Self-Taught MBA: Collaboration and Competition
Negotiations come in two basic colors: Win-win and win-lose. The first and most desirable outcome requires two parties with equivalent interests: You want to sell a house you built; the buyer wants to buy that very house. Your negotiation revolves around price, date of purchase, and perhaps a few upgrades. It can lead to a winning conclusion that leaves both parties satisfied. The win-lose scenario comes when parties have conflicting interests, and typically one party has the advantage. In this case, an investor comes to town who wants to buy a three-bedroom house to rent out. There are 60 on the market, and he makes a lowball offer on your house because he knows you need to sell it more than he needs to buy it. If this deal ever comes to a conclusion, the investor will likely have won.
Win-Win Tools of the Trade
Every negotiation begins with an exchange of information; at the very least, you want to know who you’re talking to. This exchange lays the groundwork in a win-win negotiation, and you know you’re in one almost immediately because your counterpart is forthcoming. She asks a lot of questions and volunteers details on what she’s looking for and why. You have the chance to see how what you have to offer fits this client’s needs, and you can tailor your proposal to create the best match. This does not mean that you’re best friends or have exactly the same interests. She wants your best goods and services for the lowest price; you want to make some money.
In this scenario, she wants to make sure you understand her needs and constraints clearly, and then she’ll listen to your proposal. Her needs are the specifications — for example, a three-bedroom house in a certain neighborhood with room for a pool —and her limitation, which is the amount of money she can spend on the project. Maybe her project is more limited: a complete remodel of her kitchen including a pizza oven, not to exceed $50,000. In either case, the needs and wants come with the description, as does the limitation (a price). Other limitations exist, such as time. Maybe she needs the work done immediately, or cannot close on the real estate until she sells her current house. But for simplicity, let’s stick with the price limitation.
Price has two sides: the limits of affordability and the value equation. The limits of affordability vary with the wealth of each customer. Customers simply cannot spend more money than they have or qualify to borrow. The value equation is a little more complex. While I could afford a $10 ice cream cone, knowing I can buy one for about $3 means the pricey cone would have to offer an amazing benefit before I’d pay three times as much for it. Here comes the key for overcoming price limitations: You must build up the value perception of what you offer until the customer sees the price as low, or at least reasonable, in consideration of your goods and services.
To sell me a $10 cone, you might explain that the dairy ingredients came from a select heard of Italian cows bread for the richness of their cream and the eggs from happy, free-range hens at a local farm; that the fruits are a combination of organic Georgia peaches, exotic jujubes, and the sweetest Indian mangos; and that the final product is flavored with the finest Mexican vanilla beans, agave nectar, and genuine Hawaiian macadamia nuts before it is scooped into a gluten-free, turbinado-sugar waffle cone, crisp and light. By then, I’ll at least want a taste, and may even pull out a ten.
By pointing out that your beautiful, three-bedroom ranch in the perfect neighborhood has plenty of room for a pool, and that raising the price a scant $25,000 would allow you to “throw in” the pool, which she can then pay for with her 30-year mortgage at historically low rates, you present a value equation that accomplishes her long-term goals today, saving a lot of money in the process.
You might also extend the builder’s warranty to two years or throw in a few extras, such as an alarm system or a full complement of energy-efficient LED bulbs. She might counter by offering $15,000 for the pool, and indicate that she wants both the alarm system and fancy bulbs. You settle on $20,000 and full price for your house. She got a bargain on her pool; you sold your house without a price reduction. It’s a win-win, even when she spent a little more than anticipated and you had to make a few small concessions.
In negotiation parlance, this is called “integrative bargaining.” Instead of cutting up a small pie so that one or both parties get less, you enlarge the pie so that both get as much as they want.
Win-Lose Tricks and Traps
On the opposite side of the street lives a very different negotiator who has no emotional attachment to your product and cares only about the price. You have been waiting for a big job for months, while holding a house at considerable cost much longer than you anticipated, which you would do almost anything to unload. This second negotiator has found his quarry: you.
He won’t present himself as a rival, and he may even appear like a good prospect. He will assure you of his qualifications as a buyer, and he likely has the means to pay your asking price. But he will have certain reservations to work out; after all, he could purchase a similar house right across town for a lot less money. You argue it’s a different neighborhood; he says it makes no difference because he intends to rent the house. You drop your price a little; he demands more, but offers to close as soon as possible. It’s tempting.
You’ll quickly discover that this type of negotiator only provides limited information, even as he asks a lot of questions. He won’t go straight to the bottom line because he wants you to invest a lot of time and energy into the deal before revealing his true intention, likely a price you would not have even considered as an original offer. A common strategy of the hard-core negotiator is to ask for all the specifications and then review them carefully. He may offer a low but acceptable price contingent on a review period and maybe an inspection.
Item by item, he will find defects in your house or contract terms, reducing its perceived value, and asking for concessions. He may focus on one item to distract you; he’s concerned about a damp smell in the basement. You can’t smell it, but it seems like a big deal to the buyer. He wants an expert to take a whiff. Time is passing; you see the deal evaporating; your banker is getting nervous; the realtor suggests the buyer might settle for a price reduction, and you agree to knock off $5,000 in consideration for damp-proofing repairs. You give in.
In negotiating parlance, you’ve fallen for the “red herring.” Your buyer focused on the damp odor, making it sound as the only remaining obstacle to closing the deal. You believed the deal at risk. The buyer finally “settled” for exactly what he wanted — a price reduction.
Investors and businessmen are not alone in the world of “distributive bargaining,” a term that refers to the small-pie scenario, where one side clearly wins a bigger slice and the other has to be content with the leftovers. Contractors do exactly the same thing when they engage in what’s called the “deliberate mistake.”
You look at a set of plans to bid. You know the buyer wants the cheapest price in town. You see the architect has made several omissions in the plan that will require more work than the scope of work includes. You bid the job exactly as drawn, knowing full well that completing the job will entail many extras. The buyer is giddy with what he believes is a very low quote, and he signs your contract. In your contract, you include change-order devices — such as time, materials, and a huge markup — that end up costing the buyer more than any of the quotes he received from contractors who took the real scope of work into account when preparing their bids. Subs can do the same to you.
Tactics and Techniques
The distributive or adversarial approach obviously includes war tactics and techniques aimed at winning the negotiation. But integrative bargaining entails tactics, too. After all, you sit across the table with different objectives. Your buyer wants to save money; you want to maximize your profit. You know your buyer likely would pay more than she revealed as her highest price at the outset, and hence has some room to negotiate. She knew you would probably accept less than your asking price. Instead of facing off on the issue of price, you introduced a new element, and established the value of a swimming pool by quoting the figure of $25,000.
Instead of negotiating the price of the house, you focused on negotiating the price of the pool. She’s done her homework on houses, knowing the competing properties in the neighborhood and having decided that yours is the most attractive, and is now seeking to cherry-pick features, warranty, and price. She has not done her due diligence on pools, although she revealed that she wanted a yard big enough to install one. You know the retail value of a simple pool is $25,000, but that your buddy with a pool company can sell you one for $17,500. You know the cost of the other concessions, such as the alarm and lavish light bulbs, would probably not add much more than $1,500 to your out-of-pocket expenses. By providing your buyer a pool and some upgrades at cost, you protected the full profit on your real asset, the house. She got a great deal on a pool.
Beside the common distributive and integrative approaches, which involve varying degrees of winning and losing, there exists the third option of totally collaborative bargaining, where nobody keeps secrets and all interests are laid bare. This is rarely done in real-estate transactions because both parties will likely never negotiate again, so there’s no need to foster a long-term benefit. When negotiating with subcontractors, however, the builder and his trades have a strong vested interest in each other’s success. This is the approach I will discuss in my next installment about negotiation: collaborative bargaining.
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Herrings cured by smoking and salting until they turn reddish-brown, i.e."red herrings." In 1807, William Cobbett wrote how he used red herrings to lay a false trail while training hunting dogs, an apocryphal story that was the origin of the idiom that signifies an intentional deception in bargaining.
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