence work approached, my wife and I decided we should also look at replacing our fence that ran along the back of our yard to match the new fence along the side.  This also seemed like a natural win-win since the additional cost for the fencing company to add in another section of the same fence they were installing for the school would be significantly lower than for a new job.  (Their crew and equipment would already be here, and they might get a further volume discount on the fence itself.)

As I contacted the fence company, I knew I was missing some potentially important information.  I knew what the new fence looked like and what it was made of, but I didn't know the wholesale cost or the specific product information that would let me get a bid from another fence company.  I wasn't too worried about that, however, since this was easily findable information (and the fencing company would know that).

I would never begin a large negotiation without having that homework in place but for something relatively small it can make sense to move forward and only spend time getting information if it proves necessary.  As with anything, the benefits have to be weighed against the costs.

The initial quote from the fencer was significantly higher than I'd anticipated.  Without having done my homework I was now in that uncomfortable position of wanting to negotiate them down in price while not knowing what would be a realistic counter-offer.

A useful technique in this situation is simply to ask the other party to explain their offer, providing some context as to why it seems high but not making a counter-offer of your own yet.  I told the company that I'd expected a fairly low cost for the this fence given that they would already have their crew and equipment on site and asked them to break their quote down, including detailing the cost of the fence materials (to them) and labor.

This sort of framing is useful in multiple respects.  First, it sets the other party's expectations that this is a competitive negotiation without becoming hostile or aggressive.  Second, by breaking down their bid into material cost, labor and profit it becomes very hard for the vendor to keep their bid inflated.  Any fence company can confirm their wholesale cost (so it's both fruitless and dangerous for them to lie about it) and labor is also hard to fudge.  Thus, when they come back to me they either need a rationale for the original bid (assuming I wasn't just underestimating the fence cost) or they need to come down in price before I even make a counter-offer.

In this case they did both.  The owner explained that because the school project was a public-sector job they had to pay "prevailing union wages" but that she was willing to come down 10% on the price of the job.  Now I was 99% sure that nothing prevented them from having their crew do a separate job right next to the school job and pay them normal rates (even assuming they actually had to pay higher rates for the fence along the school property line) but I didn't want to accuse her of lying.  So how do we get them to lower their bid further?

If a counterpart is telling you something that you think isn't true in order to justify a higher price, see if you can find a decision that makes sense if they're telling the truth but that they would want to prevent if they aren't.  In this case, I answered that I'd assumed that already being on-site would make the job cheaper for them.  If, in fact, it was making it more expensive then instead of having them do the extra fence we would just wait.  I asked her to give me a quote for doing the work at a later date and said that with the time pressure off we could see how we liked the new fence installed and whether we wanted to replace it after all.  We could also get a couple of other quotes before moving ahead.

If, in fact, they had to pay higher labor costs because of the proximity to the school project then this was the rational response on my end.  If, however, they can pay their normal wage rates it's a terrible outcome for them.  They risk not getting the job at all and if they do get it their costs would be higher.  Rather than accusing anyone of lying I created a situation where if they were lying they would correct the lie themselves.

It seems that my initial assumptions were correct; the fence company could indeed pay normal labor rates for the work on our fence and since they were already there they could take a lower margin on the additional work than would normally make sense.  They called back and said they had "figured out a way" that they could handle the wage issue by making it a separate job and their offer now came in at just over half the original quote.  Calls to two other fencing companies confirmed that this bid was more than competitive; no one else would match it.  One guy even said, "At that price I wouldn't make enough money to cover the cost of coming out there."

Friday, July 20, 2012

Yale and the Unions

I usually write about constructive, win-win approaches to negotiation that build trust and lead to sustainable agreements that both sides are happy with.  This isn't just because I'm a nice guy but because in most negotiations that's the optimal approach to take.  Today, however, we're going to look at a negotiation that may well have been won (a term I rarely use with respect to negotiations!) by an application of strong-arm tactics.

Yale University recently agreed a new contract with Locals 34 and 35, representing its office and blue-collar workers.  Both sides, naturally, expressed happiness with the agreement, with Yale's President expressing pleasure at the positive relationship Yale has built with its unions and how Yale will continue to be able to attract top-quality staff and the unions cheering the "unprecedented" raises, maintenance of free comprehensive healthcare, and guarantees of interviews for union employees for new job openings.  Local 35 even got a "no layoffs" clause, which its own members could scarcely believe.

By all outside accounts, the unions -- whose workers are already paid well above the norm -- captured the lion's share of the value in this negotiation.  Yale union workers may now be the best-paid university staff in the nation, with very high job security and unsurpassed benefits.

Some of the success no doubt came from conventional, even value-creating, negotiating tactics.  Yale has had difficult labor relations in the past and has a strong interest in avoiding strikes or street demonstrations.  Yale also wanted a four-year contract instead of three and was willing to pay more in wages to get it.

But there is also indication that the unions may have found an external power lever and used it to great advantage.

Last August the unions backed a slate of Aldermen (all with strong union ties).  The unions called this an attempt to rebalance power between the Mayor and the Aldermen (their view was that the Board of Aldermen was largely controlled by New Haven's Mayor); others called it a union takeover that might lead to the Aldermen acting in the best interests of the unions rather than of New Haven.

In discussing his success, Local 35 President Proto allegedly said, "Right now we control 20 out of 30 seats on the Board of Aldermen.  The University is planning to build two new residential colleges.  Any brick they want to lay down has to get approval from the new supermajority on the Board."

Mr. Proto has said he was misquoted (the newspaper originally modified the quote online and then reconsidered and stated it was confident the quote was correct).  But let's take an academic look at this and do two things.  First, let's assume for the sake of discussion that the unions supported a slate of candidates for Alderman with the explicit intention of holding up Yale by linking the union employment contracts to (ostensibly independent) decisions by the Board of Aldermen over whether to grant Yale building rights for two new colleges.  Second, let's suspend our views on whether this would be ethical or even legal if it were shown to be true.

What remains is a textbook example of one party gaining leverage in a negotiation by securing the ability to harm the other party in an unrelated area.  In simple terms, the unions worsened Yale's BATNA from "strikes and protests" to "strikes, protests, and Yale can't build the residential college buildings it needs."  Worse, for Yale, this isn't a single bullet.  Yale will presumably need regular approval from the Aldermen for various developments.  A four-year contract may provide some breathing room, but I would expect to see Local 35 workers getting a high percentage of construction jobs on new contracts.

We tend to look at negotiations somewhat in isolation.  That is, while we're aware of potential effects on relationships and reputation we tend to think about each negotiation as a self-contained exercise that focuses on the interests relevant to what is under discussion.  The negotiation between Yale and its unions is a reminder that we have to broaden our view of possibilities.

That's not to say that we should do what the unions are alleged to have done, but rather that we need to consider a broader range of possibilities.  For Yale, this could have meant recognizing the potential for the unions to add government leverage to the negotiation and looking for ways to mitigate that.  More broadly, however, negotiators need to cast their nets wide when thinking about parties that might be brought to the table, levers of power that might be pulled (for or against them) and tactical and strategic moves the other side might be considering.  I'll be looking at some examples of this in the coming weeks.

Wednesday, July 18, 2012

Mitt Romney and the Power of Norms

Mitt Romney is coming under increasing pressure to release more than just two years worth of tax returns.  Traditionally, Presidential candidates release around twelve years of returns but Romney is arguing that this is no longer sound.  During an interview with NBC in Pittsburgh he explained:

My experience is that the Democratic Party these days has approached taxes in a very different way than in the past. Their opposition people look for anything they can find to distort, to twist, and to try and make negative, and I want to make this a campaign about the economy and creating jobs. And they want to make this campaign about attacking people and diverting attention from our job picture in this country.

Let's take Governor Romney at his word.  That is, let's assume that there is absolutely no impropriety in his returns and that his only reluctance to release them stems from a belief that opposition research by Democrats has become particularly nasty in recent years.  If that's his sincere view, what's wrong with his approach?

It violates norms...those powerful, often-unwritten rules that govern the behavior we expect from each other.  When someone violates a norm we tend to have an immediate and emotional response of mistrust and/or anger which makes it very unlikely that we'll be open to the other party's reasons for doing so.

Enough Presidential candidates have released a dozen or so years of tax returns that it has become expected.  As a result, very few people are open to hearing a rational argument from Romney that he should follow a different path.  He can talk about spin and distortion all he wants; the bulk of the electorate (and the media that filters the news) isn't listening.  As a result, the only reason we will think of for Romney's choice is that he has something to hide.  It looks like he's making a terrible mistake, one that will either taint his perception among voters all the way to November or force an embarrassing reversal.  (It's unfortunate for Romney that he didn't learn from a similar controversy during the primaries, when he originally intended to keep his returns private until closer to the general election.)

Companies are often surprised when customers reject proposals that seem sensible analytically but which violate norms.  Coke and Pepsi floated the idea of soda machines with thermostats that would alter the price of a cold soda depending on the temperature of the day.  Why not?  Soda companies have already established very different price points for sodas that have nothing to do with cents per ounce.  A 20-ounce bottle typically costs more than a 2-liter bottle, and cans and bottles bought in packs cost a fraction of what individual servings cost in a convenience store.  Surely cola customers have fully embraced the fact that we pay mainly for convenience and immediate refreshment than we do for the specific mix of carbonated water and high-fructose corn syrup we happen to drink?

But no.  Testing showed universal dislike for the concept.

Negotiators should be mindful of norms, particularly when negotiating in unfamiliar territory (e.g. in another culture where we may not know the norms) and when we have come up with something particularly clever as a reason to do things differently.  As Governor Romney is learning, an argument can only work if people are willing to listen to it, and clever ideas (like variable pricing for soda) can easily blind us when the underlying problem isn't logic but the violation of a norm.

Consider banks.  Commercial banking has been consistently growing the amount of income it generates from fees, and for the most part its consumers have grumbled but gone along.  The fee too far?  Charging a monthly fee for the use of debit cards.  Similar revolts have been experienced when banks have tried to charge for checking services.

If we look at this from a purely rational point of view, what could be more natural than a service provider charging a fee for a service?  If checking or debit cards had never existed and banks introduced them with a fee then certainly some customers would choose not to buy these services but would any of them be angry at the offer?  Unlikely...but it is now a norm that these services be free.

Now let's look at a pair of moves that, while generating some blowback, seems to have stuck.  Airlines have made two significant moves that both violate long history and thus could easily be responded to as norm violations.  First, they began charging for luggage.  Second, and more recently, they have begun charging more for window and aisle seats.

I think the airlines have probably fared better for two reasons.  First, they had a near-unanimous front.  Both the change to bag fees and reserving better seats for premium fares were initiated by nearly all major airlines at the same time.  Second, while few people are really fans of airlines, it was widely understood that rising fuel costs and economic recession had pushed them to the brink.  As a result, while we may not have liked the changes, we understood them.

As a negotiator I try very rarely to break norms.  Sometimes, however, it's unavoidable.  In those cases, the following guidelines are often useful:

  1. Consider the responses of third parties.  Are their players (e.g. the other airlines) who can help your change become the new normal?  Are their competitors or rivals who may seize on your violation to gain ground?
  2. Get agreement on the underlying problem (or opportunity).  When you propose something that breaks a norm, this helps the other side recognize that you're not breaking it lightly.  Just as important, it gets them engaging in the logical side of the question before the emotional response is triggered.
  3. Openly acknowledge that your proposal would violate normal practice.
  4. Ask the other party for their input, including counter-proposals that might solve the problem without breaking any norms, or additional steps that might address issues related to the norm.
  5. Go slowly.

How might Mitt Romney have used this approach?  I'm not convinced he had a good solution, but his team should have anticipated the response.  One possible approach would have been to start a dialogue about the hit-job nature of modern politics and the trivial issues that often dominate news cycles.  He could have used clips of Obama bemoaning the fact that small issues decide big elections and perhaps some elder statesmen from both parties to help make that case.  Then, when he decided not to release more returns he should have explicitly acknowledged that this was an unusual step and that he understands that some people will think the worst.  (Instead, he appeared combative and arguably arrogant as though asking for more returns was a new and unreasonable demand.)  Finally, he should have discussed his plans and his reasoning with leading Republicans to make sure they were on board; or, if they could not be persuaded, he should probably have given up on this particular fight.

Thursday, June 28, 2012

Know Thyself, Know thy Enemy

Sun Tzu famously said, "Know thyself and know thy enemy; a thousand battles, a thousand victories." Understanding both yours and your enemy's strengths and weaknesses would enable you to choose battles and conditions that favored you, leading to victory even against a theoretically superior foe.

Knowledge of oneself and of one's counterparts (the win-win aspect of negotiation makes enemy a rarely-appropriate term) is just as important in negotiation.  As we've already discussed, the party with superior knowledge can often capture most of the value simply because he or she understands the ZOPA.  Beyond that, however, knowledge is a fundamental requirement for creating powerful options particularly when you can't count on the other side to engage in mutual problem-solving with you.

Chris asked how I would approach her negotiation with "a crazy person".  She had engaged in a number of real estate deals, one of which was done in partnership with a contractor.  Chris had raised financing from friends and family shortly after the financial crisis dried up credit and this had enabled her to buy distressed properties, refurbish them and then flip them.  Most of the deals had gone smoothly and she'd made good money but the partnered deal had been quite challenging.

The contractor was to earn half of a development fee (Chris receiving the other half) in return for managing several sub-contractors for electrical, plumbing, etc.  As she was preparing to close the deal, however, the sub-contractors showed up with liens on the property for significantly larger amounts than had been budgeted.  Her BATNA, postponing closing and potentially losing the sale, was untenable so she'd been forced to pay off the bills.  She then put the development fee in escrow and demanded an accounting from the contractor (showing that the bills were legitimate) before he could collect any of his share.

Her contractor, in theory, was either in a good position (he had a legitimate accounting and could take her to court) or a bad one (he didn't have a legitimate accounting and thus faced losing his fee and potentially criminal charges).  Not really knowing which was the case and not wanting to pursue litigation (as an attorney herself she believed that only the lawyers win this sort of case) she decided that it was in her best interests to make an offer that was bad for her but was contingent on him providing a full accounting.

The contractor hired a lawyer for the case but she stopped returning Chris's calls.  This, combined with the refusal to accept or even to negotiate on Chris's first offer led her to believe even more strongly that he couldn't account for the costs.  But if she didn't want to go to court and he wasn't willing to negotiate, what could she do?

As I talked about the case with her, my first priority was determining what her core interests were.  One could easily imagine in a case like this that a client's top priority would be not being taken advantage of, or forcing the contractor either to produce the accounting or to face criminal charges.  (These interests could arise from personal convictions or a need to protect a particular reputation so future partners wouldn't be tempted to play loose.)  In this case, however, Chris just wanted to get as much money as possible and to put an end to the dispute.

We then looked at the negotiation from the contractor's point of view.  His actions strongly indicated that he didn't have an accounting, which explained why he wouldn't (couldn't!) accept her otherwise-favorable offer.  How could she use that to her advantage?

An obvious point of leverage is that he faces potential criminal liability.  This gives him an incentive to delay (the statute of limitations would eliminate this liability next year) and means that he can't accept any deal that requires an accounting.  On the other hand it means that his aversion to being sued may be even stronger than her aversion to suing (a court could require him to show his books or at the very least award her the whole development fee if he won't) and that a deal that allows him to keep his books private is particularly attractive.

My advice, which she is now implementing, was to give the contractor three options:

  1. A repeat of her initial offer (favorable to him, but contingent on an accounting),
  2. A new offer (giving him much less money but not requiring any accounting), and
  3. If neither offer is accepted by a deadline, she will sue.
Sun Tzu often advised allowing the enemy to retreat:
If you surround the enemy, leave an outlet; do not press an enemy that is cornered.
One of Sun Tzu's points is that a cornered enemy is forced to fight and will gain bravery from desperation.  A similar point applies here; while the threat of criminal liability gives Chris leverage the smart play for her is to give the contractor a way out.  As long as her only offer was contingent on an accounting he couldn't provide he couldn't cooperate.  She needed to adjust her approach to give him an avenue of retreat from what was otherwise an untenable situation.

By adding a "no accounting" option that still gives the contractor a small share of the escrowed money and by making it clear that not accepting either offer will lead to litigation, Chris will hopefully get significantly more money than she was willing to settle for while avoiding a costly legal battle.

Wednesday, June 20, 2012

Active Listening

One of the most valuable soft skills a negotiator or mediator needs is active listening.  It combines focus on the speaker, questions aimed at improving your understanding, confirmation that you've understood the speaker and acknowledgement of the speaker's content and the emotions behind it.  It's both a set of skills and an attitude -- one that values the other party and recognizes that understanding is important but not easy.

At its best, active listening prevents miscommunication and builds trust by showing the other party that you're genuinely interested in their perspective.  It's virtually essential to creating a negotiating environment of mutual problem-solving.

As you practice active listening, however, it's important that you remain honest and that you don't assume your listening skills are getting things right the first time.  Otherwise, instead of seeming genuinely interested you can come across as "managing" the other party and only paying lip-service to their concerns.

Active listening training often includes suggested phrases or questions, like:
"It sounds to me like you're concerned about (thing).  Can you tell me more about that?"
"What specific concerns do you have about my proposal?"
"If I understand you correctly, you want (thing)."

These are useful starting points but relying on them can be a trap if they aren't genuine.  By all means practice suggested questions and phrases but the sooner you learn to adopt them into your own natural conversation the better.  You should also remember that an implicit assumption of active listening is that your initial impressions of the other person's positions and/or emotional state will often be wrong.  That's why active listening involves so much questioning and clarification.

I experienced a perfect example of how not to engage in active listening during an online customer service chat with my Internet provider.  I was having difficulty setting up an email account for one of my daughters; I'd login to my page but when I selected the option to add a new email address the page would go back to login.

I explained the problem I was having to the customer service rep, who replied that he would try to help me.  He then said, "I can see how important it is for you to be able to set up this email account for your daughter."

If I'd said something to indicate that this was urgent or important this might have been very good mirroring.  But I hadn't.  Granted, it's reasonable to guess that something a parent does for their child is important to them but by overstating his knowledge he gave the impression of an automatic response:  "I can see how important it is for you to ________ (insert customer issue here)."

By assuming knowledge and then stating it back to me, the rep did the opposite of what he (or his script-writers intended).  It might seem unfair to pick on a customer service rep who is probably just doing what he was told, but I've seen similar "active listening" errors from trained mediators and social workers.  In this case, no harm was done -- I was mildly annoyed but filed it away as an example.  In a more emotionally charged or complex negotiation, however, poor active listening can be costly.  The listener may not only fail to realize that trust has been diminished rather than enhanced but is also likely to think that his original misconception has been confirmed.

Perhaps the single best piece of advice I can give for active listening is to allow for your own error.  Ask rather than state, where possible, and if you're making a statement about the other person's perspective try to keep it open-ended.  "I can imagine that's important to you," empathizes but also gives the other party room to say, "Actually, it's not that big a deal.  What really matters to me is..."

Wednesday, May 23, 2012

Real-Estate Agents

Should you use a real-estate agent to help buy or sell your home?  You'd be forgiven for thinking that the answer is a clear, "No."  No-agent websites have proliferated, and keeping an extra 3% on your house (the typical 6% commission is divided between buyer's and seller's agents) has some obvious appeal.  This post looks at the theoretical and practical issues of using a broker (many of which apply to using agents in other negotiations as well).

Some academics have argued that the housing market suffers a pretty serious level of "agency cost," i.e. your agent may be getting you a worse result because your interests are unaligned.  Consider this passage from Freakonomics:
A real-estate agent may see you not so much as an ally but as a mark...[A study found] that an agent keeps her own house on the market an average ten extra days, waiting for a better offer, and sells it for over 3 percent more than your house -- or $10,000 on the sale of a $300,000 house...The problem is that the agent only stands to personally gain an additional $150 by selling your house for $10,000 more, which isn't much reward for a lot of extra work.  So her job is to convince you that a $300,000 offer is in fact a very good offer, even a generous one, and that only a fool would refuse it.
Let's get to the heart of Levitt's point about incentives.  Your agent is getting a good commission, so she has a strong incentive to sell your house, but she doesn't have as good an incentive to sell your house for the highest price.  The commission structure rewards her for closing the deal as quickly and simply as possible, whereas you might be willing to wait or take some risk in order to get a higher price.

Here's how it generally works.  Your agent splits the 6% commission with the buyer's agent and then splits the remainder with his or her brokerage firm, so the actual commission is more like 1.5%.  1.5% on a $300,000 house is $4,500 which is a pretty good commission for one transaction, but the incremental return on boosting the sale price is much less.  For every dollar she adds to the sale price of the house she keeps just one and a half cents.

Let's take a specific example and see how this might play out.  Suppose you're interested in moving to a larger house within your neighborhood.  You're not in a hurry, but you're ready to move -- perhaps you and your spouse have decided to have kids and you want to add a couple of bedrooms and a yard.  Your current house has a market value somewhere in the range of $450K to $550K and after exploring your purchase options (and taking into account your existing mortgage) you conclude that your BATNA (staying in your current house) is preferable to any sale price that earns you less than $460K (after commission).  Here's what that implies for the value created by selling your house, for you and for your broker:

Sale Price
Value to You
Value to Broker

If we compare sale prices of $450K and $550K we see a huge difference for you -- from unacceptable to nearly $60,000 better than your BATNA.  The broker's commission changes much less -- at the unacceptable price it's 82% of what it is at the home run price.

This can work against you in two ways.  First, the broker has only modest incentive to do extra work (trying to find a better buyer).  Let's say you've got an offer for $500K but if the broker were to really work her network and invest another twenty hours of work she could find a buyer at $550K.  That's an hourly return to you of over $2,000 but for her it's less than $50 per hour.  She's likely better off spending that time cultivating new clients since the bulk of her commission comes from getting a sale at all rather than from maximizing price.

The second potential problem is risk aversion.  Intuitively it might seem that you're more risk averse, since it's your home, but in many cases the reverse is true.  Let's again consider our $500K buyer.  Suppose we think there's a 75% chance we can get that buyer to pay $550K if we hold out, but a 25% chance that we'll lose the sale.  In this situation, that's a very good bet for you.  You have a 75% chance of gaining $47,000 in value and a 25% chance of losing $20,000 in value.  For the agent it's a bad bet.  She has the same chance of gaining, but her gain ($1,250) is much lower than what she's risking ($7,500) so her expected return is negative.

This means that the agent has an incentive to encourage you to price your house at a lower-than-optimal (for you) price and to be less aggressive in negotiating.  If you have an offer for $500,000 (which is better than your BATNA, but not much), your broker may tell you that that's the best offer you're likely to get and you should take it.

Levitt argues that there's a straightforward and obvious cost to all this -- brokers push you towards a lower price in order to close the deal, while when it's their own house they hold out and get more money.  Does this mean that hiring a broker is a bad idea?

Not necessarily.  First of all, all of Levitt's "evidence" other than one study is anecdotal...and the plural of anecdote isn't data.  As for the study itself, while it does control for factors such as "location, age and quality of the house, aesthetics, and so on" there are two rather obvious factors it did not take into account: motivation for selling and where the seller was moving.

Opportunistic sellers are by nature more patient and more likely to respond to price opportunities than someone who has to sell.  Someone who has already bought a house or who is moving for a new job faces time pressure that may prevent them from holding out for a higher price.  Brokers, being immersed in housing, are presumably more likely to sell opportunistically (e.g. when the market is particularly hot for the type of property they own, or because a colleague with a suitable client is more aware of an agent's house than a random property on the market).  Since real-estate brokers tend to nurture community relationships over a long period of time it may also be that they are more likely to upgrade locally than move to another region, which again would let them choose their timing more patiently.  Thus, the differences Levitt notes could be explainable by factors he was unable to control for.

The reality is probably something not quite as bad as Levitt suggests, but still raises the question of whether hiring a broker is a good idea given that your incentives may be mismatched.  For most of us I believe the answer is still yes.  A broker's expertise is very useful in navigating the process of buying or selling a house and reducing the risk of pitfalls.  If you're selling, a broker can advise you on how to present your house most effectively, how to respond to buyer conditions and be alert to major pitfalls that could result in legal liability.  She may also be able to interpret statements from buyer's brokers more accurately than you would, since they know each other's signals, making her a useful partner even if you want to take the lead in negotiations yourself.

The more interesting question for me is how you might address the mismatch of incentives to get the best use of your broker.  A lot of sellers are negotiating with their broker but I suspect they're doing so in the wrong way.  The typical approach is to push for a lower commission.  This saves money but worsens the incentive mismatch and essentially relegates the broker to the role of low-skill intermediary whose only value-add is likely to be handling the legal paperwork.  If Levitt is right that broker effort adds to the final selling price then the last thing we want to do is remove that effort.

In many situations a more effective approach would be to suggest a higher commission rate but based off of a floor.  Suppose in our example above the seller's agent received a 30% commission (apart from the 3% that goes to the buyer's agent) on the purchase price less $450,000?  In other words, if the price is $450,000 (which you can presumably get without an agent's help) the agent would get nothing but would get twenty-five cents for each additional dollar?  Now a $450,000 price is worthless, a $500,000 price nets her $7,500 and a $550,000 price yields $15,000.  That extra twenty hours of work would now pay almost $400/hr, making the effort worth her while.  (These numbers are used only to illustrate the point; the general idea would be to set a floor that was easily achievable and a rate that would make the broker's commission equal at a 'normal' sale price.)

A side benefit to this approach is self-selection.  An agent who is confident she can get the highest price for your property is more likely to accept a commission structure like this, whereas one who thinks they're unlikely to do better than $500K may balk.

Finally, don't forget the power of talking.  Even if you decide you don't want to negotiate an unusual commission structure, talk to your agent about the incentive problem.  If you're comfortable holding out for a higher price make sure that your agent knows this and that she thinks of her mission to get you as high a price as possible rather than just completing the sale.

Tuesday, May 22, 2012

The Brinkmanship Trap

We're witnessing two new examples of brinkmanship in world politics.  In Europe, Greece (both its newly-elected government and its voters) is in a showdown with Germany and much of the rest of Europe over the austerity plan agreed as part of the Greece's bailout.  In May, Greek voters shifted dramatically against the incumbent parties that had agreed to the austerity package in favor of parties that opposed it.  With no coalition government proving possible, Greece is headed into another set of elections in June with the very real prospect that Greece will shift further against austerity, putting the rescue package and indeed Greece's ability to remain in the Euro at risk.

At home, meanwhile, Republicans and Democrats are rattling sabers over the debt ceiling again.  We may be headed for a repeat of our recent showdown, in which Republicans stake out an extremely aggressive position and threaten to bring about default if their demands aren't met.

What is brinkmanship?

I define brinkmanship as a tactic in which one or more parties stakes out a position that, if granted, would capture far more of the ZOPA than might be expected from normal negotiation and then attempts to a real or perceived commitment to that position, such that the other parties think that failing to grant it may mean no deal is possible.

Commitment is a critical component.  If you and I are dividing $1,000,000 in a situation where we both go home empty-handed if no deal is reached, a "demand" by me that I get $900,000 is something you'd probably laugh off as an aggressive opening.  You know that you can hold firm at a much better split and that it would be irrational for me not to move.

But what if I show you a contract that compels me to pay $2,000,000 to a third party in the event that I agree to accept less than $900,000?  Now I'm committed to my position and the math has shifted against you.  Beforehand you could say, "Sorry, Chad, but I'm not going to be taken advantage of.  We can split the money evenly or we can walk away."  You'd be presenting me with a choice of $500,000 or nothing. Now, however, you're offering me a choice of negative $1,500,000 or nothing because if I accept your deal I lose far more on the contract.  It's irrational of me to take any deal less than $900,000 and thus you're the one who has to choose whether to take $100,000 or nothing.

Commitment can take many forms.  Public statements that would be embarrassing to step back from, contractual commitments or steps to make it literally impossible to step back all serve the same basic purpose of blotting out a large chunk of the ZOPA so that the other party(ies) must accept a deal they would normally balk at.

What's wrong with brinkmanship?

As we saw above, effective brinksmanship can be very rewarding.  So what's wrong with it?  Why shouldn't every rational negotiator consider brinkmanship merely another available tool, like making multiple offers or adding parties to a negotiation or anchoring?

The most obvious problem is that brinksmanship is extremely damaging to relationships.  It's essentially an effort to use force and intimidation to capture more than one's fair share of the pie -- and since it's out in the open there's no way to soften the effects.

Beyond that, brinkmanship can lead to no deal at all, even when the ZOPA is large.  There are two principal reasons for this.

First, brinksmanship is rarely clean.  My contract in the example above would be clean brinksmanship.  One moment we are negotiating on equal terms over how to split $1,000,000.  The next you can see that any deal that gives me less than $900,000 is impossible for me to accept.  In the real world, brinksmanship involves only partial commitments.  When Boehner declares publicly that he won't accept any revenue increases as part of a debt ceiling deal he's making it harder to accept them but certainly not impossible.  Many commitment gambits carry a risk that they'll be viewed as bluff and bluster by the other side.

Second, the incentive to engage in brinksmanship is generally mutual and can be mutually reinforcing.  If, in fact, the ZOPA is genuinely large that means that both sides have a lot to lose if no deal happens.  Remember, the ZOPA can be thought of as the total amount of money sitting on a table waiting to be divided.  Brinksmanship can be self-reinforcing because our rational side often takes a back seat to our emotions if we think someone is treating us unfairly or trying to push us around.  Since brinksmanship is pretty much explicitly unfair and bullying as a tactic, our natural response to it is to push back just as hard.

Thus, while brinksmanship seems like a sensible tactic in a lot of game theory scenarios it is highly problematic (at best) in most real world situations.  Moreover, it is almost never a good thing to be on the receiving end of.  This brings us to our final question.

How can we prevent our counterparts from employing brinkmanship against us?

The key to fighting brinksmanship is to remember the ingredients that make it attractive:

  1. Large ZOPA, relative to value creation opportunities
  2. Rational expectation that brinksmanship may lead to capturing the lion's share of the ZOPA
Both of these can be fought.  Let's start with the ZOPA.  A large ZOPA is a good thing but sometimes a ZOPA is big because both sides have a terrible BATNA rather than because the deal is wonderful.  A strong BATNA makes you less vulnerable to brinksmanship (and a number of other strong-arm tactics), which is another reason why you should never think of your BATNA as fixed.

It's also important that brinksmanship (because it tends to shut down value creation efforts) depends on a ZOPA that's large relative to value creation opportunities.  You can't always ensure that every deal you do has value creation but you can often influence deals in this direction.  Moreover, you can improve the chance that your counterpart is aware of value creation possibilities by raising them up-front, e.g. by including multiple options in your initial proposal.

Next, you can attack the "rational expectation" problem.  The simplest way to do this is not to give in to brinksmanship and to let other parties know that you haven't.  I like sharing stories of times people have attempted strong-arm tactics against me in part because they're often good learning examples but also because it reminds people that while I'm a sweetheart of a guy who loves to share information and to create value I'm not a pushover.

Similarly, if you are facing brinksmanship now you want to send a clear signal that you're not going to give in to it and also consider building a bridge that will let the other party pull back.  This can include suggesting a shared principle by which the disagreement could be settled or a third-party whose opinion could be sought.  Brinksmanship is a gambit in which the aggressive party traps him or herself in the hopes that doing so will force you to give in.  If you're not going to give in (and most often you shouldn't) then it may be that the only way to save the deal is for you to help the person out of their trap.

Tuesday, May 15, 2012

The Mancini Coalition

One of my formative moments as a negotiator took place almost fifteen years ago during a case exercise at  Harvard.  I had been assigned the role of Enviromental Lobby in a multi-party negotiation over how an economic region would be developed.  Other roles included organized labor, the state's governor, business interests and a fifth party representing general voters.  As with many such exercises, the range of agreements was abstracted into several different issues, each of which could be given a score from 1 to 5. An agreement didn't have to be unanimous but required any four of the five parties.

As I read through the case, finding a good strategy looked difficult.  My goal (as defined by the case) was to get the highest possible score for environmental regulation but no other party seemed likely to have that high on their list of priorities.  (The case specified that the Governor had run on a "jobs" campaign.)  My best chance was to form a coalition with another party but I worried that it would be relatively tempting for the other four parties to shut me out and either form an agreement without me or present me with an ultimatum of agreeing to support a bad environmental result or having them go ahead with a worse one.

I arrived early at the designated negotiation spot without a solid strategy.  I hoped I could feel out other parties and find a favorable surprise -- perhaps the Governor really wanted a unanimous decision and could be persuaded to apply some pressure to the other parties.

Then Walter Mancini arrived.

Walter is one of those people who embodies the best traits of the military.  He's confident but humble, always ready to lead or to follow as the situation warrants, and completely trustworthy.  It turned out that he was playing organized labor and that, like me, he had one metric that was by far the most important to him.  He had a mild preference for low environmental regulation but it wasn't critical.

I proposed a coalition.  He and I would tell the other parties that we would agree to any deal that scored a 4 out of 5 on each of our primary metrics but would refuse any deal that was below 4 on either.  Walter agreed.

When the rest of the parties arrived, we explained our agreement.  Predictably, the other three parties tried to break our coalition, mainly by offering Walter more favorable deals.  Predictably, they failed.  In the end the three remaining parties negotiated separately to reach a deal that met our requirements.

Ever since then I've been a student of coalitions.  In my experience, negotiators often fail to get good value out of coalitions, either missing opportunities to build them, failing to nurture them or using them poorly.  I offer the following as a set of guidelines for building and using coalitions effectively.

  1. Think broadly about potential coalition partners.  Many people look only for parties with common interests -- our natural coalition partners.  Many times, however, your ideal coalition partners don't share your interests.  Walter was an ideal partner even though our interests were somewhat at odds because we trusted each other.  Knowing the other wouldn't defect made it easy for us to turn down favorable deals with confidence that we wouldn't get punished for it.
  2. Think about the purpose of your coalition.  Coalitions frequently exist to increase the power of their members but that's not the only function they can serve.  Some of the most effective coalitions are designed to persuade rather than to exert power.  Bringing on board someone your counterpart trusts and thinks highly of may convince them to take your proposal more seriously or to give credence to your claims where otherwise they might be skeptical.
  3. Consider how other parties may react to your coalition.  If your coalition gives you a position of power you risk having the other parties feel threatened or that you're not negotiating in good faith.  More broadly, inviting the wrong ally into a coalition may push others away.  A classic example is the Bush coalition in the first Gulf War.  Israel was kept out of the alliance of nations that pushed Iraq out of Kuwait precisely because their inclusion would have forced other Arab states to exit.  Being aware of office politics can let you avoid a similar trap, where a seemingly-powerful addition to your coalition causes other key parties to balk.
  4. If your coalition is powerful, consider moderating your requests.  One of the most dangerous situations for negotiators is when they have the other party over a barrel.  It can be very tempting to use your power to the utmost and to extract every ounce of value but often this is not the best approach.  First, there is always a risk that the other party will reject your strong-arm tactics, either out of principle, out of anger or because you have misjudged how costly it is for them to say "no deal".  Second, such tactics can seriously damage relationships and become part of your reputation.
In our case, Walter and I diffused potential tension by asking "only" for scores of 4 out of 5 in our preferred metrics and in stating our willingness to agree to any deal that met that condition.  This was clearly a good result for us but not excessive.  Instead of being angry our counterparts respected our tactical move.  We got better outcomes than we might have working independently and we strengthened our reputations going forward, being seen as trustworthy partners and as strong but reasonable opponents.

Monday, May 7, 2012

Recognizing Weakness from Inconsistency

One of the most common ways people give away deception is through inconsistent behavior.  A recent case I mediated is a perfect illustration.  The two parties were very far apart.  The plaintiffs were willing to settle for a bit less than their full suit but not much.  They thought they had a winning case; on top of that they were emotionally invested, having (in their view) been treated quite unfairly.  The defendant's position was that they were wasting their time.  He'd declared bankruptcy subsequent to the debt being incurred and in addition he had a counter-claim against them for substantial damages.

By all appearances, it looked like a deal with no ZOPA, since each party thought their BATNA (going to court) was far better than what the other party might agree to.  During a private meeting my co-mediator in the case expressed extreme skepticism that any deal would be reached, and the court liason (a highly-experienced mediator) said afterwards that she didn't expect an agreement either.  I was almost certain that they would settle.  Why?  Poker experience.

It had come up during private session that the defendant had offered to pay nearly half of what the plaintiffs were suing for.  Normally this might be a "final offer" at his reservation value as a last chance to avoid going to court but what struck me about it was that it was wholly inconsistent with his stated beliefs.  If he indeed thought that bankruptcy protected him from the debt or that his counter-claim was likely to have the court award him money then why offer to pay half?  He wouldn't.  Either he was extremely risk-averse or he was bluffing.

Poker players are familiar with this form of bluff.  The last card comes up in a game of Hold-'em and someone bets big.  An experienced player calls because the bettor's play in prior rounds is inconsistent with a hand that would have benefitted from that card.  Perhaps their early betting suggested a high pair or AK and they bet big on a 4 that created no straight or flush possibilities. The trick is looking at a party's behavior as a set rather than in isolated pieces.  If some of that behavior is inconsistent with other words or actions it's likely that he or she is misrepresenting something (or, more charitably, is confused about their own interests).  That contradiction is often a point well worth analyzing closely.  After all, if someone is trying to conceal information from you it is likely to be information that you want to be aware of!

Almost every negotiation book discusses the importance of stepping back mentally during moments of stress.  William Ury coined the phrase "going to the balcony" to describe the mental exercise of imagining that the negotiation is taking place on a stage and then removing yourself to the balcony to look down on it calmly and objectively.  While it's certainly true that you should do this whenever your emotions are taking over it's just as important to do so whenever something your counterpart says strikes you as off.  A contradiction between what a person says and their previous statements (or known facts) often signals a chance for you to gain important information.  Make sure you take the time to reflect on those signals and to make the best inference as to what they mean.

(As it happened, the defendant did offer to settle for what the plaintiffs were asking.)

Monday, March 19, 2012

A Nice Example of Value Creation

A lot of value creation in negotiation boils down to identifying things that are more valuable to one party than the other and finding ways to put them in that party's hands.  All too often negotiators fight over what should be "theirs" instead of looking for opportunities to trade for value.

Niko organizes tournaments called Pro Tour Qualifiers, which involve large numbers of Magic: the Gathering players competing for the right to go to yet another tournament called the Pro Tour.  It's something I used to do myself (playing, not organizing!) and it's great fun if you like that sort of thing.  For our purposes it's enough to know that he needed to rent a large space in which to hold a tournament for a couple hundred players and that his revenue comes mainly from entry fees but is supplemented by selling snacks.

His original search left him with two main choices.  One hall, at a hotel, was clearly superior but the price he'd been offered was significantly higher than he'd hoped.  He assumed there was some room to haggle but he needed a significant reduction in cost to make the hall attractive.  In discussions with the hotel, Niko raised the fact that it was traditional for the organizers to sell snacks and asked whether that would be a problem.  The hotel said they could set up a stand themselves but didn't want competition in food sales.

It would have been easy for Niko to see this as a negative point in the negotiation.  On top of a high price he was losing the income from selling snacks.  Many negotiators would have fought to retain a traditional source of income.

Instead Niko recognized that while selling snacks was valuable for him it was clearly more valuable for the hotel.  They could offer a wider variety of food, including meals, buy it more cheaply and have less risk of under- or over-estimating demand.  He didn't fight over the issue but instead pointed out that two hundred hungry gamers were likely to buy a lot more food than the average event for that hall and that this extra value needed to be factored into the price.

The hotel later accepted a substantially lower offer, one that likely wouldn't have been possible without the value creation of moving the "food sales" asset to the hotel.

Tuesday, February 28, 2012

The Future of Mediation

At a recent Harvard Law School symposium on mediation, a leading figure in the mediation world said we should challenge the "A" in ADR (alternative dispute resolution).  After all, only a small percentage of civil disputes actually go to trial, so is ADR even alternative anymore?  And if so, alternative to what?  It was an interesting point but I think that the future of mediation lies not in questioning the first letter but rather in growing beyond the second and third.

Imagine for a moment that there was no such thing as preventative medicine.  Doctors would treat illness but no one would make vaccines.  Dentists would fill or pull bad teeth but not clean them or give them a protective coating.  Chemotherapy would exist to fight cancer but no efforts would be made to reduce the incidence of cancer in the first place.

I believe that much of the mediation world is trapped in just such a world.  Framed as a subset of alternative dispute resolution, very few mediators are expanding their practice or even their research beyond situations where a serious dispute already exists.  This is unfortunate because the skills and knowledge of mediation offer a great deal of value outside of a dispute context.

Consider divorce mediation.  Recognizing the high costs and likelihood of emotional escalation inherent to an adversarial, contested divorce, mediation has grown as a popular alternative.  But both the soft skills (e.g. active listening, moving from positions to interests and avoiding a host of emotional traps) and the value creation tools of negotiation would be at least as valuable to couples hoping to strengthen their marriage, to prevent any problems from reaching the point where divorce would be their preferred option.

Companies often choose mediation to settle disputes in order to avoid expensive litigation.  Sometimes mediation enables the original business relationship to continue unharmed or even to be strengthened.  But why should mediation only be useful when an agreement has broken down?  Third party neutrals could be invaluable to companies forming new agreements, leveraging their expertise about how deals can go wrong as well as a broad range of value creation tools to help create a deal that is both durable and of maximal value.

Mediation also has a lot to offer for improving working effectiveness within companies.  We're all familiar with Dilbert cartoons that depict the common tensions between departments, e.g. engineering and sales or production and marketing.  These tensions are often based on divergent interests between the respective groups, implying that corporate retreats or "trust fall" bonding sessions will be of little use.  How much more effective might it be to have an experienced mediator train the key players in negotiation skills and then to mediate a value-creating and sustainable internal negotiation?

Overcoming self-imposed category limits is never easy, but I believe the future of mediation lies not merely in gaining "market share" in dispute resolution but in recognizing that our field can and should get involved in relationships (personal, corporate or between states) much earlier on, when the goal can be not merely minimizing damage or fixing what's been broken but improving what is to come.

Monday, January 23, 2012

The Problem with Winning

Most of us like to win.  Winning feels good, winning means we got the prize, winning...well, it sure beats losing.  A drive to win can sometimes be very useful in negotiations.  It can keep us sharp and aggressive and help us resist tactics designed to draw out unnecessary concessions.  The best hagglers are often people who take a great deal of pleasure in winning, and I don't think that's coincidental!  Unfortunately, the desire to win (and particularly our aversion to losing) can also hurt us in negotiations. Knowing how to harness your desire to win is a critical negotiation skill.

A Focus on Winning Can Distract us from our Interests

The goal of negotiation is to meet our own interests as well as possible.  If that's true, then winning or losing is virtually irrelevant.  Suppose you had to choose two deal outcomes.  One gives you a value of 100 happiness points.  The other gives you a value of 50 happiness points.  Which outcome do you prefer?

Does your answer change if you know that in the first case the same deal gave me 500 happiness points and in the second case it gave me 40?  Hopefully not -- but in my experience many people prefer the second outcome (where they "win") to the first (where their interests are better met but they "lose").

If we're engaging purely in value claiming then this doesn't really apply.  If the game is zero-sum, then if I get more than you it's entirely likely that you could have achieved an outcome that would have better met your needs.  But winning is still a sideline; what matters is how well your interests were met compared with the range of achievable outcomes.

I recently interviewed a man who negotiated the sale of drilling rights for natural gas on his property.  He and a group of other landowners joined together in an association and hired an expert attorney to negotiate on their behalf.  First, of course, they had to negotiate with the attorney.

In order to align the attorney's incentives with their own, they agreed to give him a percentage of whatever up-front payment was negotiated (above a floor level).  They deliberately didn't include any incentives on the royalty payment.  (A typical deal includes some per-acre up front payment followed by annual royalty payments which are a percentage of the value of gas that is harvested from the field.) When I asked why, he explained that the royalties are where the real money was, so if they gave the attorney any percentage of that it could turn out to be a huge amount of money.

The deal they'd signed was for 20% gross royalties, i.e. for every $1 of revenue from natural gas the landowners would be paid twenty cents.  I asked him why they couldn't have done a similar incentive system on royalties, e.g. giving the lawyer some percentage of any royalties beyond 20%.  For example, if they gave him 10% of any additional royalties and he negotiated a rate of 22% then they would get 21.8% and he would get 0.2%.  The reason was that that 0.2% could turn out to be much more than they would want to pay, but of course they would only be paying it if they in turn were getting $9 for every $1 the attorney got.

The landowners were happy with their attorney getting paid well for getting them a good deal but they based their strategy in part on a desire not to "lose" by paying the attorney a fortune.  This may have caused them to miss an opportunity to create a true "win win" whereby the attorney could make a fortune but only by making them a bigger one.  (This, by the way, is the only criticism I have of the way they approached the deal -- from what I can tell they got a very good outcome through a combination of thorough preparation and a very healthy approach to the deal.)

Competition can be Disastrous

One of my negotiation professors often begins his seminars with what game theorists call a dollar auction.  The rules are simple:

  1. The auction is for a $100 bill.
  2. The first bid must be for exactly $5 and every subsequent bid must be exactly $5 higher than the current high bid.  Thus, the bidding will go $5, $10, $15, etc.
  3. Bidding continues until the high bid stands for ten seconds.
  4. The winner pays his or her bid and receives $100.
  5. The second-highest bidder also pays his or her bid but receives nothing.
Typically there will be a lot of people interested in bidding low amounts.  When the bidding reached $40 or $50 there are typically only a few people bidding, but no one seems particularly worried.  When it gets to $80 or so the remaining bidders generally recognize that they're in a trap.  The problem is that since the number two bid also pays there is always an incentive to keep bidding.  For example, if your bid is $80 and the high bid is $85 you can either lose $80 or bid $90 at which point you stand to make $10...except of course that now the same incentive pushes the other party to bid $95.

Once the bidding goes over $100 there's typically a chuckle in the room.  Both bidders (there are rarely more since three people bidding will let one escape the trap) are now losing money but both have the same incentive to keep bidding.

Typically at some point below $200 one of the players gives in.  But not always.  He has seen auctions continue past $1,000 when both people are unwilling to lose.  Of course, by almost any rational measure two people who lose a lot of money purely because they don't want someone else to lose less money aren't exactly winning.

A focus on winning can make value creation harder.  It can blind us to opportunities to find mutual benefits or creative solutions to problems.  At its worst it can cause negotiations to break down or negotiators to engage in mutually destructive behavior, all in the name of coming out ahead.  By all means, use your killer instinct but beware that it doesn't dominate your negotiations.

Thursday, January 5, 2012

Buying a Car (a personal case study)

My wife and I just bought a new car, after a decade of loyal service from our Honda Accord.  Car buying is arguably the classic negotiation, so I'm going to use my own experience as a case study.  This is not meant to illustrate the best way to get the lowest possible price; as we'll see, at one point I deliberately didn't push for the lowest price I might have gotten.  My goal here is to focus on how to approach a negotiation to maximize the chances of coming out with a result you're happy with.

Negotiation is costly

It might seem odd to hear it from me, but negotiation is a costly activity -- in time, in emotional energy and often financially.  One of the first steps, therefore, must be to assess the potential gains from negotiation work and plan your own investment accordingly.

The cars my wife and I were most interested in cost about $30,000.  The difference between what one might pay given absolutely no preparation and the lowest possible price is perhaps $2,000.  Most of that gain will likely come from the first few hours of research, with diminishing returns afterwards.  (For example, it's probably pretty easy to get within $500 of a dealer's normal walkaway price, but if you want to track down the special incentives that may be in play that's going to take more work.)

That forms a base point for thinking about how much time I want to invest in negotiation.  Someone else might well use that same information to make a different choice -- investing less time if they don't enjoy the process and time is scarce or more if they really want to get the best possible price or need to save every dollar possible.

Know thy Enemy

One of the most common mistakes people make in negotiation is failing to look at it from the other side(s).  Putting yourself in your counterpart's shoes is one of the best ways to find value-creation as well as value capture opportunities.  Once you understand their interests, their constraints and where you want to improve your knowledge you're in much better shape.

A car dealership faces some pretty significant challenges.  Their fixed costs aren't small, and they sell a relatively modest number of cars in order to cover them.  Their capital requirements aren't as big as one might think (the cars on their lot are largely financed by the manufacturer), but they still need to make several hundred dollars per car (on average), even allowing for future profits from service & maintenance.

The big problem with charging that kind of margin is that dealers are, essentially, commodity brokers.  The car held at one dealer is identical to the car (of the same model) at another dealership; in fact, dealers typically have swap agreements in place to maximize their effective inventory so if you're talking with multiple dealers about, say, a Subaru Outback 2.5i Limited in deep indigo pearl, they may be negotiating with you on the exact same car that just happens to be sitting in one of their lots.

Let's say you need to average $600 in profit from selling something.  Now imagine that you and two other people have equal right to sell it.  Do you expect to make $600?  Of course not...because if you're offering me a price that earns you $600, one of those other people is going to undercut you.  Then you'll undercut them, and so on until you're barely better than not selling it at all.

This brings us to the approach that websites like recommend.  Get the dealer cost from their website, then invite multiple dealerships in your area to offer you quotes.  Play one against the other until you've gotten the best possible price.

A great chess coach once wrote, "Your opponent also has a right to exist."  Car dealerships aren't just shrugging their shoulders and saying, "Wow, I wish we weren't dependent on making good margins in a commodity business."  What should we expect them to do in response?

First off, they should strive to maintain their biggest advantage -- information.  It's a safe bet that "dealer invoice" isn't going to be nearly as accurate as when sites like first got started.  We have to assume that a host of hidden payments make their true cost less than invoice.  (I was able to confirm this by asking one dealer what he recommended I do for research -- when he said, "The first thing I'd do is check out the websites that have dealer invoice data so you know exactly what my cost is," it was obvious that his cost was usefully less than invoice!)

Next, we should expect them not to cooperate with our efforts to turn the negotiation into an auction.  A hidden price doesn't help them much if they're bidding against each other.  Thus, we should see behavior that balances out their wish to get the sale with a recognition that a full-out auction should be resisted.

Sure enough, my request for bids from the four local Subaru dealers didn't come back with four clean, competitive bids.  One dealer called me and said that one of his Internet specialists would be putting together an offer but what he really wanted to know was whether there was a price I had in mind that would close the deal right there.  Another made an offer that was only a few hundred dollars below MSRP (i.e. way too high) but added that his email constituted a guarantee to match or beat any competitor's offer.  Another came in a bit better (but still too high) with a similar guarantee.

Whether you've anticipated your counterpart's responses or not, it's important not to lose control of the negotiation.  Even if you do have an aspiration price already in hand, don't share it yet!  You can make an outrageous offer if you like, but in my view your best bet is to keep steering the negotiation (or, rather, negotiauction) in the direction that favors you.  In this case you want to make clear that you plan to keep talking with multiple dealers so they know they won't get the sale with anything much higher than their reservation value.

As I was soliciting bids I was also researching other price information.  As I mentioned I didn't have much faith in the dealer invoice number (just under $29K) but Edmunds offers another useful number -- the average price at which this car (including options) has been sold at in your region.  For us, that was $29,775.

Beware of Bias

As I discussed here, one thing I do after every negotiation is a review with a focus on where I went wrong or could have done better.  As we'll soon see, in this case I exhibited two very common "mind bugs": susceptibility to anchoring and small pie bias.

Remember how I knew that the dealer invoice number couldn't be right?  Despite that knowledge, it stuck in my head as a "real" number and subconsciously I considered it the dealer's BATNA.  This combined with small pie bias led me to set a target price of $29,500 for our car when I went in to negotiate with the dealer with whom we'd done our test drive.  At this price I'd be almost $300 better than the average deal.  The dealer's margin would be about $500 (if only the invoice number was really his cost), which was enough to be better than me going somewhere else and high enough that I could close the deal without losing a whole day haggling.  (I love to negotiate but I only love haggling when it's on behalf of someone else; again, know thyself!)

Close the Deal

Negotiating for a car is part theatre.  Prices get written down.  Salespeople go talk to their boss to see whether there's anything they can do with your unreasonable demand.  Ours went about like this:

I started off by explaining that I'd looked up the invoice information and was only willing to pay a small premium to it.  I made it clear that I had solicited bids from other dealers and was still in discussions with them but that my preference was to give him the business since he'd spent real time helping us compare models, test drive, etc.  I was open to closing the deal that day but only if I was happy with the price and otherwise I would have to go back to the other dealers.

He came back with a printout of what he said was the actual invoice for the car we were interested in.  It was pretty low on details but gave the invoice price at $29,700, over $700 higher than what was on Edmunds.  He explained that in order to cover their costs they aimed to make $800 per car, so his offer was $30,500.  At this point I took a different approach than the normal back-and-forth.  I told him that we might have a problem because my walk-away price was lower than his cost.  I was willing to agree today to a price of $29,500 but that anything higher than that would mean that I went back to the other dealers.

He went "behind the curtain" and came back with a price of $29,910.  I reiterated that I had put my cards on the table but was no longer haggling; either he could do $29,500 or not.  He left and returned with $29,596.  When I repeated my position he said, "Come on, it's less than a hundred bucks.  I'm doing all the moving here!"  A few minutes later he did another round trip, muttered, "My boss is not a happy man," and agreed to my price.

Despite his protestations, I suspected I hadn't been ambitious enough.  Three iterations was less than I expected, although I do know that a car dealer hates to see a customer leave to think it over.  Sure enough, that very evening one of the other dealers (the one who had asked me for a price) decided they'd waited long enough for me to go to them and made an offer of $29,000.

Know the Rules

Once you agree on a price, a car dealer typically does everything they can to make that deal feel fixed in stone.  They bring out paperwork, ask for a deposit, etc.  You want to make sure you know what you're actually committed to.  In this case I knew that the paperwork was non-binding and the deposit could only be applied to actual expenses incurred by the dealer if I didn't take the car.  Thus, I had every legal right to take the lower offer (or to try to squeeze it even lower).

Instead, I called the salesperson I'd met with and explained what had happened.  I told him I understood my legal rights but that the sale was still his if he would come down $400.  He conferred with his boss and, as expected, agreed to the lower price.

Why did I leave money on the table?  First, personal preference.  I don't like to waste people's time, and while I don't think test drives and talking with a salesman incur any obligation I also know that I'll feel better (assuming he did a good job) giving him the business.  Second, going with the other dealer would have involved some additional time and potential risk.  I'd already found one "trick" in the offer (on paper it looked like it was even lower, but not all the fees were identical) and there was some cost in time to going to this different dealership and confirming that everything was as it seemed.  With those considerations in mind I preferred to close the deal quickly with a $400 improvement rather than to try for more.

Enjoy the Prize

While I strongly encourage negotiators to review their performance and identify mistakes, don't let that ruin the experience or taint the results.  Trish and I now have a new car that we're very happy with.  I didn't get the lowest possible price but I got one I'm very comfortable with and didn't sink too many hours into either the research or haggling.  Negotiation should be fun and rewarding; if you're not enjoying it, and the outcomes from it, that's your real problem.