Distributive Negotiations

Roman Sheremeta, Ph.D.

Professor, Weatherhead School of Management

Case Western Reserve University

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Exercise: Rules

• Exercise: BioPharm
• Two-person negotiation over the sale of a biotechnology plant.
• A buyer: BioPharm.
• A seller: Seltek.

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• Rules:
• You will be randomly assigned a role.
• You will have 30 minutes to read the instructions.
• You will be matched with somebody else in the other role.
• You will have 30 minutes to reach a deal.
• All signed contracts must be submitted before the deadline.

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Exercise: Role Assignment

• Roles:
• BioPharm = odd number (1, 3, 5, …)
• Seltek = even number (2, 4, 6, …)

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Distributive Negotiation

• Distributive Negotiations is a type of negotiation in which the parties compete over the distribution of a fixed pool of value.

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• Also known as:
• Zero sum negotiation.
• Win-lose negotiation.
• Hard-bargaining negotiation.
• Positional negotiation.

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• Win-lose negotiation:
• Any gain by one party represents a loss to the other.

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Bargaining and Surplus

• Bargaining zone is the region between parties’ reservation points in which a final settlement should be obtained.
• Sometimes bargaining zone is called zone of potential agreement (ZOPA).
• Positive bargaining zone: there is room for economic gains.
• Negative bargaining zone: parties should pursue other alternatives.

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• Negotiator’s surplus is the positive difference between the settlement outcome and the negotiator’s reservation point.

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Positive Bargaining Zone

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Seller’s Bargaining Range

Buyer’s Bargaining Range

$5

$10

$15

$20

Positive Bargaining Zone

B_T, Buyer’s Target Point

S_R, Seller’s Reservation Point

B_R, Buyer’s Reservation Point

S_T, Seller’s Target Point

Seller’s Surplus

Settlement

Buyer’s Surplus

S_R

B_R

Exercise: Debriefing

• BioPharm, a buyer:
• Introduce your role.
• Why do you want to buy the plant?

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• Seltek, a seller:
• Introduce your role.
• Why do you want to sell the plant?

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Exercise: BioPharm

• What is BioPharm’s target?
• $20 million appraisal value (discounted by 20% in the last two years).
• $12 million based on public accounting information.
• $8 million insured.
• Target: $8-$16 million.

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• What are BioPharm’s BATNA and reservation price?
• Buy a plot of land for $500k.
• Build a new plant for $25 million.
• Lose $12 million of profit during 12 months of construction.
• In addition, FDA approval is needed and new workers.
• Reservation price: $37.5 million ($500k + $25 million + $12 million).

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Exercise: Seltek

• What is Seltek’s target?
• $20 million appraisal value (discounted by 20% in the last two years).
• $12 million based on public accounting information.
• $8 million insured.
• Target: $8-$16 million.

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• What are Seltek’s BATNA and reservation price?
• Reconfigure the plant for $3 million.
• It will take 6 months (potentially lost profit).
• Need to pay workers a compensation of $1 million.
• The estimated appraised value of the plant is $10 million.
• Reservation price: $6 million ($10 million - $3 million - $1 million).

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Exercise: Bargaining Zone

• What is the bargaining zone?
• BioPharm’s reservation price is $37.5 million.
• Seltek’s reservation price is $6 million.
• Bargaining zone is $31.5 million ($37.5 million - $6 million).

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Exercise: Closing the Deal

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Pie-Slicing Strategies

• Strategy 1: Set high aspirations.
• Aspiration defines the upper limit on what you can get in a negotiation.
• If aspiration is too low, you get the winner’s curse:
• A situation in which a negotiator makes an offer that is immediately accepted by the opponent, thus signaling that the offer was too high.
• If aspiration is too high, you get the chilling effect:
• A situation in which a negotiator makes an outrages offer, thus risking to lose credibility and break negotiation process.
• Advice: “Be realistic but optimistic”.

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Pie-Slicing Strategies

• Strategy 2: Improve your BATNA.
• BATNA is your main source of power in a negotiation. Having a great BATNA will help you get a better slice of the pie.

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• Strategy 3: Do not reveal your BATNA.
• Exception 1: You have exhausted your time and are about to walk out without a deal, and you sense that the bargaining zone is very small.
• Exception 2: You have a great BATNA and thus an aggressive reservation price, and you would be happy if the counterparty matched or barely exceeded your reservation point.

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Pie-Slicing Strategies

• Strategy 4: Research the other party’s BATNA.
• The process of negotiation has two purposes:
• (1) gathering and sharing information;
• (2) behavior influence.
• Ask questions to obtain information about the other party’s BATNA.
• Be careful not to reveal your own information!
• If possible, try to weaken their BATNA.

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Pie-Slicing Strategies

• Strategy 5: Make the first offer (if you are prepared).
• Your first offer represents the most important anchor point.
• Van Poucke and Buelens (2002) find that 60% of negotiation outcomes can be explained by buyer’s and seller’s initial offers.
• Generally, the party making the first offer obtains a better final outcome.
• However, if you have no information about the other party’s BATNA then you may be better off letting them make the first offer.
• If the other party opens first, you should immediately counteroffer. Counteroffer reduces anchoring effect and it signals your willingness to negotiate.
• Your first offer could be a range (but the lowest number in the range will serve as an anchor point).

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Negotiation Biases

• Cognitive biases are mental errors caused by our simplified information processing strategies:
• Overconfidence.
• Agreement bias.
• Anchoring bias.
• Incompatibility bias.
• Fixed-pie bias.
• Confirmation bias.
• Self-serving bias.
• Availability heuristic.
• In-group bias.
• Exaggeration of conflict bias.

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Anchoring Bias

• Anchoring bias:
• The tendency to rely on the first piece of information offered in a conversation as a reference point (“anchor”) for the entire conversation.
• Example: If a seller initially suggests that the price of a vehicle is in the range between $20k-$23k, the conversation will remain anchored to those numbers.

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• Rationality behind the anchoring bias:
• Insufficient adjustment.
• Attitude change (“If this is an offer, then it must be reasonable”).

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• Potential solutions:
• Prepare for negotiation in advance: Run your own estimates before negotiation.
• Weigh in all pieces of information equally.

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Pie-Slicing Strategies

• Strategy 6: Support your offers with facts.
• People who provide rational for their offer usually get better deals.
• Balafoutas et al. (2021) find that providing rational increases compliance by 40%.

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• Strategy 7: Use precise (not rounded) numbers.
• Using precise numbers creates a perception that you did your homework and signals that you are close to your bottom line.
• Hukkanen and Keloharju (2019) find that making precise offers (increments of 0.5 instead of 5) is associated with a better purchase price and a higher probability of deal completion.
• But make sure that these numbers are used closer to the end of negotiation, it will create a perception that your counterpart is squeezing everything from you.

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Pie-Slicing Strategies

• Strategy 8: Use “loss frames”.
• It is important to show the other side not only what they would gain from a successful negotiation, but also what they would lose.
• According to prospect theory of Kahneman and Tversky (1979), people are willing to take greater risks to avoid losses then to make gains. Therefore, you need to show what the other side would lose if the deal does not go through.

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• Strategy 9: Plan your concessions.
• Don’t offer more than a single concession at a time, wait for the other side to respond (“Don’t negotiate with yourself”).
• Don’t make consistently greater concessions than one’s opponent.
• Don’t fall for the even split (sales people often make very small concessions and after you go down substantially they offer an “even split”).

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Pie-Slicing Strategies

• Example of concessions:

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Pie-Slicing Strategies

• Strategy 10: Appeal to fairness norms.
• Buelens and Van Poucke (2004) find that the opponent’s BATNA and fairness rules are the main determinants of an initial offer.
• Three fairness rules:
• Equality rule: equal shares for all.
• Equity rule: the share is proportional to a person’s contribution.
• Needs-based rule: the benefits should be proportional to the needs.
• Rules of fairness are situation-specific:
• Trials in court are based on equality rule, grading on equity rule, and parking on needs-based rule.
• Friends use equality while non-friends use equity.
• Costs are shared based on equality while benefits based on equity.

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“30 Rock”

• Negotiating with Jack Donaghy
• http://www.youtube.com/watch?v=a7-eoiY4bOo

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Thank you!

Roman Sheremeta, Ph.D.

Professor, Weatherhead School of Management

Case Western Reserve University

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References

• Thompson, L. (2004). The Mind and Heart of the Negotiator. New Jersey: Prentice Hall. (Chapter 3)
• Van Poucke, D., & Buelens, M. (2002). Predicting the outcome of a two-party price negotiation: Contribution of reservation price, aspiration price and opening offer. Journal of Economic Psychology, 23(1), 67-76.
• Buelens, M., & Van Poucke, D. (2004). Determinants of a negotiator's initial opening offer. Journal of Business and Psychology, 19(1), 23-35.
• Hukkanen, P., & Keloharju, M. (2019). Initial offer precision and M&A outcomes. Financial Management, 48(1), 291-310.
• Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263-292.
• Balafoutas, L., Faravelli, M., & Sheremeta, R. (2021). Conflict in the Pool: A Field Experiment. Working Paper.

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