Your reservation value is the lowest value you will accept in a deal. It goes by many names -- your bottom line, your walkaway point, but whatever you call it it is the worst possible deal you would be willing to accept. We always hope to do better than our reservation values, but it's important to know what yours is, both to avoid accepting a deal you shouldn't have and as a reference point for how much a current deal is worth to you.
If you read a typical textbook on negotiation, you might think that the question of how reservation value relates to BATNA is trivial. Most books define Reservation Value in terms of the value of one's BATNA and assume that they are equal. This makes sense -- as long as the deal is better than your BATNA you'd rather take it than walk away; if it's of equal value then you're indifferent and if it's worse than you'd rather follow your BATNA than take the deal.
For example, imagine you're selling a used car and your BATNA is to sell to someone who has offered you $6,000 in cash. Your BATNA is therefore worth $6,000 and any deal worth less than that will be refused. If you had a deal for $6,100 and were sure you couldn't increase it, you'd take the deal. Right?
I'm not so sure. I think there are good reasons to set your reservation price at a premium to your BATNA, coming from such diverse fields as psychology and poker.
Pot Odds
Experienced poker players will make bets they expect to lose because of "pot odds". If the cost of losing is small relative to the gain of winning, the expected return can be positive even if the most likely outcome is a loss.
Suppose we're playing no-limit poker and I'm down to my last $1,000. There's $10,000 in the pot and it's raised $1,000 to me. Based on my read of my opponent I think I'm an underdog, with only a 25% chance to win. Even though I expect to lose, I should call assuming my decision is based purely on maximizing my expected return on this hand. The math works as follows:
Fold: 100% chance of having $1,000.
Call: 25% chance of having $12,000 ($10,000 plus $1,000 bet plus $1,000 call) and 75% chance of having $0 which is a weighted average return of $4,000.
Since the payoff was much larger than the investment the expected return on calling was positive even though I expect to lose three times out of four.
One professional negotiator I know defines reservation price as "the lowest price you'd accept if you were positive you couldn't get more" but this assumes knowledge we almost never have -- that the other person really won't do any better than their "final" offer.
In our car example, suppose you refuse the $6,100 offer and say you want $7,000. What might happen? It's possible that the other party will say, "Sorry, $6,100 really is the best I can do." They might groan and say, "I can do $6,300 but that's really it." Or they might actually value the car at $8,500 and accept your price. Since $6,100 is really only worth $100 to you (relative to your alternative offer), it's quite likely that you have a positive return on holding out for more, even if you think it's likely that $6,100 really is the buyer's top price.
A final consideration is that refusing someone's final offer isn't always irrevocable. If you say "no" to $6,100 and the buyer walks away you can often (not always) call back and say you've changed your mind.
Underestimation of your BATNA
I find people frequently underestimate the value of their BATNA -- in particular the potential to improve it. Is your BATNA regarding the used car really $6,000? That's an offer you have, but it might be negotiable. You might also find another buyer. We tend to focus on the most tangible aspects of our BATNA, which can lead us to undervalue it. Of course, in theory this means we may need to improve the evaluation of our BATNAs rather than that our reservation price should be set higher, but in practice it speaks to holding out for more.
Reputation
Many negotiations you undertake are semi-public -- people you'll negotiate with in the future (including those you're negotiating with now!) will have some awareness of the results. Given that, it's worth thinking about the reputation you'd like to craft and then weighing that in to the decisions you make. An ideal reputation would include integrity and an ability and willingness to create value but I think it should also include being someone who expects significant value out of a deal and will walk away if that proves impossible to achieve. This may shield you from wasting time on deals that don't offer you much and it encourages your counterparts to adopt a value-creation posture rather than trying to squeeze you.
Cognitive bias
There are at least two types of common cognitive bias that make a no-gain reservation value dangerous: small pie bias and focal point bias.
Small pie bias is pretty straightforward -- people tend to underestimate the size of the pie, which can lead to missed opportunities to grow it and to accepting too small a piece. Focal point bias refers to research showing that in stressful, complex situations (e.g. negotiations) people tend to gravitate mentally to whatever focal point is the most significant to them.
Combined, these factors can easily lead us to think that our reservation value is the value to think about and that any gain above that is a win -- a prescription for leaving a lot of value on the table.
One strategy for fighting this is to set an aspirational target and try to focus on that, keeping the reservation value in your back pocket to be looked at only if the negotiation goes more poorly than expected. This approach has some validity but I think it's risky for all but the most experienced negotiators. Moreover, if you come to believe you've misunderstood the ZOPA and are faced with a deal that is better than your BATNA but worse than the reservation value you've set there's nothing stopping you from taking a step back, re-examining the new information you've received, and adjusting your numbers accordingly.
Putting it all together
Let's look at an example. You've been tasked with buying the patent rights for a piece of technology that's worth $10 million more to your company than your best alternative. Based on a classic BATNA analysis, you'd set your reservation price at $10 million. Your company, however, is the only natural buyer for the technology and you're fairly confident from your analysis that the patent isn't worth anything to its owners and that the best rival offer they're likely to get (from a company in a different business) is in the $3-4 million range and probably less.
There are a lot of away-from-the-table steps you'd take if this was a real situation, but to keep it simple let's assume that they have an unknown but firm offer and are negotiating with you to see whether your company gets the patent.
Suppose they say, "We have a very good offer from (the firm you expected would pay at most $3-4 million), but we know this technology is very valuable to your firm. We'll sell it to you for $15 million."
You take this in stride as an anchoring tactic, state clearly that they have substantially overestimated how much the patent is worth, and make a counter-offer of $2 million. There is some back-and-forth but abruptly they say, "Our absolute final offer is $9.7 million. If you won't pay that, we'll have to go with the other company."
You tell them you'll consider their offer, cautioning them that it's high, and go back to your desk. You revisit your analysis with your team and bring in an outside expert for a fresh view. You still can't believe that it's worth more than $4 million to the other company. But what if it is? You don't want to throw away money, even if it's "only" $300K.
In this situation, there are some compelling reasons not to accept their "final" offer.
First, let's be pessimistic and assume there's only a 20% chance that they're bluffing -- but that if they're bluffing you'll be in the driver's seat and can reasonably expect to pay $5 million. That's an expected return of $1 million relative to your BATNA, which is greater than the $300K on offer.
Second, if your analysis is correct and the ZOPA is $6 million or $7 million in size, neither your firm nor your own career benefits from capturing so small a piece of it.
Next, is your BATNA really to do without the technology? If the firm that buys it is in a different business you may be able to license the technology from them.
This is, of course, simplified. You have a range of tactics available to gain information...but at some point in a negotiation you can be presented with a "final" offer that doesn't make sense given everything you can learn but that is slightly better than your BATNA. Theory says you should take it -- I hope I've provided some reasons to question theory on this point.
Thursday, September 22, 2011
Wednesday, September 14, 2011
Own Your Mistakes
I started this blog while at an executive negotiation class at Harvard Business School. It was a fantastic opportunity to negotiate with professional investors from around the world, and I take real pleasure in the fact that in all of my negotiations I reached agreements that created the maximum value possible (in one case my group was the only one that did) and captured significantly more of that value than average.
All of them but one, that is. In one simulation, I failed to reach a deal at all.
The negotiation involved three entrepreneurs who had formed a very loose ownership agreement when they started a new venture. A few months in, one of the founders (me, in the exercise) concluded that he was working harder and contributing more that was reflected in the original agreement and that this should be reflected with a higher share of equity. He initiated a renegotiation, sending a proposal to his co-founders which formed the starting point of the exercise.
Our discussion didn't go well. One of the other co-founders was keen to make a deal but the other wasn't. He made demands that we couldn't meet, said things that were frankly insulting (always interesting in a simulation!) and ignored our responses. As an example, one of the topics for discussion was his salary (the other co-founders were working just for equity) and neither of us could agree to anything above $110K as we didn't think the venture's cash flows could handle it. Even after we'd made that clear he was proposing deals in which he got paid $150K.
Near the end of the exercise it looked like we might be able to reach a deal, but at the last moment he said he couldn't agree to what was on the table and we "agreed to disagree". Upon returning to the class
My initial reaction was to blame our difficult partner. This was reinforced as we learned more about the other roles and it became clear that salary -- what he had made the largest demands about -- was actually his least important interest and he'd failed even to bring up his most important one. Small wonder we couldn't create enough value to reach agreement when a key player was giving poor information.
Unfortunately, life is rarely so simple. Negotiations is a complicated endeavor and one where we rarely, if ever, get a precise read on how well we did. For this reason it is vital that we review our negotiations candidly, gathering new information if possible and evaluate our performance as objectively as possible. Most of all, we have to own our mistakes. That's why I always review and analyze my negotiations to see what went well and, in particular, what I should have done differently.
In this case I did at least a few things wrong. Foremost, I was in too aggressive a mindset. This exercise, the second in the class, came immediately after a review of a solo exercise in which I had paid $70K for an asset on which the median purchase price was over $200K. Our negotiation had been discussed in class and I judged (correctly) that in the next exercise my counterparts were going to be aggressive in order to avoid a similar result against "the tough negotiator".
Because I was gearing up for a fight, I didn't put as much thought as I normally would into understanding where my counterparts were coming from, something that is key to successful negotiation. Afterwards I would blame our difficult partner for not raising his key issue but normally I would have figured it out ahead of time and been able to raise it myself.
In negotiations it is generally preferable to take an aikido approach. If someone is being aggressive, don't meet that aggression head-on. Doing so makes irrational escalation more likely and makes it harder to work together to create value. Instead, disarm him with a lateral move. In this case if I'd put myself in his position I would have realized that he was feeling like an employee rather than a partner and that "my" initial proposal emphasized that.
Imagine that you're feeling unappreciated and are gearing up for a tough negotiation against a hard-nosed bargainer. Imagine that he begins by saying that he tried looking at the situation from your side and realized that if he was in your position he would feel taken for granted. He wants to start the discussion by asking if that's the case for you, apologizing for it, and then asking what factors are most important to making you feel good going forward?
Another mistake I made was in my orientation to any final deal. As we discussed here, the value you capture in negotiations that involve ongoing relationships are a combination of the tangible factors covered in the deal itself and the intangible consequences of how your counterparts behave in the future based on their own sense of the deal.
In this exercise, three entrepreneurs were agreeing on principles of fairness and value distribution...but what value was being distributed? The equity of the company! This is far from a fixed pie; if we reached a deal but ended up not wanting to work together, we'd each end up owning a slice of nothing. Even in a class exercise this should have affected my approach.
One of the most common forms of human bias is thinking we've performed better than we have. A famous example is car drivers. In one survey, motorists were asked to rate their own driving skill on a scale of 1 to 5 as well as the average skill of other drivers. Other drivers came in at 2.7, while drivers rated themselves 3.9. Unfortunately, this self-delusion can be extremely costly when it prevents us from improving. A tough self-assessment in which we explicitly look for our own errors is one tool to help us resist it.
All of them but one, that is. In one simulation, I failed to reach a deal at all.
The negotiation involved three entrepreneurs who had formed a very loose ownership agreement when they started a new venture. A few months in, one of the founders (me, in the exercise) concluded that he was working harder and contributing more that was reflected in the original agreement and that this should be reflected with a higher share of equity. He initiated a renegotiation, sending a proposal to his co-founders which formed the starting point of the exercise.
Our discussion didn't go well. One of the other co-founders was keen to make a deal but the other wasn't. He made demands that we couldn't meet, said things that were frankly insulting (always interesting in a simulation!) and ignored our responses. As an example, one of the topics for discussion was his salary (the other co-founders were working just for equity) and neither of us could agree to anything above $110K as we didn't think the venture's cash flows could handle it. Even after we'd made that clear he was proposing deals in which he got paid $150K.
Near the end of the exercise it looked like we might be able to reach a deal, but at the last moment he said he couldn't agree to what was on the table and we "agreed to disagree". Upon returning to the class
My initial reaction was to blame our difficult partner. This was reinforced as we learned more about the other roles and it became clear that salary -- what he had made the largest demands about -- was actually his least important interest and he'd failed even to bring up his most important one. Small wonder we couldn't create enough value to reach agreement when a key player was giving poor information.
Unfortunately, life is rarely so simple. Negotiations is a complicated endeavor and one where we rarely, if ever, get a precise read on how well we did. For this reason it is vital that we review our negotiations candidly, gathering new information if possible and evaluate our performance as objectively as possible. Most of all, we have to own our mistakes. That's why I always review and analyze my negotiations to see what went well and, in particular, what I should have done differently.
In this case I did at least a few things wrong. Foremost, I was in too aggressive a mindset. This exercise, the second in the class, came immediately after a review of a solo exercise in which I had paid $70K for an asset on which the median purchase price was over $200K. Our negotiation had been discussed in class and I judged (correctly) that in the next exercise my counterparts were going to be aggressive in order to avoid a similar result against "the tough negotiator".
Because I was gearing up for a fight, I didn't put as much thought as I normally would into understanding where my counterparts were coming from, something that is key to successful negotiation. Afterwards I would blame our difficult partner for not raising his key issue but normally I would have figured it out ahead of time and been able to raise it myself.
In negotiations it is generally preferable to take an aikido approach. If someone is being aggressive, don't meet that aggression head-on. Doing so makes irrational escalation more likely and makes it harder to work together to create value. Instead, disarm him with a lateral move. In this case if I'd put myself in his position I would have realized that he was feeling like an employee rather than a partner and that "my" initial proposal emphasized that.
Imagine that you're feeling unappreciated and are gearing up for a tough negotiation against a hard-nosed bargainer. Imagine that he begins by saying that he tried looking at the situation from your side and realized that if he was in your position he would feel taken for granted. He wants to start the discussion by asking if that's the case for you, apologizing for it, and then asking what factors are most important to making you feel good going forward?
Another mistake I made was in my orientation to any final deal. As we discussed here, the value you capture in negotiations that involve ongoing relationships are a combination of the tangible factors covered in the deal itself and the intangible consequences of how your counterparts behave in the future based on their own sense of the deal.
In this exercise, three entrepreneurs were agreeing on principles of fairness and value distribution...but what value was being distributed? The equity of the company! This is far from a fixed pie; if we reached a deal but ended up not wanting to work together, we'd each end up owning a slice of nothing. Even in a class exercise this should have affected my approach.
One of the most common forms of human bias is thinking we've performed better than we have. A famous example is car drivers. In one survey, motorists were asked to rate their own driving skill on a scale of 1 to 5 as well as the average skill of other drivers. Other drivers came in at 2.7, while drivers rated themselves 3.9. Unfortunately, this self-delusion can be extremely costly when it prevents us from improving. A tough self-assessment in which we explicitly look for our own errors is one tool to help us resist it.
Thursday, September 8, 2011
Adding Issues to Create Value
As we’ve discussed in prior posts, one of the most straightforward and effective ways to create value in a negotiation is to identify and implement value-creating trades. If getting your way on an issue is worth a million dollars to you while getting my way is worth half a million to me, then my goal shouldn’t be to get “my way” but rather to let you get your way…in exchange for more than half a million dollars in value.
In some deals this is relatively easy. The discussions begin with a variety of interests identified, the parties are sophisticated enough to be able to evaluate trade-offs efficiently and discussions move effectively towards the value-maximizing configuration of terms.
Frequently, however, life isn’t so simple. Today’s post looks at introducing issues to a single-issue negotiation using a real-world negotiation I’ve just begun with a software developer.
Some years ago I published a card game called The Battle for Hill 218. It’s fun, quick and deep and has been my most successful single product (still selling quite well today). A few different players have asked me to consider making a version for the iPhone or iPad and recently one of them introduced me to a developer who was interested in creating an iOS version on a revenue share basis (i.e. instead of me paying for his time, he’d be paid out of a share of sales for the app).
The developer’s initial offer was a 70/30 revenue split in his favor. Alternately, I could pay him a flat fee which would be somewhere in the $10K to $20K range.
If the revenue split is all we’re negotiating there’s not much we can do to create value in the deal. Naturally there’s some value in each of us being happy with our agreement and being motivated to promote the app, but for the most part we’d be haggling on price and trying to capture as much of the ZOPA as possible. If there’s only one issue, there’s no room for value-creating trades.
Price, however, is rarely the only important issue worth discussing and in this case there are a number of other possibilities worth considering besides the split of sales.
Price of the app. Even if we agree on what price will maximize revenue of the iOS version of Hill 218, either of us might want to set a lower price in order to attract more users to the app. The developer might like wider exposure of his work and to be able to say (to other potential clients) that he produced an app that a lot of people downloaded. More concretely, I have a monetary incentive to maximize users (especially new users) since I’m still selling the physical game. I’m convinced that offering a free Java version of Hill 218 played an important role in sales of the physical game, and having an iOS version is likely to lead to more sales as well.
Let’s assume for illustration purposes that his ideal price is $3.99 and mine is $1.99. Our next task is to determine how strongly we prefer those prices, as well as how we feel about prices in between. If a price of $1.99 is worth $5,000 more to me than $3.99 and is worth $3,000 less to him, then pricing the app at $1.99 creates $2,000 in value between us. Put another way, I can give up over $3,000 in value from app revenues (which makes him better off) and as long as I give up less than $5,000 I’m better off as well.
Marketing budget. Presumably we can increase sales somewhat by advertising, but I get a double benefit since advertising should boost sales of the physical game as well. To keep things simple, let’s assume that we each think that each dollar (up to $1,000) of advertising would lead to only eighty cents in additional app revenue (forty cents to him and forty to me if we’re splitting things evenly) and that I also think it will be worth forty cents in additional revenue from physical sales. The total value of advertising is $1.20 per dollar, so it’s clearly attractive. If, however, we don’t negotiate advertising then it won’t happen; he gets only forty cents on the dollar and I get eighty (forty from the app and forty from the physical game). Neither of us gets enough to justify doing it alone. If, however, the developer “pays” me more than twenty cents and less than forty cents for each dollar of advertising I do, we’re both better off. (Payment could be done directly (i.e. we share the actual ad expense) or indirectly (i.e. factored into the terms of the deal).
Split based on results. Hill 218 is a new game for the developer. He’s played it online and likes it, but he’s naturally cautious about how much it will sell. I’m more optimistic, given its sales numbers and how popular the Java app has been.
This difference will naturally factor into our discussion over what a split should be. He’ll point to the number of game apps that sell less than a thousand copies and argue that he’s unlikely to make a normal developer fee even with 70%. I’ll talk about how many unique players the Java version has, how the physical game has nearly sold out its second print run and the posts on BoardGameGeek asking for an iOS version.
The key to moving that discussion past arguments for value capture is to recognize that different expectations create room for a compensation split that both parties prefer to any flat fee they might agree.
To keep things simple, let’s assume a price of $3.99 (before Apple’s 30% commission) and volume forecasts as follows:
| | Developer’s Guess | Chad’s Guess |
| 1,000 | 70% | 15% |
| 4,000 | 15% | 30% |
| 10,000 | 15% | 55% |
| Total Sales (unit) | 2,800 | 6,850 |
| Total Revenue ($) | $7,820 | $19,456 |
| Each party’s share | $3,910 | $9,566 |
(Total sales is calculated by multiplying each percentage estimate by that amount of sales, i.e. the Developer’s total sales is 70% of 1,000 plus 15% of 4,000 plus 15% of 10,000.) N.B. These are not my assumptions and I have no idea what assumptions the developer may have -- I put them up here purely for the sake of discussion!
The developer’s average estimate puts total dollar sales at less than $10K and he thinks there’s a 70% chance that sales will only be about 1,000 units, or less than $3,000. I think sales will be nearly $20K and my most likely scenario is a “hit” with 10K unit sales and about $28,000 for us to split.
Given this variance, the last thing we should try to do is agree a single fixed split. That’s could break the deal altogether and is likely to lead to resentment down the road when one of us turns out to be right. If I persuade the developer to take 50% and he ends up getting paid $1,400 it’s a turkey for him; similarly if sales are close to $30,000 and he got 70% of it I’d wish I’d never agreed to a revenue share deal.
A simple alternative is a split that changes as sales grow. Suppose the developer gets 100% of the first 1,000 sales, 75% of the next 1,000 and 25% of sales beyond that. The developer would expect to receive $4,480 (on average), an increase of 15%, and his risk is much lower. If he’s right that the most likely outcome is only 1,000 units at least he gets 100% of the sales. I also expect to receive about 16% more this way, albeit with a higher risk of getting nothing.
Some would argue against calling this value creation since eventually one of us will be proved wrong. Both parties might like this deal better up front but in the future one will be better off and one worse off by exactly the same amount. I would counter with two points. First, being able to “bet” according to one’s beliefs is generally regarded as valuable. Investors buy and sell stocks, companies invest in markets and technologies, collectors buy stamps, coins and other items based in part on their estimation of what the future will bring. Enabling two parties to act according to their expectations of the future is a valid goal of negotiation.
More fundamentally, while one of us will be worse off we’re more likely to be satisfied with the variable commission because the result will be much closer to what we would have agreed if we knew the sales up front. If unit sales are just 1,000 I won’t feel bad that the developer gets all the revenue…and if I expected sales to be that modest I would view the app as a nice promotional item rather than a source of revenue. Similarly, if app sales are 10,000 units can the developer really feel badly about only getting around $10K? Not only do sales of that level imply that the game (my contribution) was highly valuable, but if we knew that sales would be that high I could contract to have the app done by a professional firm for that amount.
How to Introduce Issues
Introducing issues is generally trivial with experienced, sophisticated negotiators. They’re eager to include as many important issues as possible for the same reason you are – they know that’s a powerful way to maximize the deal’s final value. The challenge arises when your counterpart doesn’t have this perspective. He may see an attempt to introduce issues as some sort of gamesmanship or a waste of time. Perhaps worse, he may see it as a request by you that merits a reciprocal concession – that is, your effort to introduce value creation may be met by a value capture effort by the other side.
I’ve found the best approach is to be up front and open about why you want to add issues and then to share at least top-level thoughts about where your interests lie (and where you think your counterpart’s may lie) on each topic. For example, here’s an excerpt from the email I sent to the developer on the subject:
If we can put haggling aside for a moment, however, I'd like to make sure that whatever agreement we reach is as valuable to us in total as possible. As you may guess from my signature, I'm a negotiations geek in addition to being a game geek. This doesn't mean that I'm a particularly hardball negotiator but rather that I'd like us to make sure that we aren't forgetting any "levers" in our agreement that might make the final deal more valuable to each of us. In addition to royalty split, I can think of some other terms we should discuss and I'll share my thoughts about my own interests on them.
I start off by establishing this as separate from haggling over price. This helps avoid the “OK, we can discuss these things but you’ll have to do better on price” trap and makes it clear that adding issues is a mutual and collaborative process of value creation. I finish by offering my thoughts, which then invites him to reciprocate with his.
Value Creation in Parallel with Value Capture
A key consideration through all this is that adding issues (along with other value-creation techniques) don’t replace value capture efforts. They happen in parallel. While raising other issues with the developer, I also expressed my view that his initial offer of a 70/30 split was too high. I’m also addressing his implicit anchor and working on my BATNA by getting quotes from iOS development firms for a cash-only development deal. Although I want my counterpart to be happy with our final deal, emphasizing value creation in no way means that I have to give anything away. It just means that when we finally split up the figurative pile of money on the table, we’ve got as big a pile as possible.
Monday, August 8, 2011
Your Bad BATNA is Your Own Fault
Everyone, even professional negotiators, sometimes find themselves forced to negotiate with a bad BATNA. In another post I looked at some of the ways you can still negotiate effectively with a bad BATNA but today I want to focus on the fact that our BATNAs, good and bad, are generally self-created. I'll go through some examples and then talk about how you can develop good BATNAs long before you even know you're going to be negotiating.
Walking the Dog
We recently got a puppy. In order to keep the option of day and half-day trips to places Jordan can't come we found two local companies that offer dog-walking and "doggy day care" services. One of the companies was well-established and the owner was a friend of a friend. We knew several people who used her service. The other was a relative newcomer.
I met first with the owner of the established company. We had a good conversation about how her service worked and what they offered, and she a contract to fill out at my convenience if I wanted to hire them. I always think you can learn a lot about a firm by the contracts they offer, so I skimmed through it as we talked and found several "interesting" terms.
As you can imagine, one problem a dog walking service has is preventing "poaching" by walkers. The firm hires and trains young workers and then introduces them to clients, in exchange for which it keeps a significant cut of the walking fees. The value provided by the firm is largely up front -- once the walker is trained and has met the client the client doesn't lose much by paying the walker directly so they split what the agency would normally get. In order to avoid this problem, the owner had come up with a creative solution -- a $1,500 "referral" fee the client would pay if he or she hired one of the agency's walkers other than through the agency.
Another problem she must have had was collecting, and she had another solution -- a clause that said that the client was responsible for any legal fees the agency incurred in order to enforce the terms of the contract.
It's likely that if we hired that agency nothing would ever go wrong. I have no interest in poaching and I pay my bills. But disputes do happen, even in relationships where they seem unlikely. When you sign a contract you need to ask how the terms of that contract will affect the resolution of disputes in the event that they do happen?
Let's say a couple of years from now I'm taking Jordan for a walk and we meet a college kid who mentions that he walks dogs to make some extra money. Unbeknownst to me, he once worked for this agency -- or perhaps he actually walked Jordan once but I forgot. The owner thinks that we're "poaching" and demands her fee. Can I negotiate? Not very effectively -- instead of a mutually unpleasant BATNA of going to court, the pain of court is all on my side because I'd have to pay her expenses. She could even make my BATNA worse by mentioning that if we do go to court her attorney happens to be from a premium firm (i.e. very expensive for me)!
Inability to Tolerate a "Normal" BATNA
In discussing how to negotiate with a bad BATNA I mentioned my work with a healthcare non-profit that wanted to negotiate higher reimbursement rates. One of our biggest challenges in those negotiations was that the organization's balance sheet was weak, meaning it couldn't easily afford the lost revenue that would come from temporarily refusing to accept any of the major insurers. Put simply, their BATNA was weak and for purely internal reasons.
Sometimes it's not that your BATNA is all that bad but that you're unable to bear the costs of a moderately bad BATNA that is normal for the negotiation you face. If a union can't afford to strike, a person can't afford to go to court or a client can't afford to change providers for a key service then their negotiation position is weak for potentially unnecessary reasons.
Creating Our Own Problem
All too often we create our own bad BATNA out of whole cloth.
For a vendor, two of the most beautiful words in the world are "switching costs". Switching costs are expenses a customer needs to incur in order to change service providers, and companies work hard to build them in. Some switching costs are natural. If your company contracts out key services it's likely that any new provider would require at least a learning period before they provided as good a service. In some areas, particularly involving software or services that are tightly intertwined with one's core business, switching costs can become prohibitive. In extreme cases, a company can have no viable alternatives at any bearable cost.
Switching costs occur regularly in day-to-day life as well. Loyalty programs are designed to create a benefit (e.g. miles) that loses some or all of its value if we don't continue to buy from that company. Switching costs can be non-financial, too. My main email address, that I've used for many years, ends in the name of my cable company rather than gmail.com and as a result there would be a non-trivial switching cost for me if we ever decide to change cable providers.
It's not realistic to avoid all switching costs, but excessive switching costs can be disastrous, especially if protective measures (e.g. a maximum annual fee increase) aren't built in. If you can't afford to switch you have a terrible BATNA in any negotiation about pricing.
Avoiding Bad BATNAs
To reduce the number of situations in which you have a bad BATNA, the following steps are useful:
Above all, remember that your BATNA isn't something you're stuck with. You can affect both how it starts and how it develops over time.
Walking the Dog
We recently got a puppy. In order to keep the option of day and half-day trips to places Jordan can't come we found two local companies that offer dog-walking and "doggy day care" services. One of the companies was well-established and the owner was a friend of a friend. We knew several people who used her service. The other was a relative newcomer.
I met first with the owner of the established company. We had a good conversation about how her service worked and what they offered, and she a contract to fill out at my convenience if I wanted to hire them. I always think you can learn a lot about a firm by the contracts they offer, so I skimmed through it as we talked and found several "interesting" terms.
As you can imagine, one problem a dog walking service has is preventing "poaching" by walkers. The firm hires and trains young workers and then introduces them to clients, in exchange for which it keeps a significant cut of the walking fees. The value provided by the firm is largely up front -- once the walker is trained and has met the client the client doesn't lose much by paying the walker directly so they split what the agency would normally get. In order to avoid this problem, the owner had come up with a creative solution -- a $1,500 "referral" fee the client would pay if he or she hired one of the agency's walkers other than through the agency.
Another problem she must have had was collecting, and she had another solution -- a clause that said that the client was responsible for any legal fees the agency incurred in order to enforce the terms of the contract.
It's likely that if we hired that agency nothing would ever go wrong. I have no interest in poaching and I pay my bills. But disputes do happen, even in relationships where they seem unlikely. When you sign a contract you need to ask how the terms of that contract will affect the resolution of disputes in the event that they do happen?
Let's say a couple of years from now I'm taking Jordan for a walk and we meet a college kid who mentions that he walks dogs to make some extra money. Unbeknownst to me, he once worked for this agency -- or perhaps he actually walked Jordan once but I forgot. The owner thinks that we're "poaching" and demands her fee. Can I negotiate? Not very effectively -- instead of a mutually unpleasant BATNA of going to court, the pain of court is all on my side because I'd have to pay her expenses. She could even make my BATNA worse by mentioning that if we do go to court her attorney happens to be from a premium firm (i.e. very expensive for me)!
Inability to Tolerate a "Normal" BATNA
In discussing how to negotiate with a bad BATNA I mentioned my work with a healthcare non-profit that wanted to negotiate higher reimbursement rates. One of our biggest challenges in those negotiations was that the organization's balance sheet was weak, meaning it couldn't easily afford the lost revenue that would come from temporarily refusing to accept any of the major insurers. Put simply, their BATNA was weak and for purely internal reasons.
Sometimes it's not that your BATNA is all that bad but that you're unable to bear the costs of a moderately bad BATNA that is normal for the negotiation you face. If a union can't afford to strike, a person can't afford to go to court or a client can't afford to change providers for a key service then their negotiation position is weak for potentially unnecessary reasons.
Creating Our Own Problem
All too often we create our own bad BATNA out of whole cloth.
For a vendor, two of the most beautiful words in the world are "switching costs". Switching costs are expenses a customer needs to incur in order to change service providers, and companies work hard to build them in. Some switching costs are natural. If your company contracts out key services it's likely that any new provider would require at least a learning period before they provided as good a service. In some areas, particularly involving software or services that are tightly intertwined with one's core business, switching costs can become prohibitive. In extreme cases, a company can have no viable alternatives at any bearable cost.
Switching costs occur regularly in day-to-day life as well. Loyalty programs are designed to create a benefit (e.g. miles) that loses some or all of its value if we don't continue to buy from that company. Switching costs can be non-financial, too. My main email address, that I've used for many years, ends in the name of my cable company rather than gmail.com and as a result there would be a non-trivial switching cost for me if we ever decide to change cable providers.
It's not realistic to avoid all switching costs, but excessive switching costs can be disastrous, especially if protective measures (e.g. a maximum annual fee increase) aren't built in. If you can't afford to switch you have a terrible BATNA in any negotiation about pricing.
Avoiding Bad BATNAs
To reduce the number of situations in which you have a bad BATNA, the following steps are useful:
- Get used to thinking about the potential for disagreement. Most people dislike conflict and in particular most people dislike thinking about future conflict at the start of a relationship. At the same time, we recognize that disagreement, conflict and divergent interests exist in even the healthiest relationships. (Just ask any successful business partners or happily-married couple!) Get in the habit of asking yourself what the context for future disagreements is likely to be. If it's tilted against you, the start of the relationship is the right time to act.
- Look forward, reason back. At the start of any long-term relationship, imagine yourself (and, more importantly perhaps, your counterpart) in the future. Does one of you have undue leverage over the other? Are your interests diverging? In my post about negotiating with a bad BATNA I gave the example of a homeowner who had some custom moulding made for his house and found himself with a bad BATNA when he wanted a small amount of additional work done using the same moulding. He could easily have avoided that if he'd asked, "What will happen if it turns out I want some more work done?" and asked the contractor to agree at the start of the original job that any future work using that moulding would be done at a comparable rate.
- Build trust, social capital and mutual need. There is a world of difference between negotiating with someone where you need them and where you need each other. Similarly, integrated organizations can avoid painful games of brinkmanship if they develop social capital and norms that make such behavior unacceptable. This is generally even more effective with individuals.
- Develop your BATNA before you need it. If you're in the habit of looking forward and exploring the potential for future disagreements you can prepare for those disagreements by strengthening your BATNA so that if and when they arise you're in solid shape. As a by-product, your strong BATNA may prevent disagreements from occurring at all, since your counterpart's incentive to force a renegotiation may not exist absent your weakness.
Above all, remember that your BATNA isn't something you're stuck with. You can affect both how it starts and how it develops over time.
Friday, August 5, 2011
How to Create a Scoring Matrix
After my last post I got an email from a reader who said that a scoring matrix sounded like it could be really useful but that she had no idea from what I wrote how she should go about making one. This post will walk through the creation of a simple scoring matrix and then discuss some practical ways one might use it beyond evaluating competing offers.
Let's take a common life decision, leaving one job for a new one. In our hypothetical case, Jane has a job she's happy with but after exploring the market she identified some other interesting opportunities. After pursuing them she's in final interviews with two other companies (we'll call them A and B) and is doing her homework to negotiate in the event any offers come through.
The first step is to set her "utility currency". This is what you'll use to score each component of your offer. For this exercise we're going to use money, but for someone for whom money wasn't a key motivator that might be the wrong way to go -- you could use generic points instead.
Jane currently has a salary of $100,000 and last year she earned $20K in performance bonuses. She's having a good year this year and expects a bonus closer to $35K and a raise to $110K, so her BATNA has a compensation of around $145K. She'll evaluate competing offers accordingly.
Jane identifies the following criteria as important to her decision:
Let's take a common life decision, leaving one job for a new one. In our hypothetical case, Jane has a job she's happy with but after exploring the market she identified some other interesting opportunities. After pursuing them she's in final interviews with two other companies (we'll call them A and B) and is doing her homework to negotiate in the event any offers come through.
The first step is to set her "utility currency". This is what you'll use to score each component of your offer. For this exercise we're going to use money, but for someone for whom money wasn't a key motivator that might be the wrong way to go -- you could use generic points instead.
Jane currently has a salary of $100,000 and last year she earned $20K in performance bonuses. She's having a good year this year and expects a bonus closer to $35K and a raise to $110K, so her BATNA has a compensation of around $145K. She'll evaluate competing offers accordingly.
Jane identifies the following criteria as important to her decision:
- Growth potential. Jane's current company is large but it's also a family business. Some non-family members have reached high levels within the organization but Jane is concerned that she may not be able to accomplish as much as she'd like there. Company A offers more normal growth potential and Company B is particularly exciting because she'd be reporting to a woman who was a longtime client and who has an excellent reputation as a career mentor. Jane estimates that the improved growth prospects are equal in value to $20K in salary at Company A and $40K in salary at Company B.
- Commute. Jane's commute currently takes over an hour each way and combined with long work hours has been taking a toll on her outside life. Company A is only ten minutes away; Company B, unfortunately, is almost an hour and a half away. Jane estimates the commute difference as worth $30K in salary at Company A and -$10K in salary at Company B.
- Vacation time. Jane's family has two traditional events each year, both of which take up a week of vacation. Jane is also passionate about travel and really values the five weeks of vacation she has at her current job. The HR representatives at A and B have told her that new employees only get three weeks of vacation. Jane is very concerned about this; she would rate four weeks salary as -$15,000 and three weeks is almost a deal-breaker. She reluctantly puts it as -$50,000.
A real job evaluation would likely consider more -- possibly many more -- factors than this. How many you include depends on personal preference but you should try to include all significant factors. Once you have a list and start scoring them you may decide to drop some. For example, Jane might have included "quality of nearby lunch options" and then realized that this only scored at $500 which would be rounding error compared with other factors.
Jane's scoring matrix now looks like this:
| | Company A | Company B |
| Salary | Offer - $145K | Offer -$145K |
| Growth | $20K | $40K |
| Commute | $30K | -$10K |
| Vacation | -$50K | -$50K |
| Total | Offer - $145K | Offer - $165K |
The total line is how much better (or worse) an offer is than staying put. From this Jane can tell that any offer above $145K from Company A or above $165K from Company B has a positive score and thus seems better than her BATNA of staying where she is. More importantly it's a useful tool for negotiating with her new company and for creative problem-solving on her own.
Let's start with the commute. Once Jane has it down on paper that she'd give up $30K in salary to shorten her commute she might think about moving. There aren't any places she'd like to live that are closer to her current company but there's an attractive neighborhood close to Company B. Rent is likely to be $15,000 a month higher but that's still a net improvement of $15,000 ($30K value of short commute less $15K in higher rent) instead of the negative $10,000 if she were to stay where she is. Thinking through her priorities thus led her to realize that what looked like a drawback could be converted into a positive.
Fully understanding her interests might lead Jane to improve her BATNA as well. Either before or after she gets an offer, Jane may decide to talk to her manager and explain that limited career prospects are playing a significant role in her considering a different firm. It's possible that they'll want to keep her and will find a way to give her confidence that she can advance there.
Then there's vacation. Jane really cares about her travel time; going from three weeks to four is worth the equivalent of $35,000 in salary to her and a fifth week is worth another $15,000! Recognizing that should guide her in her negotiation but it also suggests a possible solution if the three week policy is indeed firm -- her contract could include two weeks of unpaid leave. If her compensation is roughly $3K per week, then taking two weeks of unpaid time costs her $6K compared with her current job, which is much better than $50K.
Assuming Jane gets an offer from Company B, this problem solving suggests a different scoring matrix:
| | Company B (original) | Company B (revised) |
| Salary | Offer - $145K | Offer -$145K |
| Growth | $20K | $40K |
| Commute | $30K | $15K |
| Vacation | -$50K | -$6K (assuming 2 unpaid wks) |
| Total | Offer - $145K | Offer - $84K |
One last point. A scoring matrix is only as accurate as the assumptions used to make it. It should be reviewed and challenged and you should never forget that it's a tool. For example, if Jane gets an offer of $90K her matrix gives that a positive score but such a significant drop in salary might indicate that her new firm sees her playing a less important role than she anticipates.
Thursday, August 4, 2011
Create Your Scoring Matrix
If you've ever taken a negotiation class or read an MBA negotiation case, you've probably noticed one major difference between a case and the real world. A typical case provides a scoring matrix that converts any deal into a value that can be compared with other deals.
For example, in the Harvard Business School case Moms.com, a television production studio negotiates with a local TV station to sell syndication rights for reruns of a popular show. The central issue is price, but the worksheet in the back of the case also tells you the dollar value of being allowed to do four, six or eight "runs" (essentially how often you can show each episode) and exactly how much to discount cash received in future years.
These matrices are extremely helpful in finding value-creating tradeoffs. In Moms.com it costs the production company less (in lost value) to allow eight runs than it gains the TV station (in higher ad revenue), so four or six runs are dominated by eight. Up front payment also dominates any delayed payment because the production company has a higher discount rate, so it costs them more to delay being paid than the TV station benefits. (To say term A is dominated by term B means that for any deal with A it is possible to find a deal with term B in which all parties are better off.) Figuring this out is trivial if the parties share information openly, but isn't hard even if they don't, provided the parties really know what the various options are worth.
Professor Max Bazerman says probably the most common criticism he hears of cases is precisely that in the real world you aren't provided with a scoring matrix. His response is perfect:
In order to evaluate alternatives you need to know all of your interests and how important each of your interests are to you. Start by brainstorming and getting a rough sense of priorities, as well as any trigger point. (For example, if you have a major family reunion planned at your home in September, that may mean that any finish later than August is a deal-breaker.) Try to formalize your list into a set of utility values that can be offset against each other. (This is sometimes easier to do when the central factor is money, but even in a non-financial negotiation you should be able to say that X is about +20 and Y is -5.) Write it down and then test what you've written by comparing your reaction to hypothetical offers to what your scoring system says. Make sure you know the score value of your BATNA so that in addition to comparing offers A and B you also know whether and by how much each meets your interests better than your no-deal alternative does.
Finally, test your scoring system with other people. If you're the only stakeholder (e.g. you're single and you're negotiating a job) a friend who knows you well may be able to identify interests you haven't considered or help you see scores that don't mesh with what she knows about you. If you have lots of stakeholders, this step is even more important because it's not just your scoring system. The more buy-in you have, the more flexibility you'll have to make value-creating trades and the less chance you'll find that you have to backtrack from what seemed like a promising proposal.
For example, in the Harvard Business School case Moms.com, a television production studio negotiates with a local TV station to sell syndication rights for reruns of a popular show. The central issue is price, but the worksheet in the back of the case also tells you the dollar value of being allowed to do four, six or eight "runs" (essentially how often you can show each episode) and exactly how much to discount cash received in future years.
These matrices are extremely helpful in finding value-creating tradeoffs. In Moms.com it costs the production company less (in lost value) to allow eight runs than it gains the TV station (in higher ad revenue), so four or six runs are dominated by eight. Up front payment also dominates any delayed payment because the production company has a higher discount rate, so it costs them more to delay being paid than the TV station benefits. (To say term A is dominated by term B means that for any deal with A it is possible to find a deal with term B in which all parties are better off.) Figuring this out is trivial if the parties share information openly, but isn't hard even if they don't, provided the parties really know what the various options are worth.
Professor Max Bazerman says probably the most common criticism he hears of cases is precisely that in the real world you aren't provided with a scoring matrix. His response is perfect:
In the real world, it's your job to create your scoring matrix as part of your negotiation prep work.People often enter negotiations with only a general understanding of their own interests. If you're contracting an addition to your home it's trivial to know that you'd rather pay less than more, that you'd rather pay later than earlier, that you'd rather have the work finished earlier than later, etc. That's not enough to answer a question like, "Would I rather pay $50K to have the work done by September or $60 to have it done by June?"
In order to evaluate alternatives you need to know all of your interests and how important each of your interests are to you. Start by brainstorming and getting a rough sense of priorities, as well as any trigger point. (For example, if you have a major family reunion planned at your home in September, that may mean that any finish later than August is a deal-breaker.) Try to formalize your list into a set of utility values that can be offset against each other. (This is sometimes easier to do when the central factor is money, but even in a non-financial negotiation you should be able to say that X is about +20 and Y is -5.) Write it down and then test what you've written by comparing your reaction to hypothetical offers to what your scoring system says. Make sure you know the score value of your BATNA so that in addition to comparing offers A and B you also know whether and by how much each meets your interests better than your no-deal alternative does.
Finally, test your scoring system with other people. If you're the only stakeholder (e.g. you're single and you're negotiating a job) a friend who knows you well may be able to identify interests you haven't considered or help you see scores that don't mesh with what she knows about you. If you have lots of stakeholders, this step is even more important because it's not just your scoring system. The more buy-in you have, the more flexibility you'll have to make value-creating trades and the less chance you'll find that you have to backtrack from what seemed like a promising proposal.
Monday, August 1, 2011
Debt Ceiling Deal
It now looks like we have a deal on the U.S. debt ceiling. While the deal hasn't yet passed, it seems very likely that it will for two reasons. I don't think Obama, Reid, Boehner and McConnell would be endorsing it unless they already had a pretty good sense of the vote. More fundamentally, prior bills failed because one party or the other was 100% against them so all the yes votes had to come from the other side. Even if Tea Party Republicans vote no on this compromise the bill can still pass since some number of Democrats in the House will vote in favor.
I usually blog about one specific idea, but today's post is going to move about a bit as there are a number of really interesting things to discuss about the negotiation and the deal, so I'm going to move around between them.
Agreement at the Last Minute
As has been widely noted, this negotiation came down to the wire. This is very common and is seen not only in negotiations but in complex auctions as well. Until the deadline (or final round) approaches, a lot of activity is kept on hold. There are some good reasons for this and some bad ones but recognizing it is important when we consider our own negotiations, especially those in which we have some control over process.
There is some research that suggests that a willingness to wait to the last second helps capture value. In one study of negotiation exercises conducted between Americans and Israelis, for example, the Israelis captured more value and the main factor seemed to be their comfort in waiting. The downside is that reducing the amount of constructive negotiation time and keeping cards close to one's vest are both harmful to value creation. As we've discussed, in many deals the potential to do well by increasing the size of the pie outweighs incremental gains in one's share of the original pie. Negotiators should consider how much value creation potential they see, and if it's high they should consider working against the "deadline" phenomenon.
The greater the amount of brinkmanship involved (and this deal had a lot), the more likely it is that real progress waits until the last moment possible. Trust and a mutual commitment to value creation are essential if major progress is to be made throughout a negotiation.
Deal within a Deal
The current deal accomplishes a modest amount of deficit reduction now and empowers a 12-person group (nicknamed the Super Congress) to propose further deficit reductions. If it fails to do so, or if those reductions are blocked by Congress (difficult, but theoretically not impossible) then further spending cuts are automatically triggered, divided between defense and domestic programs. Thus, the main consequences of this deal are not fully known at this time and will depend on which members are chosen for the committee.
The Wall Street Journal notes this and says
Deliberately Creating a Bad BATNA
Agreeing on substantial deficit reductions won't happen easily, since each party wants them to happen in different ways. The initial agreement happened largely because Republicans created a bad BATNA for both sides by threatening to block an increase in the debt ceiling. The current deal takes a less drastic approach by saying that unless an agreement can be reached the cuts (or shortfall in the event that a partial agreement is reached) will be triggered automatically. Since half of the cuts would come from Defense and half from domestic programs, it's hoped that members from each party would find a compromise preferable.
Most observers are summarizing this as a situation where Republicans would hate half the cuts (to defense) while Democrats would hate the other half (to domestic programs) but I think there's something more subtle at work. Creating a mutually painful BATNA works when the negotiation in question has the potential for value creation, i.e. it's easily possible to create deals that are better for both parties than their BATNA. Electoral politics is very nearly zero-sum. Thus, from a political perspective, it's hard to see how any particular outcome is damaging to both sides.
I suspect that this structure really aims at creating political cover for, and applying political pressure on, individual members. A reluctant Congressperson can say, "This proposal isn't perfect but it's what the Committee has agreed on and the alternative means failing to support our troops in the field and cutting medical support to the most needy." Alternately, any block that attempts to prevent a proposal from being enacted (e.g. because it includes some tax increases) is in a more vulnerable position than when the consequences of no deal being reached are vague or theoretical.
As Always, the Fine Print Matters...and sometimes it's Dominant
The agreement calls for deficit reductions...but from what? The current CBO baseline (which is what the triggers are based on) seems both obvious and neutral but it includes an assumption that is politically volatile: that the Bush tax cuts will expire in 2013, adding $3.5 trillion in revenues.
This is huge. Republicans have long insisted that the Bush tax cuts should be made permanent and Obama and most Democrats have supported making them permanent for those making less than $200,000 per year. Either proposal would mean a bigger change to the CBO baseline than the entire targeted level of reductions.
The WSJ editorial argues that this is such a large increase that the Super Congress is unlikely to consider any further increases, but this is pretty simplistic analysis. The Super Congress is likely to want to ignore the Bush tax cuts altogether in its proposal, since any change would make their task monumentally more difficult, and their timeline theoretically makes ignoring the cuts easy. Obama, however, can use his threat to veto a later extension of the cuts to pressure Republicans to accept some tax increases as part of their overall deficit reduction recommendation. Obama has some real leverage here, as the cuts expire after the 2012 election, giving Republicans limited recourse against a veto threat. It's entirely possible that a two-prong agreement will be reached, with some tax increases being part of the Super Committee's recommendation in exchange for concessions on the Bush tax cuts.
More fundamentally, it means that this deal should be seen as just one salvo in an ongoing struggle. A small agreement has been reached with a medium-sized negotiation scheduled through November but a larger issue remains very much on the table and barely discussed in the context of the current deal. Regardless of where you fall on the political spectrum, we continue to live in interesting times.
I usually blog about one specific idea, but today's post is going to move about a bit as there are a number of really interesting things to discuss about the negotiation and the deal, so I'm going to move around between them.
Agreement at the Last Minute
As has been widely noted, this negotiation came down to the wire. This is very common and is seen not only in negotiations but in complex auctions as well. Until the deadline (or final round) approaches, a lot of activity is kept on hold. There are some good reasons for this and some bad ones but recognizing it is important when we consider our own negotiations, especially those in which we have some control over process.
There is some research that suggests that a willingness to wait to the last second helps capture value. In one study of negotiation exercises conducted between Americans and Israelis, for example, the Israelis captured more value and the main factor seemed to be their comfort in waiting. The downside is that reducing the amount of constructive negotiation time and keeping cards close to one's vest are both harmful to value creation. As we've discussed, in many deals the potential to do well by increasing the size of the pie outweighs incremental gains in one's share of the original pie. Negotiators should consider how much value creation potential they see, and if it's high they should consider working against the "deadline" phenomenon.
The greater the amount of brinkmanship involved (and this deal had a lot), the more likely it is that real progress waits until the last moment possible. Trust and a mutual commitment to value creation are essential if major progress is to be made throughout a negotiation.
Deal within a Deal
The current deal accomplishes a modest amount of deficit reduction now and empowers a 12-person group (nicknamed the Super Congress) to propose further deficit reductions. If it fails to do so, or if those reductions are blocked by Congress (difficult, but theoretically not impossible) then further spending cuts are automatically triggered, divided between defense and domestic programs. Thus, the main consequences of this deal are not fully known at this time and will depend on which members are chosen for the committee.
The Wall Street Journal notes this and says
While the "trigger" includes no revenue increases, the committee itself could agree to raise taxes to meet the $1.2 trillion deficit reduction target. This means GOP leaders Mitch McConnell and John Boehner have to be especially careful in their choice of appointees. No one from the Senate Gang of Six, who proposed tax increases, need apply. The GOP choices should start with Arizona Senator Jon Kyl and House Budget Chairman Paul Ryan, adding four others who will follow their lead.We don't know, however, whether the membership of the Super Congress has already been agreed. Nor is it clear that Boehner and McConnell would choose six hard-liners. The whole purpose of creating the Super Congress is to make it more likely that politically difficult deficit reduction decisions will be taken, both by reducing the number of people who need to reach agreement and by providing political cover to members of Congress who might otherwise have trouble supporting it. Republicans were able to hold firm on tax increases in the initial agreement but at the cost of being seen as unreasonable according to many polls. Continuing to hold that hard line carries real political risk, so the Super Congress may be a "golden bridge" (to borrow terminology from William Ury) that lets them compromise on some tax increases. From the perspective of internal politics it's also likely that Republican leaders don't want to give too much power to the element of their party that was the least tractable.
Deliberately Creating a Bad BATNA
Agreeing on substantial deficit reductions won't happen easily, since each party wants them to happen in different ways. The initial agreement happened largely because Republicans created a bad BATNA for both sides by threatening to block an increase in the debt ceiling. The current deal takes a less drastic approach by saying that unless an agreement can be reached the cuts (or shortfall in the event that a partial agreement is reached) will be triggered automatically. Since half of the cuts would come from Defense and half from domestic programs, it's hoped that members from each party would find a compromise preferable.
Most observers are summarizing this as a situation where Republicans would hate half the cuts (to defense) while Democrats would hate the other half (to domestic programs) but I think there's something more subtle at work. Creating a mutually painful BATNA works when the negotiation in question has the potential for value creation, i.e. it's easily possible to create deals that are better for both parties than their BATNA. Electoral politics is very nearly zero-sum. Thus, from a political perspective, it's hard to see how any particular outcome is damaging to both sides.
I suspect that this structure really aims at creating political cover for, and applying political pressure on, individual members. A reluctant Congressperson can say, "This proposal isn't perfect but it's what the Committee has agreed on and the alternative means failing to support our troops in the field and cutting medical support to the most needy." Alternately, any block that attempts to prevent a proposal from being enacted (e.g. because it includes some tax increases) is in a more vulnerable position than when the consequences of no deal being reached are vague or theoretical.
As Always, the Fine Print Matters...and sometimes it's Dominant
The agreement calls for deficit reductions...but from what? The current CBO baseline (which is what the triggers are based on) seems both obvious and neutral but it includes an assumption that is politically volatile: that the Bush tax cuts will expire in 2013, adding $3.5 trillion in revenues.
This is huge. Republicans have long insisted that the Bush tax cuts should be made permanent and Obama and most Democrats have supported making them permanent for those making less than $200,000 per year. Either proposal would mean a bigger change to the CBO baseline than the entire targeted level of reductions.
The WSJ editorial argues that this is such a large increase that the Super Congress is unlikely to consider any further increases, but this is pretty simplistic analysis. The Super Congress is likely to want to ignore the Bush tax cuts altogether in its proposal, since any change would make their task monumentally more difficult, and their timeline theoretically makes ignoring the cuts easy. Obama, however, can use his threat to veto a later extension of the cuts to pressure Republicans to accept some tax increases as part of their overall deficit reduction recommendation. Obama has some real leverage here, as the cuts expire after the 2012 election, giving Republicans limited recourse against a veto threat. It's entirely possible that a two-prong agreement will be reached, with some tax increases being part of the Super Committee's recommendation in exchange for concessions on the Bush tax cuts.
More fundamentally, it means that this deal should be seen as just one salvo in an ongoing struggle. A small agreement has been reached with a medium-sized negotiation scheduled through November but a larger issue remains very much on the table and barely discussed in the context of the current deal. Regardless of where you fall on the political spectrum, we continue to live in interesting times.
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