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, May 7, 2012
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.
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.
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:
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:
- The auction is for a $100 bill.
- 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.
- Bidding continues until the high bid stands for ten seconds.
- The winner pays his or her bid and receives $100.
- 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 Edmunds.com 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 Edmunds.com 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.
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 Edmunds.com 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 Edmunds.com 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.
Wednesday, November 9, 2011
Information
If, as Sun Tzu famously said, war is about deception then negotiation is about information. I advise people to begin every negotiation by asking questions about the information they have at hand, such as:
- What information is critical to this negotiation?
- What parts of this information am I missing and how can I acquire them?
- How confident am I of the information I do have, and how can I test and/or improve it?
- What information do my counterparts have? How confident am I about my assessment of their information?
- What information do I want to share with my counterparts? What is the best way to do so?
- What information might my counterparts want to share with me? What misinformation might they want to share?
Guhan Subramanian tells the following story to illustrate the gray area of ethics and law that negotiators can find themselves in. To me, however, it's an even better example of the importance of asking questions about information.
A large division was being sold at auction by an investment bank. It was understood that the number of serious potential bidders would likely be small (probably as few as three), and the bankers approached each of them to discuss the terms of the deal. Due diligence would take place over a weekend at the bank's main offices, and bidders would get half-day slots, beginning on Saturday morning. One interested party asked for the Saturday morning slot, but it was taken. Same with Saturday evening and Sunday evening. Sunday morning, starting at 8:00am was available. When they came in on Sunday the trash cans were overflowing with Chinese food takeout boxes and the investment bankers had stubble and looked a bit rough.
You can probably guess the rest. When the bankers approached the likely bidders only one was interested so they created the perception of strong interest in order to force the buyer to bid as though they were in a competitive auction. The buyer paid hundreds of millions of dollars more than necessary.
The legal side of this behavior is interesting. (Subramanian says that most American lawyers think the bankers acted legally; most European lawyers disagree.) But let's take a step back and think about what asking the above questions about information might have made possible.
If you're bidding on something that only two other parties are likely to be interested in, what information is most critical to your negotiation? Surely their level of interest. And how might you learn something about that? A rather obvious solution would be to hire someone to photograph (from a distance) everyone entering the building on Saturday and Sunday. That wouldn't work in all cases, but a typical investment bank has extremely low foot traffic on weekends. Given that the potential buyers would all be familiar to each other, it's quite likely that those pictures would have been worth many millions of dollars.
A large division was being sold at auction by an investment bank. It was understood that the number of serious potential bidders would likely be small (probably as few as three), and the bankers approached each of them to discuss the terms of the deal. Due diligence would take place over a weekend at the bank's main offices, and bidders would get half-day slots, beginning on Saturday morning. One interested party asked for the Saturday morning slot, but it was taken. Same with Saturday evening and Sunday evening. Sunday morning, starting at 8:00am was available. When they came in on Sunday the trash cans were overflowing with Chinese food takeout boxes and the investment bankers had stubble and looked a bit rough.
You can probably guess the rest. When the bankers approached the likely bidders only one was interested so they created the perception of strong interest in order to force the buyer to bid as though they were in a competitive auction. The buyer paid hundreds of millions of dollars more than necessary.
The legal side of this behavior is interesting. (Subramanian says that most American lawyers think the bankers acted legally; most European lawyers disagree.) But let's take a step back and think about what asking the above questions about information might have made possible.
If you're bidding on something that only two other parties are likely to be interested in, what information is most critical to your negotiation? Surely their level of interest. And how might you learn something about that? A rather obvious solution would be to hire someone to photograph (from a distance) everyone entering the building on Saturday and Sunday. That wouldn't work in all cases, but a typical investment bank has extremely low foot traffic on weekends. Given that the potential buyers would all be familiar to each other, it's quite likely that those pictures would have been worth many millions of dollars.
Wednesday, November 2, 2011
Relationship Building Before Negotiation
Back when I was a kid, my Dad decided to repaint the outside of our garage. The garage was at the end of a driveway that bordered the property line with our neighbor, so one of the side walls was visible from the neighbor's house (and not really from anywhere else). Dad approached the neighbors and asked what color they would like the wall painted.
It was an unusual request, and if I recall the story correctly they thought at first that Dad was asking them to help pay for the project. No. He just recognized that since the wall was only visible from their property they were the ones with an interest in its color and it didn't hurt us to have the color be different from the rest of the garage. They chose something that suited them and Dad bought the paint.
I don't think we ever had any serious negotiations with our neighbors, but suppose we had. Dad's simple act of generosity would likely have earned him their trust and goodwill, greatly improving the chances that any difficult discussion went well.
One of the most important lessons of negotiation success is that your most profitable work is done away from the table -- sometimes when there isn't anything to negotiate! We don't always know where we'll find ourselves needing to negotiate, so even cynics should look for ways to strengthen their relationships and in particular their reputation for taking the other party's interests seriously.
Opportunities to generate goodwill, at low or no cost, are all around us. The challenge is to be mindful of the opportunities so that the next time we're painting a garage or have some other chance to help someone out, we take it.
It was an unusual request, and if I recall the story correctly they thought at first that Dad was asking them to help pay for the project. No. He just recognized that since the wall was only visible from their property they were the ones with an interest in its color and it didn't hurt us to have the color be different from the rest of the garage. They chose something that suited them and Dad bought the paint.
I don't think we ever had any serious negotiations with our neighbors, but suppose we had. Dad's simple act of generosity would likely have earned him their trust and goodwill, greatly improving the chances that any difficult discussion went well.
One of the most important lessons of negotiation success is that your most profitable work is done away from the table -- sometimes when there isn't anything to negotiate! We don't always know where we'll find ourselves needing to negotiate, so even cynics should look for ways to strengthen their relationships and in particular their reputation for taking the other party's interests seriously.
Opportunities to generate goodwill, at low or no cost, are all around us. The challenge is to be mindful of the opportunities so that the next time we're painting a garage or have some other chance to help someone out, we take it.
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