Negotiation Fundamentals: Life is a Negotiation

Episode #75 Negotiation Fundamentals: Life is a Negotiation

Hey there and welcome to Episode 75 of the No Bullsh!t Leadership podcast. This week’s episode, Negotiation Fundamentals: Life is a negotiation. In No Bullsh!t Leadership, as you know, I generally stick to the leadership, culture and human performance elements of business. The concepts are universal and they transcend industry and organisational nuances to a large extent. I generally leave it to the business schools to teach the theory of business and the skills you need to acquire to be successful as an executive, so finance, marketing, economics, law, and so forth. There are lots of great courses and programs including a plethora of MBA and executive education options. However, one of the elements of business and life that’s fundamental to success is negotiation. I dedicate a lesson of our Leadership Beyond the Theory program to this subject, albeit, from the perspective of a leader’s need to handle conflict. Conquering, this is a critical step on the way to being a great negotiator. I guess it’s the secret of temperament over technique.

Well, today I’m finally relenting to many listener requests to talk about how to be a great negotiator by uncovering some of the core skills required from a technical perspective. It’s another bumper episode, so buckle up. I’m going to start with some basic concepts that many of you will perhaps already be familiar with. We’ll explore the role of value and trust in negotiation and I’ll finish with some tips for how to improve your capability. So let’s get into it.

Negotiations can get sort of complicated, but as with all well understood and tested models, the core principles don’t change with increasing complexity. One of the most complex negotiations I’ve been involved in was for the sale of a coal mine, which my company did known but relied upon entirely for its coal supply and had long term contracts with the mine owner. There were a number of parties involved in this negotiation. There was the current mine owner, the potential new owner who was looking to acquire the mine, our joint venture partner who held a 25% ownership stake in the asset pool that relied on the coal. There were a number of financial backers that potentially were going to support the new mine owner. There were the receivers, for joint venture partner when they had to endure a short stint in administration and of course our owners who were considering providing security over the mine asset for the new miner.

Obviously a pretty complex framework to work within. Now, the outcomes of this negotiation were extremely significant for all counterparts and for most organisations it was actually defining. It took well over a year to negotiate this simple deal and when the deal was finally agreed to and ready to execute, the collection of contracts I was required to sign was stacked several inches deep and lined up along a five metre boardroom table. Like I said, pretty complex. But casting my mind back to a point 10 years before that, I sat in my first lecture of the negotiation stream of the Advanced Management Programme at Harvard Business School. I thought I would totally kick ass in this subject because I was confident how much of a strength for me negotiation actually was. Less than an hour later, I had been comprehensively humbled in a rudimentary negotiation exercise with one of my peers. Shit, I really had a lot to learn. It was a really simple price and contingency based negotiation exercise and I allowed myself to be manoeuvred into making a bad deal as I responded to time pressure. Like I said, pretty humbling. But what I learned in the following weeks in this negotiation unit helped me to set about becoming the type of negotiator who could lead multidisciplinary teams to land multiple B2B contracts worth billions of dollars in revenue.

There are a few basic concepts in negotiation that you need to know. These concepts are equally relevant, whether you’re choosing a restaurant with your other half or negotiating a supply contract for your company worth millions of dollars. Many of these concepts originated from the classic book ‘Getting to Yes’ by Fisher and Ury who are part of the Harvard negotiation project. The book was first published in 1981 so the concepts have been with us for almost 40 years. I’m going to tackle a few of these here to give you an outline of the terminology as well as some of the core principles.

So principle number one is the size of the pie. As a negotiator, do you focus on creating value or claiming value? Because these are two very different things. As Deepak Malhotra taught me at HBS, good negotiators capture value and close deals, but great negotiators seek to find the most valuable deal to negotiate before they worry about divvying that value up.

So rule number one is you make the pie as big as you can first. You’ll have plenty of opportunity to cut the pie up later. And one of the biggest sources of lost opportunity is not exploring the entirety of a deal in terms of potential value creation.

Concept number two is about haggling versus negotiating. Now, many people see negotiating simply as haggling. Negotiation is a sophisticated trading of multiple terms to arrive at an agreeable solution that maximises value for all parties. Haggling on the other hand, is a one dimensional process of finding a compromise on price. Now, I’m sure many have had the opportunity to haggle in the flea markets of Asia because they’re haggling is de rigueur. So for example, “How much for that silk scarf?” “Oh, that’ll be 150 Yuan.” “150! You’re kidding, I’ll give you 30” and so it goes until you settle at 90 at which point the vendor has still made a tidy profit and you’ve convinced yourself that you bought what you were going to buy at a discount.

The third concept is reservation value. Now in simple terms, this is the lowest price at which your prepared to do a deal in negotiations. You need to know your reservation value and you need to know your counterparts. So let’s use the example of a residential house auction. The seller of the house has a reservation value that you don’t necessarily know, but that’s the lowest price at which they’re prepared to let go of that property. You have a budget which the other auction participants don’t know about, but how often in the heat of the moment does one of the parties compromise their reservation value because they become emotionally involved in the process. Good negotiators know the reservation value and don’t get distracted.

The fourth concept is what we call BATNA. And BATNA is an acronym that stands for ‘Best Alternative To Negotiated Agreement’. So in other words, what’s your next best option if you don’t do the deal? Now, the BATNA may be the same as your reservation value, but it’s not always. There may be other factors that lead you to take no deal rather than to strike a deal around the same valuation BATNA. So for example, it may be time dependent. If I can get a really good price now for this asset, I would consider selling it, otherwise I’ll wait until the market improves. BATNA might simply show you the gap between the value of the deal you have and what could happen if you don’t manage to strike that deal as a minimum. But generally it’s your BATNA that dictates how you proceed in any negotiation.

Concept number five is ZOPA another acronym, and this stands for ‘Zone of Possible Agreement’. So once you’ve established your own reservation value and the reservation value of your counterpart, you can calculate the ZOPA. The ZOPA is the range in which you perceive a deal could potentially be consummated.

So for example, in the worst case, I might be prepared to sell my house for $1.25 million. But in the best case scenario, I think I can find a buyer who’s willing to pay $1.5 million for it. Ergo, my ZOPA is between $1.25-$1.5 million. Now, the important concept here is that the ZOPA is based on your perception of the counterpart’s reservation venue. You don’t know this for sure. You only find this out through negotiation, if you listen and you read the play well enough. But you can adjust the ZOPA on the fly, as more information comes to light. You may find the vast majority of sellers are willing to pay no more than $1.4 million, in which case you’ve overestimated the reservation value. On the other hand, there may be a particular buyer who for some unknown reason, convenience, necessity, conservatism, etc. may be prepared to pay $1.7 million. Once it comes to process of creating value, it’s important to know that your ZOPA is workable for both parties.

Concept number six is information asymmetry because when we talk about information and putting together a ZOPA, we need to talk about information asymmetry. One of the key goals for negotiation is to gather information that helps you confirm or discredit your view of what’s important to your counter-party. What makes negotiations fun and interesting is that you don’t have access to all the information that they do and they don’t have access to all the information that you do. And this is called information asymmetry. Neither of you has complete information and different people learn to use this asymmetry to their advantage to differing extents.

Concept number seven is called anchoring and there’s a lot of discussion about whether or not you should make the first offer in any negotiation. Like the answers to all good questions – it depends. I’m not going to go into that here, but what is important to know is that when the first offer is put on the table, it acts as an anchor. Once a firm value is tabled, discussion tends to be conducted with reference to that value. So let’s go back to the example and say that you offer me $1.1 million for my house, which is below my reservation value and outside of my perceived ZOPA. My natural reaction is then to spend my time trying to convince you to shift your perspective and pay me more. In other words, why the house is worth a lot more than you have offered. So the discussion becomes around the anchor, not the value. Now, the final concept I want to deal with is a little more esoteric, but I’ve seen a lot of deals fall over because of the perceived risk of proceeding.

This final concept can help to manage these risks and this is contingency contracts. These are very common in situations like the sale of a business, a sale process is agreed, but often a contingency contract is put in place. Sometimes it’s even called an earn-out. Now this is basically when the buyer says to the seller, “I’m prepared to pay the price but I’m not prepared to pay it all upfront at the point of acquisition”. There would be conditions stipulated in the contract that set out a formula for variations to the total sale amount depending on the performance of the business in its first couple of years of ownership. So for example, one of those criteria might be the retention of key customers. If the seller wants to achieve the maximum value, it’s in their interest to see the new owner succeed. This increases the incentive for the seller to ensure that the business value is fairly represented and upheld during the transition. It also reduces the risk of overpaying for the buyer.

What role do value and trust play in negotiations? I remember many years ago hearing a radio interview on a current affairs program we have in Australia called Hack. The guest was Sabeer Bhatia who cofounded Hotmail with Jack Smith and they sold it in 1997 to Microsoft for a reported 400 million. Now the interviewer asked Sabeer for negotiating tips. If memory serves his question when something like this, “Sabeer, Let’s say I want to go into my boss tomorrow and ask for a pay rise. What are some of the things I should do from a negotiation standpoint?” Bhatia related the story around some of the final negotiations with Microsoft for the sale of Hotmail held in a boardroom at the apex of Microsoft’s Seattle offices. There was Bill Gates sitting, staring out a window while a phalanx of a dozen or so lawyers engaged in the negotiation. Bhatia had himself, his business partner and their accountant – intimidating to say the least!

Bhatia’s advice was simple and compelling. Number one, be realistic. You can’t just walk into your boss’s office and say, “I want $100,000 a year pay rise because I’m a kick ass negotiator.” You’ve got to understand what you’re trying to achieve and understand where that fits in the overall scheme of things for yourself and the other party. So that comes back to understanding the ZOPA. Number two, know your value. Now Bhatia and Smith, as the story goes, knocked back Microsoft’s first offer, which was around $160 million when they were on the way to selling it to them for $400 million. And this was at a time when both those owners of Hotmail were still on the bones of their asses. They had no money, and the interviewer asked them what gave them the confidence to do that. Bhatia simply said, “Because we knew it was worth more”. Number three, find a way for both parties to win. Now sometimes you can win in a negotiation, so to speak, but at the expense of your counterpart. If they have a terrible taste in their mouth, this may have ongoing ramifications, particularly if you need to maintain an ongoing relationship.

So for example, the best price from a supplier isn’t always the best deal. Now, here’s the main point I want to make about value. You’ll often find yourself in a negotiation which is more complex than just a price for service or a price for product. In fact, this is the norm rather than the exception. Many other components are essential ingredients of a well-constructed outcome. So for example, is flexibility valuable to you? Who carries the risk of failure of the contract? How enforceable is the deal that you’ve got? Are appropriate incentives in place so that each counter-party is rewarded for over performance. Now these are just a couple of examples of the non-price sources of value, but different elements of negotiation very often provide different levels of value for each of the counterparts. What’s most important to you, is often not the most important thing for your counterpart and vice versa.

So the real art of negotiation is to find those venue mismatches and trade so that you can create maximum value and each get what you want. Now just a word on trust. Sometimes the absence of trust can be a huge impediment to a deal. I have actually squeezed counterparts out of deals before, even though they look potentially advantageous on paper, because they demonstrated that they couldn’t be trusted. So doing things like re-trading, changing their position, seeking to re litigate terms after an agreement is reached. All of those things erode trust. The mine sale negotiation that I mentioned before had a huge amount of historical baggage. The contractual dispute had been going on for almost 10 years. Three of the parties had previously sought legal remedy through contractual enforcement in the courts. The lack of trust coloured every single interaction. Some of the individuals involved in the negotiation had been there from the get go and they were scarred by the history.

A massive part of this negotiation was simply about building trust, which took a lot longer than normal, given the starting position. But over a period of years, trust was sufficiently established on all sides to make a deal possible. At one point, I even jumped on a plane to London for a meeting with one of the CEOs involved just so that he could eyeball me and test how serious we actually were. And nothing says “I’m serious”, better than flying halfway around the world for a meeting. Now you obviously don’t do that for deal worth a few thousand dollars. As I said earlier, the materiality of this deal for all involved was in the hundreds of millions of dollars.

I want to leave you with some tips for improving your negotiation capability and I’ve just got half a dozen of them. Number one, do your homework. You’ve got to know what creates value for you and what creates value for your counterparts. Without this, you’re flying blind and you’re shooting from the hip. You may be able to do a deal, but it’s likely to be a pretty poor one. You need to spend time and effort on research. Know your competitors. Know what creates value for your counterparts and take every opportunity in the negotiation to test your knowledge and to test your assumptions.

Number two, listen. There is no substitute for good listening skills. Now, I know it sounds really obvious, but most people are more interested in what they have to say to try to convince the other person of their position rather than genuinely try to seek the highest value path forward.

If you can listen, you’re much more likely to be able to satisfy the constraints of a deal. Number three, continually look at a way to increase the size of the pie. You can always divvy it up later as I said. If you’re driven by creating value and giving your counterparts greater value, while of course claiming additional value for yourself, your deals will be inordinately sweeter once they are done. If you can stay in a posture of shared value rather than the zero sum game of the haggle, you will do a hell of a lot better.

Number four, never give away something for nothing. It’s always got to be a trade. So one of my favourite constructs when testing something in a negotiation is the sentence, “If you then I”. So for example, if you were able to guarantee a four hour turnaround, then I would consider paying a 10% premium for that service. Remember, you’re trying to explore what might be valuable to your counterparty and use that to win concessions for yourself.

Number five, keep improving your EQ. This is ultimately your strongest weapon as a negotiator. All of the technique in the world won’t help you unless you can manage the relationships and the flow of a negotiation. And finally, number six, become a student of the discipline of negotiation. I’m going to recommend two things here. One book, one course. The book is called ‘Negotiation Genius’ and it’s been written by Deepak Malhotra who taught me at Harvard and Max H. Bazerman and it’s a cracking book. It’s an easy read, comprehensive with great examples, so it’s really going to help you get your mind around the whole negotiation discipline. The second is the course which I’ve also done, which is called Scotwork, and Scotwork is a global negotiation specialist with offices in over 40 countries, it’s all they do.

Of course, I have no affiliation with any of these people. If I ever recommend anything on this podcast, it’s only because I think this is the stuff that’s really going to take you forward and I would never gain personally from it, so I hope you remember that. Now, I hope that this episode has given you a little perspective on the complex but exciting domain of high end negotiation and most of all a taste to explore this further and really find ways to uplift value for any organisation that you work for in the future. Remember, a leader’s number one job is to create value. The hard bit is often working out what actually constitutes the greatest value in any given context.

Alright, so that brings us to the end of Episode 75! Thanks so much for joining us, and remember at Your CEO Mentor, our purpose is to improve the quality of leaders globally. So please spread the word about No Bullsh!t Leadership in your leadership community. I look forward to next week’s episode, The Family Affair: Making founder led businesses work.

Until then I know you’ll take every opportunity you can to be a No Bullsh!t Leader.