Negotiation Secrets

CLAIM VALUE IN NEGOTIATION

Value is whatever people find useful or desirable. You may measure value in dollars, utility, happiness, or a variety of other metrics. Negotiation helps to create value through agreements that make both parties better off than they were without an agreement. But how much better off is each party? This depends, in part, on which party managed to claim (or capture) more of the value that was created. For example, if a buyer negotiates a very low price for an item, she claims more value; the seller claims more of the value (created by the deal) when the price is high.

Let's say you are the seller of a large piece of land located in the town of X. The amount that a potential buyer will pay for the X property depends on a number of factors, including the buyer's ability to pay and their planned use of the property. For example, you have estimated that if the land were developed for commercial use (e.g., office buildings), the land might be worth 2 times as much as if it were developed for residential use (e.g., apartment buildings). Unfortunately, commercial developers are unlikely to be interested in the property because X zoning laws don't allow for commercial development. The highest offer you've received is for $38 million from A, a developer that that is planning to construct a set apartment buildings on the X property. You expect that you could negotiate the price up an additional 10-15% if you chose to pursue the offer. For now, however, you've chosen not to negotiate with A because B, another developer, has just sent word that he is also interested in the X property. You believe that B would develop the property for the construction of luxury condos, and you could get a higher selling price for the X property if the land is to be used for luxury condos rather than for apartment buildings. You have decided to meet with B to negotiate a sale. If these talks are not successful, you plan to return to A and finalize a deal. The following is public knowledge: You purchased the X property ten years ago for $27 million. An evaluation of recent sales of comparable properties suggests that the X property could be worth $36-44 million if developed for apartments and an additional 20% if used for condos.

Prepare To Negotiate

To prepare effectively for negotiation, follow this five-step pre-negotiation framework:

1_Assess your BATNA: The first step in any negotiation is to ask yourself, "What will I do if the current negotiation ends in no deal?" In other words, you need to assess your BATNA, or Best Alternative To Negotiated Agreement--the course of action you will pursue if and when the current negotiation ends in an impasse. Without a clear understanding of your BATNA, it is impossible to know when to accept a final offer and when to walk away in order to pursue other options. Your BATNA is not what you think is fair, or what you originally paid for the item you are selling, or the price that you hope to achieve. Your BATNA is the reality you will face if you reach no deal in the current negotiation. Your BATNA assessment requires the following three steps: 1) Identify all of the plausible alternative options you might pursue if you are unable to reach an agreement with the other party. 2) Estimate the value associated with each alternative. 3) Select the best alternative; this is your BATNA. In the X case, you have a number of alternatives: you might wait for other offers, you might approach A to finalize the deal, or you might decide not to sell at all. The information available to you suggests that your BATNA would be to finalize a deal with A.

2_Calculate your reservation value: An analysis of your BATNA is critical because it allows you to calculate your reservation value (RV), or your walk-away point in the current negotiation. As the seller in the X case, your reservation value is the lowest offer you would be willing to accept from B. A has offered $38 million. Is $38 million your RV? Not quite, because you could negotiate this price further with A--a 10-15% increase in the offer, yielding an amount ranging from $41.8-$43.7 million. Your RV should fall within this range.

3_Assess the other party's BATNA: You don't want to settle for a low sale price, so you'll need to figure out how high a price you might be able to negotiate. In other words, you have to figure out the other party's RV. B's RV is the highest amount that B would be willing to pay for the X property. You figure this out by assessing the other party's BATNA. This critical step can make the difference between getting a good deal and getting a great deal. In the X negotiation, thinking through B's alternatives can help you to discover his BATNA. Presumably, if he is unable to purchase the X property, B will want to invest his money in a different development project. For now, let's presume that your analysis suggests that B's BATNA is to wait out. In other words, if he is unable to reach an agreement with you, B will hold on to his cash and wait for new opportunities to arise in the future.

4_Calculate the other party's reservation value: Now that you have evaluated B's BATNA, a reasonalbe way to determine his RV is to consider what he is likely to do with the X property. You believe that B will build condos on the property rather than apartments, which makes the property more valuable to them than it would be to A. Specifically, development for condos would increase the value of the property by 20%. To assess B's RV (or highest willingness to pay), the following reasoning may be appropriate: _Estimates suggest that the property is worth $36-44 if used for apartment buildings. _The midpoint of this range is $40 million. _A 20% increase (due to development for condos) over $40 million yields a value of $48 million. _Thus, it's reasonable to expect that B's RV is $48 million.

5_Evaluate the ZOPA: Once you have an idea of each party's RV, you can evaluate the Zone Of Possible Agreement, or ZOPA. The ZOPA is the set of all possible deals that would be acceptable to both parties. Put another way, the ZOPA is the space between the seller's RV and the buyer's RV. In the current negotiation, the ZOPA is any offer that falls between $42.75 million and $48 million. Now that you have an idea about how much value is up for grabs ($48M-$42.75M=$5.25M), you are ready to do your best at claiming the lion's share of it.

Make The Deal

To set up our own analysis of the case, let's consider how your negotiation with B might have unfolded: You met with B and made the case for a high sale price. You mentioned that you had received several other offers and made an aggressive opening offer of $49 million. B made a counteroffer of $45 million. This offer already exceeded your RV, but you wanted to make as much profit as you could, so you continued to haggle. At the end of the day, you were able to convince B to accept a price of $46 million.

Negotiation Postmortem

One way to evaluate your performance is to ask whether you surpassed your RV: clearly, you did. While this is certainly good news, it may not be a great measure of negotiation success. Why? Because it's possible to surpass your RV and yet only claim a small portion of the total value up for grabs. Another way to evaluate your performance is to consider the entire ZOPA. The price you negotiated ($46 milliion) seems closer to B's RV than yours, suggesting that you claimed significantly more than 50% of the value that was up for grabs. Depending on how high you aspirations were at the outset of this negotiation, you might be happy or displeased with this outcome.

While these two metrics are useful, they both suffer from one important drawback: they evaluate your performance relative only to what you knew before the negotiation. A more complete measure would evaluate your outcome according to what you could have discovered during the negotiation. How would you feel if you discovered that B's RV was not $48 million but $46 million? Presumably, you would feel that you did even better than you had originally thought: you captured all of the ZOPA. Alternatively, how would you feel if B's RV was much higher--$55 or $60 million? In that case, B would have captured the lion's share of the value. As you can see, how well you actually performed in this negotiation depends on an evaluation of how well you could have done.

Now consider some information that only B knew at the outset of the negotiation: _B was actually not interested in developing the X property for residential construction; they hoped to use this property to enter the commercial development industry. _B, with his strong political ties, was among the first to know that zoning laws in X were scheduled to change in the coming months, making commercial development possible. _B would have been willing to pay up to $60 million to purchase the X property. Given this new information, the $46 million sale price looks a lot less impressive. In this new light, the outcome you negotiated is much closer to your RV than it is to B's. It looks as if B captured most of the value that was up for grabs. You could have done much better.

Should You Make The First Offer?

The right answer is "it depends." The primary benefit of making a first offer in negotiation is that it establishes an anchor. An anchor is a number that focuses the other negotiator's attention and expectations. Especially when the other party is uncertain about the correct, fair, or appropriate outcome, they are likely to gravitate toward any number that helps them focus and resolve their uncertainty. As it turns out, first offers tend to serve this purpose well: they anchor the negotiation and strongly influence the final outcome. For example, imagine that you calculated B's RV to be $48 million and that you expected him to make an aggressive first offer of about $40 million. If, instead, he makes a first offer of $32 million, you are likely to start questioning your assessment of B's RV. Would B start so low if he could actually pay as much as $48 million? Is B planning to build apartments, not condos? Perhaps his maximum willingness to pay is much lower than $48 million. When the other party sets an anchor, it influences not only your perceptions of their RV (and, hence, of the ZOPA), but also your counteroffer. You may have planned to start the negotiation at $50 million, but given B's surprisingly low first offer, you now begin to think that you should start a little lower. An offer of $50 million now seems extreme, carrying with it the risk of impasse. Instead, you counter the $32 million offer with a more reasonable-sounding offer of $45 million. B's anchor has worked.

Given the powerful effects of anchoring, it becomes clear that there may be an advantage to making an aggressive first offer in a negotiation. Why, then, is it sometimes better to let the other party make the first move? When made prematurely, a first offer can be extremely costly. Consider what happened in the X negotiation. Your "aggressive" first offer of $49 million was based on your belief that B's RV was $48 million. As it turns out, your perception was incorrect, and the first offer was disastrously low. Because B's actual RV was $60 million, you probably could have negotiated a much higher sale price than you actually did. However, the moment you made a first offer of $49 million, you set the upper limit for what you could possibly capture. In other words, you lost your claim to a large portion of the ZOPA by making a first offer that was well below the other party's RV.

As this discussion suggests, whether you should make the first offer or not depends upon how much information you have. If you believe you have sufficient information about the other side's RV, it pays to make an opening offer that anchors the discussion in your favor. If you suspect that you may not have enough information about the ZOPA, you'd be wise to defer an opening offer until you have collected more information. In this case, it may even be a good idea to let the other party make the first offer. You might forgo the opportunity to anchor the negotiation, but you also avoid the downside of not anchoring aggressively enough. A lack of information can also lead you to anchor too aggressively, demanding an amount that might offend the other side and drive them away.

How Should You Respond To Their Initial Offer?

1_Ignore The Anchor: The best thing to do in the event that the other party make an aggressive first offer--whether high or low--is to ignore it. This doesn't mean you should pretend you didn't hear it. Rather, respond to this effect: "Judging by your offer, I think we might be looking at this deal in very different ways. Let's try to bridge that gap by discussing ..." In this manner, you can shift the conversation to an entirely different topic, one that allows you to reassert control of the discussion.

2_Seperate Information From Influence: Every offer is a combination of information and influence. The other party's offer tells you something about what he believes and wants (information), but it also has the power to derail your strategy (influence). Your task is to separate the information contained in the particulars of the offer (and the way in which it was made) from the other side's attempt to influence your perceptions. The best way to stave off influence is to stick to your original game plan. If you walked in with a prepared first offer, don't allow the other side's anchor to soften it. This doesn't mean that you should ignore substantial information that changes your beliefs about the actual ZOPA. However, it's important to realize that anchors will affect perceptions and counteroffers even in the absence of any real information provided to you.

3_Avoid Dwelling On Their Anchor: The more an anchor is discussed in a negotiation, the more powerful it becomes. If you ask the other party to justify their offer or discuss it further, you increase the power of that anchor to define the negotiation parameters. Almost always, your counterpart will find a way to frame the negotiation such that their offer makes at least a modicum of sense. On the other hand, you don't want to miss out on the opportunity to learn something new about the deal or about your counterpart's perspective. To resolve this dilemma, try the following: if you are surprised by their offer, probe a little to find out if there is in fact any substantive new information that you can obtain. If no such information is forthcoming, quickly shift attention away from the anchor by sharing your own perspective and defining the negotiation in your terms.

4_Make An Anchored Counter-Offer, Then Propose Moderation: If it's not possible to ignore or dismiss the other party's anchor, you should offset its influence by making an aggressive counteroffer. In doing so, you retain the ability to capture as much of the ZOPA as possible. However, countering aggression with aggression comes at a risk: the possibility that both parties will become entrenched and reach an impasse. To mitigate this risk, you should offset their anchor with an aggressive counteroffer, and then suggest that you need to work together to bridge the gap. In addition, you should offer to make the first move toward moderation by discussing your own perspective (i.e., by justifying your aggressive counteroffer). This allows you to deflate their anchor while shifting from an aggressive exchange to a quest for common ground.

5_Give Them Time To Moderate Their Offer Without Losing Face: If the other party's initial offer is very extreme--far outside the ZOPA--you may need to inform them that their offer is not even a basis for starting the discussion. This assertion should be followed by information regarding your own perspective and a candid invitation to reopen negotiations from a very different starting point. Of course, it may not be easy for them to quickly reduce their demands so drastically--doing so would reveal that they were simply posturing when they made their initial offer. As a result, you may want to give them some time to "think about it." If they decide to moderate their demands, they will need time to save face. They can return to the bargaining table in a day or a week, after "having figured out a way to make this happen," "having re-crunched the numbers," or "having fought it out with our constituents." In other words, when reacting to very extreme offers, your foremost goal should be to re-anchor successfully, not to convey your outrage. And this often means helping the other side find a way to retract earlier demands and arguments.

What Should My First Offer Be?

1_Keep The Entire ZOPA In Play: Make an offer that falls outside the ZOPA--one that you know the other side will not accept. In this manner, when substantive negotiations begin, you will still have the ability to claim as much value as possible. The idea is to force the other party to negotiate their way into the ZOPA. If your first offer is already inside the ZOPA, you have given up the ability to claim value that lies between your offer and the other party's RV from the very start.

2_Provide A Justification For Your Offer: How far outside the ZOPA should your offer be? On the one hand, the higher your first offer, the more likely it is that if you reach an agreement, it will be closer to the other side's RV than to yours (and hence more profitable for you). However, the more aggressive your first offer, the more likely it is that the other party will be offended by it, think that you are not serious, or believe that there is no way of reaching an agreement with you. To balance these concerns, consider the context: the degree of aggressiveness should be appropriate to the situation. In most real world negotiation contexts, you will not want to be too far outside the ZOPA; otherwise, you lose credibility. In other situations (business disputes, labor-management negotiations, haggling with a street vendor, etc.), it's normal and expected for both parties to open with extreme demands. It would be unwise in these cases to moderate your demands too much because the other side is still likely to anchor aggressively. To determine your exact offer, ask yourself the following question: "What is the most aggressive offer that I can justify?" You should never make an offer so extreme that it can't be stated as follows: "I'd like to propose X, because ..." If you can't finish this sentence in any meaningful way, you're probably asking for too much.

3_Set High, But Realistic Aspirations: Those who set high aspirations tend to make more aggressive first offers in order to reach their target. And those with aggressive targets work harder at haggling once both parties's opening offers are on the table. High aspirations serve as self-fulfilling prophecies; they motivate the kinds of behaviors that help us achieve aggressive targets.

4_Consider The Context And The Relationship: The most important thing to consider when making any offer is the context of the negotiation. What type of relationship do you have with the other side? Will hard bargaining be ill-received? Are reputations at stake? What norms drive your interactions? Your offer and justifications should be informed by your understanding of the needs and sensitivities of the relationship. You goal should not simply be to get the best possible deal while preserving the relationship, but to get the best deal while strengthening the relationship and your reputation. You may have to forgo some short-term gains to meet this goal.

How Far Can I Push Them?

Knowing the other side's walk-away point tells you just how far they can be pushed--and how much value you can capture. To get the information that will help you estimate the other side's RV, follow these steps:

1_Exhaust all pre-negotiation sources of information: There are often many ways to collect information that do not entail guessing or asking the other party directly. For example, in the X negotiation, the seller should begin by talking to state and local politicians to assess the likelihood that commercial zoning laws will change. Gaining a clearer understanding of the ZOPA and the other side's interests is just one benefit of acquiring information prior to negotiation. Information also helps you to avoid being manipulated or lied to during the negotiation and to be taken more seriously.

2_Identify your assumptions prior to the negotiation: Make a comprehensive list of what you are assuming and what you don't know prior to your negotiation. In the X negotiation, you assumed (incorrectly) that commercial development was not an option.

3_Ask questions that challenge your assumptions: Never start bargaining as if your assumptions are correct. Instead, ask questions to clarify matters. In the X discussion, you might start, "If the land is used for commercial development, that'll make it quite valuable. With that in mind, let's discuss some specifics. What are your plans for this excellent piece of real estate?"

4_Ask indirect questions: The other party will sometimes refuse to answer questions that could help you determine their RV. In that case, you need to ask questions that are less direct--and less threatening. For example, you might ask B about the challenges his business faces, what he hopes to accomplish in the next ten years, what kinds of projects you might be able to help him with in the future, or how the X purchase fits into his portfolio of projects.

5_Protect yourself from lies and uncertainty with contingency contracts: Contingency contracts are agreements that leave certain elements of the deal unresolved until uncertainty is resolved in the future. In the X negotiation, a contingency contract might state: "The sale will be made at a base price of $46 million, with the condition that if the land is used for commercial development in the next ten years, the buyer will pay an additional $10 million to the seller."

Effective Haggling Strategies

1_Focus on the other party's BATNA & RV: Negotiators who focus on their own BATNA ("What can I do without the other party?") tend not to set high aspirations and are happy getting anything better than their RV. Meanwhile, those who focus on the other party's BATNA ("What will they do without me?") are paying attention to the amount of value they bring to the other party and tend to set higher aspirations and capture more value.

2_Avoid making unilateral concessions: Be willing to make concessions, but demand reciprocity. Avoid making unilateral concessions. A norm of reciprocity pervades most negotiation contexts: parties expect and understand that they will take turns making concessions. If the other party violates this norm, you should rectify this problem immediately.

3_Be comfortable with silence: A particularly dangerous time to speak is after you have made your offer and the other side is considering it. If the other seems to be taking too long to respond, negotiators often grow nervous and start bargaining against themselves. Before your counterpart has even voiced a concern or a grievance, you might be tempted to retract your offer or to make further concessions. Use silence to your advantage: Instead of responding negatively to an offer, simply wait it out. Very often, the party that has made the offer will begin to qualify it, moderate it, or simply signal a greater willingness to concede. Train yourself to become comfortable with silence. If you speak when it is their turn, you'll be paying by the word.

4_Label your concessions: People are motivated to undervalue or ignore the concessions of others in order to escape feelings of obligation. It's easy for people not to reciprocate when the other party's concessions are not top of mind. For this reason, it's critical to label your concessions. Instead of simply giving something away or moderating your demands, make it clear that your action is costly to you. Because labeled concessions are hard to ignore, it becomes difficult for recipients to justify nonreciprocity.

5_Define what it means to reciprocate: Reciprocity is even more likely if you not only label your concessions, but specify what you expect in return. This strategy eliminates another piece of ambiguity. Even if the other side acknowledges your concession, they might still reciprocate with something of low value unless you make it clear that such a move does not fulfill their obligation to reciprocate.

6_Make contingent concessions: Contingent concessions explicitly tie your concessions to specific actions by the other party. In other words, you can phrase your concessions in a quid-pro-quo manner to clarify that you will only make them if the other party does their part. For example: "I can pay a higher price if you can promise me early delivery."

7_Be aware of the effects of diminishing rates of concessions: In most negotiations, concession rates follow a pattern: early concessions are larger in size than later concessions. In other words, negotiators tend to offer diminishing rates of concessions over the course of the negotiation. This may be a reasonable trend: as a negotiator gets closer to his reservation value, there is less room for large concessions. As a result, most negotiators expect this pattern and take it as a signal that the other party's RV is approaching. But it's also possible that the other party could use this expectation strategically. That is, a party that is far from his RV might suggest that he is running out of room by offering concessions that quickly diminish in size.

Negotiate The Relationship

Whether the relationship is strengthened, weakened, or destroyed in the negotiation does depend on how satisfied each party is with the final outcome--but satisfaction has less to do with how well someone actually negotiated and much more to do with how well they think they negotiated. The people with whom you negotiate will be satisfied to the degree that they believe they got a good deal/felt respected/felt the outcome was equitable. This means that your reputation as a negotiator hinges on your ability to manage the other party's perceptions.

Imagine that you have thought hard about your first offer and have come up with one that you believe to be very aggressive. You make the offer and the other grins and accepts your offer immediately. How do you feel? In all likelihood, you feel terrible. It dawns on you that you have misjudged the ZOPA, made a poor first offer, and failed to capture much of the value that was up for grabs. You blew it. Now turn the situation around. Imagine that the other side has made a first offer that you find surprisingly attractive. How should you respond? If you accept too quickly or too enthusiastically, you are likely to upset the other party. To increase their satisfaction from the deal, you might take some time to ponder the offer. Then, when you eventually accept the offer without enthusiasm, they are likely to feel that they got a great deal.

If you really want to increase your counterpart's satisfaction from the deal, you might want to do more than simply wait before you respond. If you accept their first offer, even begrudgingly, they are likely to feel some regret and wonder whether they could have gotton more from you. This suggests a different strategy: make a counteroffer and ask for additional concessions. That is, if you really want the other side to feel satisfied with the negotiation, take more of their money. This interesting result illustrates the dissociation between outcomes and satisfaction in negotiation: satisfaction has more to do with how well you think you did than with how well you actually did.

When, in the early 1930s, the Institute for Advanced Study at Princeton University was recruiting Albert Einstein, the head of the institute wrote to Einstein asking him how much he expected to be paid. Einstein wrote back: "$3,000 (annually), unless you think I can get by with less." Princeton's response: "We'll pay you $15,000 a year." Einstein accepted and the deal was done. Why didn't Princeton accept Einstein's low offer or, better yet, negotiate an even lower salary? For one thing, as the adage proclaims, "Time reveals truth." Writing from Austria, Einstein may not have known how much he was worth to Princeton, but this would change when he joined the faculty in the United States. In other words, Einstein's perception of the ZOPA may have been inaccurate while negotiations were under way; eventually, however, he would update his assessment. When he did, he might feel as if Princeton had negotiated in bad faith by accepting his uninformed initial offer. In addition, by offering Einstein five times what he requested, Princeton administators sent a strong message about the school's integrity, their interest in his well-being, and their desire to negotiate in good faith. This story suggests that sometimes the smartest response to an offer that you love is to give something back. If you have been given an opportunity to strengthen the relationship or enhance your reputation, and all you need to do is reciprocate in kind to a generous opening offer, it may be foolish to do otherwise.

If the other side makes an offer that appears to give you everything you could hope for and more, it is critical that you stop and ask yourself: "What do they know that I don't?" For example, if the other side offers to buy something from you for more than you could have dreamed, you should ask yourself whether you made a mistake in estimating their reservation value. Maybe the item you are selling is more valuable than you thought. Maybe they are more desperate than you expected, or have a lot more money than you thought. In short, if you are surprised by an offer, don't celebrate--think. You might still decide that they have made too generous an offer, but it is better to postpone your counteroffer until you are sure you know where things stand.

Negotiators who set aggressive targets tend to capture more value but also tend to be less satisfied with the deals they negotiate. Why? Because when the negotiation is over, everybody likes to compare their final outcome to their initial aspirations, and those with high aspirations are more likely to fall short. Thus, increasing your satisfaction with a deal requires a change of mental habits: focus on your target during the negotiation; when it is over, shift your focus to your reservation value. By doing so, you will negotiate effectively (thanks to your high aspirations) and still be satisfied with your outcome afterward (because you are now comparing it with your RV). Because your satisfaction with a deal depends on your point of comparison, or reference point, it pays to pick a low reference point when there is nothing more that you can do to change the outcome.

CREATE VALUE IN NEGOTIATION to be continued