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On negotiation

Posted on July 02, 2018

When I was on exchange in Davis, CA, I bought a bicycle so I could get around the small town more conveniently. Davis is a small town, yet it doesn’t mean I can handle my daily commute simply by walking.

In University Mall there is a bike shop opened by a Vietnamese. Accompanied by my Airbnb host, we went to the bike shop, chose a bike and asked where the U-locks are. The owner pointed at a crate full of used U-lock, I picked one and asked “How much?”. “$12” he answered.

Not a price I would willingly accept, so I asked “What if I get this bike and the kick-stand, will you give me this lock for free?”, “Are you paying cash?”, “Yeah”, “Ok then”. He accepted my counteroffer, so apparantly he wouldn’t mind giving me the bike-lock for free. I saved myself $12 just by asking.

This happened before I took a course at negotiation. I realized later that it involved principles of reservation point, anchoring effect and trade. It’s intriguing to see negotiation happening in daily life.

Last semester I took MGMT3140 Negotiation, it ended up to be one of the most rewarding courses I have taken in my university life. It was pretty hands-on, with one negotiation case and one case debrief each week. The negotiations were designed to practice one or a combination of the following principles.

BATNA

BATNA is the shorthand for “Best Alternative to a Negotiated Agreement”, which is the best alternative one can take if the negotiation fails and no agreement can be reached. Mind the part “Best”. It is only the best out of one or many alternative actions you could take.

The concept of BATNA has two implications: 1) it’s ok to walk away without an agreement (avoid agreement bias); and 2) don’t go beyond your BATNA in the negotiation, otherwise you’re losing a better opportunity outside of the negotiation.

For example, my alternatives in the bike-buying scenario above is not buying the bike and just take the bus or walk. My “best” alternative is bus instead of walking because it’s faster and more convenient.

The bus service Unitrans is free for UC Davis students, so how do I work out the monetary value of my BATNA (taking bus)? This leads to the concept of reservation point.

Reservation point (Bottom line)

Reservation point has the equivalent value to you as your BATNA that you can get out of the negotiation. Going beyond your reservation point (too expensive/not receiving enough) means you are making a deal worse than your bottom line, in which case you could just walk away unless the countarpart gives you anything better.

To calculate your reservation point, let’s consider the scanario above where my BATNA to buying a bike is to take bus. Does free bus means I shouldn’t be willing to pay anything for the bike? No. Riding a bike allows me to explore the Davis bike loop during weekends, and I wouldn’t be bound to the bus schedule. I could ride to the movie theatre to watch Deadpool out of impulse, which I did.

How should I value the added convenience? It’s totally on me. I could say my willingness to pay (WTP) for the added convenience is $125. Any purchase pricier than $125 wouldn’t worth the price. With that in mind, I refused to pay for the $12 U-lock right away because my willingness to pay was $125 yet the owner’s offer of bike ($120) + kickstand ($5) + U-lock ($12) was $137.

I could have just walked away knowing I didn’t make myself a bad deal right? Not entirely ture. Negotiation usually isn’t a game of take it or leave it. In fact, many were too greedy with their offer, or they walked away too early when they don’t get what they wanted, they missed out on a potentially win-win deal,

Know your own reservation point so you’ll never lose.

Know your counterpart’s reservation point so you’ll always win!

Bargaining zone

Bargaining zone is the overlapping zone between the opening offers and the willingness to pay (WTP)/willingness to accept (WTA) of two parties.

Positive Bargaining Zone

We define positive bargaining zone as the zone in which the buyer and seller’s prices in mind allows for a possible agreement. Let’s see how this works in the following example.

For example, Adam has brought a pack of chocolate cookie to office and Betty, who has a sweet tooth when she is stressed, intends to buy it from Adam.

This chart shows their WTA/WTP.

   -----------------------------> Adam's WTA
   |
   | <--------------------------- Betty's WTP
   |                            |
======================================= price
  $10                          $20

Adam would accept anything more than $10 (= his reservation point), while Betty, now heavily stressed from work, is willing to pay at most $20 (her reservation point). Betty could have taken a walk to buy that cooke for its original price of $8, but the added benefit of eating it right now and not having to walk to the convenience store worths $12 to her, thus she has a $20 reservation point.

Now Adam has made an opening offer of $23 and Betty replied with an counter offer of $8, we can add this to the chart above:

    |------------------------------------|
    $10 (WTA)                            $23
    <===== Bargaining zone =====>
|-------------------------------|
$8                              $20 (WTP)

Of course neither of them would accept the deal because the offers of their counterparts are beyond their own reservation points. However, it’s still possible to reach an agreement if either, or both of them give ground. Adam could lower his offer to $20 and Betty should take the offer, albeit rather unwillingly as that’s right at her limit. Or they could both get closer to each other’s first offer, say agreeing at $15.

Negative Bargaining Zone

When there’s a negative bargaining zone, there’s no way any of the parties would accept a deal without going beyond their reservation points.

Let’s illustrate this with the same example, except that Adam’s WTA is changed to $20 and Betty’s WTP is changed to $10.

<------- Betty's WTP
       |
       |               -----> Adam's WTA
       |               |
================================== price
       $10             $20

There’s no overlapping between the ranges of their WTP and WTA, assuming Adam again offers $23 and Betty counters the offer $8, like the last time, how would the bargaining zone look like?

            |------------|
            $20 (WTA)    $23
    Bargaining zone???
|---|
$8  $10 (WTP)

There is no overlapping in ranges between their offers and their reservation points. In no way could they reach an agreement without going beyond their reservation points unless their WTA/WTP is somehow changed. In later section, trading serves as a possible way to break out of this stalemate.

Opening offer

Before going into trade and interactive bargaining, let’s talking about opening offer, the first offer being made by one of the parties in a negotiation.

Preparation

Before a negotiation, it’s helpful to know about the matter being negotiated on and your counterpart. Going back to my bike-purchasing scenario.After having bought the bike, I discovered that the bikes were cheap because the shop was selling bikes built from used parts the owner ripped off from salvage bikes abundant in the city of Davis.

With this piece of imformation, I could have expected that it’s possible to bargain with the owner because the bikes probably don’t have a fixed price like the new ones do.

In many cases, offers from shops are the take-it-or-leave-it kind, which means the seller wouldn’t accept anything except the stated price. You need to be prepared to walk away when the stated price is beyond your reservation point such that you won’t lose any money to a bad deal.

Therefore, preparation is necessary in any negotiation situation. You need to establish your stop-loss price to avoid being controlled by the agreement bias (too eager to make an agreement, even if it’s a bad deal), or social pressure (losing face by walking away). You don’t lose a negotiation because there’s no deal, you are actually winning by avoiding a loss.

Knowing your counterpart’s reservation point from the preparation stage can help you make an opening offer that’s advantageous for yourself, while still reasonably acceptable by your counterpart.

Anchoring effect

Anchoring effect is powerful and inherent in human cognition.

What is the lowest temperature in August in Kazakhstan, is it lower or higher than 5℃?

When the second part of the question in italic are shown, the average estimate made by human would be lower than that of those who wasn’t shown that part. This is because people usually have no idea about the climate in Kazakhstan, so they take the information available in the question (5℃) as an anchor and adjust around it.

In negotiation, sellers can set a high anchor and buyer can set a low anchor when they are giving their first offer. This is especially powerful to counterpart who has minimal to none preparation, as they don’t know the value of the goods they are buying, they may under-adjust from the anchoring value and end up over-paying.

In the chocolate cookie example with Adam and Betty, they are both trying to set a price far away from their own reservation point to anchor each other. It’s interesting that in the early part of the course, many deals land right in the middle between the first offer made by two parties. For example, if one offered $10 and another $20, it’s likely they’ll reach an agreement at $15.

Anchoring wouldn’t work if the anchor is unrealistic. Making an opening offer way beyond your counterpart’s reservation point, your counterpart may doubt your goodwill and simply walk away instead of continue negotiating.

Aspiration point

People should have goals that’s better than the bare minimum for themselves. Aspiration point is a bit of a stretch goal in a negotiation, if your reservation point is $10, aim for $15. Like working out in gym, you achieve more if you aim higher. Your mind and body would adjust to meet the goal you set for yourself.

However, it’d be counterproductive to reject a deal that lies perfectly within the bargaining zone. As any possible deal within a bargaining zone is already a win-win situation (though one side may win more), walking away from a win-win deal because of an unrealistic aspiration is a bad way to negotiate.

Who makes the opening offer?

As a general rule of thumb, you can make an opening offer after ample of preparation that gives you insight into the reservation points of yours and your counterpart’s. As such, you know the opening offer is closer to your aspiration point than your reservation point, and that it’s closer to your counterpart’s bottom line than their aspiration point.

In an unfavorable situation where you’re forced into a negotiation unprepared, it’s better to let the other side to make an opening offer. You could then ask questions to gather information about your counterpart to adjust your expectation, before making a counteroffer.

Trade

Interest vs. Stated Position

To understand trade, let’s first look at the difference between interest and stated position. A stated position is an offer, such as a price and some bundled terms that represents the underlying interest(s) of a negotiating party.

Recall how reservation point is worked out from BATNA, we converted interests (added convenience of owning a bike) into monetary values ($125). The underlying interest of added convenience is represented by a stated position of $125.

Trade Opportunity

At first the owner offered me $137 for the bike, a kickstand an a U-lock. This is beyond my bottom line of $125. This is a negative bargaining zone.

            |
            $137 (assumed seller's WTA)
------|
      $125 (WTP = my bottom line)

Note: I don’t exactly know the seller’s WTA so this is just an estimate

There’s a negative bargaining zone and no deal is possible with the current WTA/WTP. Does that mean I should walk away? No. I offered a trade.

Me: “What if I get this bike and the kick-stand, will you give me this lock for free?”

Shop owner: “Are you paying cash?”

Me: “Yeah”

Shop owner: “OK then”

That’s a trade. The shop owner traded a U-lock with a term to pay in cash. My WTP hasn’t changed because I must now pay in cash because I intended to do so from the very beginning, while the seller’s WTA decreased to $125.

            |
            $137 (assumed seller's WTA)
------|-----|
      $125  | <- seller's perceived value of $125 + cash payment
      | <- buyer pays this much

Note: I don’t exactly know the seller’s WTA so this is just an estimate

By trading something that I have little interest on (payment methond), I receive something of greater value to me (free U-lock). The story goes the same for the owner, he traded that second-hand U-lock for cash payment which he obviously values more.

At the end, everyone was happy. By trading we can convert a negative bargaining zone into a positive one with minimal cost. Later we’ll see how trading can also maximize the combined benefit for both negotiating parties.

Integrative vs. Distributive bargaining

Generally people think of negotiation as a zero-sum game, like dividing a fixed pie where nobody could gain without someone else losing their share. This is called distributive bargaining, and it’s how many negotiation goes.

In the previous section we also discussed trading, which one can trade away issues of little interest in with issues of higher interest to obtain a win-win situation.

Let’s look at another example. Recall the chocolate cookie case: Adam has a WTA of $20 and Betty has a WTP of $10. They have made their first round of offers.

            |------------|
            $20 (WTA)    $23
    Bargaining zone???
|---|
$8  $10 (WTP)

This is a negative bargaining zone. If the deal falls apart, they each take home their own BATNA. For Adam, he gets to keep the chocolate cookie that worths $8. For Betty, she had to walk to the store to buy a pack of cookie, which costs her $8 + $2 (perceived value of not walking). The total gain in each party from the negotiation is $0.

Now if Adam offers a trade: to please his girlfriend, he wants Betty to introduce him some nice restaurants. Adam is willing to pay up to $12 for this piece of information. To Betty, the information worths nothing because it’s not even a secret to her.

|============|------------|
             $20 (WTA)    $23
<===> <- Bargaining zone
|---|
$8  $10 (WTP)

By trading, Adam’s perceived WTA has reduced to $8 ($20 - $12). As Betty is telling Adam information about nice restaurants at no cost to her, her valuation of her own payment remains $8. As such, a negative bargaining zone is transformed into a positive one.

Adam’s gain becomes $12 worth of information, and Betty’s gain is $2 for skipping a walk to convenience store. By trading, they grew the combined value to $14 from $0.

This is integrative bargaining in which value can be created by trading issues between negotiating parties such that everyone ends up getting better off.

Pareto Efficiency

A pareto efficient outcome describes a situation where the trade has been done to extreme and all integrative potential has been exhausted. No amount of trading would make one party better off without making other parties worse off.

Pareto efficiency only concerns the total benefit of all parties. Trading doesn’t mean you can capture any of the added benefit. With bad negotiation tactics you may still end up at where you are before the trade, or you may be pushed back all the way to your bottom line. So you may wanna be cooperative for trading but not too cooperative that you got taken advantage of.

Negotiation Style

You may have met assertive and collabative people in negotiation, or people on the other side of the spectrum. The course introduced 5 negotiation styles.

Assertive
   ^
   |  Competitive         Collaborative
   |
   |           Compromising
   |
   |  Rejecting           Accomondating
   |------------------------------------> Cooperative

Being accomondating may be disadvantageous when negotiating with a competitive person because you’re easily taken advantage of. For matters you have little interest in (say giving seat on public transport), there’s probably no point even negotiating, just be accomondating and give your seat to the people in need.

Knowing your counterpart’s negotiation style and that of your own can avoid mistakes, and even take advantage of your counterpart to make yourself better off at the end.

Closing Thoughts

In this post I briefly talked about some concepts I learned in the negotiation class. There are more such as decision making biases, multiparty negotiation, salary negotiation, why you shouldn’t celebrate in front of your counterpart, stupid time, playing chicken game…

As we negotiate on different matters in different ways every day, it’s important to review our past negotiations and figure out what worked for ourselves or for our counterparts to constantly improve our negotiation skills.

Even if you didn’t get a good deal at the end, don’t feel discouraged. Experience and self-reflection are a good teachers to help you do better next time. And remember —

Know your own reservation point so you’ll never lose.

Know your counterpart’s reservation point so you’ll always win!