Academic polish on how to haggle
Daniel Pink, in his bestseller To Sell is Human
(reviewed in Moneylife
), argued that we are all sales people, all the time in some situation or the other. Someone who wants to persuade you to buy a pair of shoes is no different from the parent who is trying to persuade his daughter to study harder. Exactly the same can be said for negotiating. We are negotiating all the time say Margaret Neale and Thomas Lys, whether we are aware of it or not. Here is a story they narrate at the start of the book to drive home what they mean.
In early 1996, one of their students, working as a product manager for a pharma company, approached them for help in responding to business proposal. A physician had offered the student a chance to buy off the patent the physician had developed and given out for annual royalties. His asking price was $3.5 million.
After some complex calculations, Thomas and the student decided that the company would, at most, pay $4.1 million. This meant an immediate gain of $600,000. On the other hand, if he could negotiate the purchase price down to $3 million, the gain would be $1.1 million.
At that point, Margaret pointed out: “Just a second; you are not ready to negotiate.” In his mind, the student was already thinking of the potential benefit of $1.1 million for his company and his next promotion. From the doctor’s perspective, the deal did not make sense. The expected present value to the physician for the next seven years of royalty payments was $5 million.
Why was his opening bid only $3.5 million? “Our student had fallen into a classic negotiation trap,” write the authors. He had focused on the analysis from his own perspective, ignoring the doctor’s side. Caught up in the prospect of closing the deal, he became convinced by his initial, favourable computations and failed to do any due diligence.
According to the authors, three psychological factors contributed to this behaviour: the power of a familiar story, the confusion of accuracy and precision, and the inherent attraction of reaching an agreement.
First, the company and the physician had a decade-long relationship and the student was too familiar with the patent and the difficulties of that had arisen from the contract. It was easy for him to believe that the doctor had decided to sell the patent simply as a matter of convenience.
Second, the student had computed a value for the patent to several decimal points that made sense to him, promised a quick deal and a great return. The numbers were precise which probably prevented further analysis.
Third, once people are negotiating for a while, getting to say ‘yes’ often feels like success, even if accepting the deal was not sensible. After some further analysis, the student backed out of the deal. In less than a year, the company was using a new patent, not developed by this physician, which was a better one. The older patent had become worthless.
Stories like these are peppered throughout the book which is divided into two parts. The first explains the basics of negotiation including when to negotiate (chapter 1); how do you know what a good deal is and at what point you should walk away (chapter 2); what are the trades you need to consider when you think about claiming value and creating value (Chapters 3 and 4); what should you know (or attempt to discover) about your counterpart (Chapter 5); what information will help you claim value—and what information will hurt (Chapter 6); when should you make the first offer (Chapter 7); how can you fill in the gaps in your knowledge about your counterpart (Chapter 8); what strategies can you use to encourage your counterpart to make concessions (Chapters 9, 10 and 11); how should your strategies change when your counterpart is a team or when you are confronting multiple counterparts (Chapter 12); when should you think about switching from negotiations to auctions (Chapter 13); and, how should you end your negotiation (Chapter 14).
Maragret Neale is the Adams distinguished professor of management at Stanford Business School where she holds the position of director of the influence and negotiation strategies executive programme, among other positions. Thomas Lys is the Eric L Kohler chair in accounting and professor of accounting information and management at the Northwestern School of Law.
The book deftly brings together psychology and basic economic logic to arm you in your next negotiation. Worth a read.