I’m not criticising EU commission President Juncker, I’m sure he would say that this quote was taken out of context… but when he said Britain must leave the EU immediately, it was just the first step in a negotiation, and to do this effectively we had better learn about the mental tools associated with negotiating.
I recently came across Charlie Munger’s 1995 speech, The Psychology of Human Misjudgment, which introduced me to an explanation of what I’d been doing all my business life – using the power of applying mental tools from a wide array of disciplines and applying these to the business questions I had.
Last week I introduced tools for making decisions, this week we look at negotiating.
The Third Story — “The Third Story is one an impartial observer, such as a mediator, would tell; it’s a version of events both sides can agree on.” So how can I use this, here’s an example.
Suppose two regional sales reps share responsibility for sending weekly updates to their manager. Brad, rep 1, always submits them on time, but Frank (rep 2) often turns them in late.
Saying to Frank, “You’ve turned in the sales reports late again” would only put Frank on the defensive as they discuss how they should negotiate creating the reports they are jointly responsible for. Instead, Brad opens the conversation this way: “Frank, you and I place a different value on deadlines. I want to explain why meeting them is important to me, and then I’d like to hear your take on them.”
Brad then learns that Frank, when faced with the choice of possibly making a sale or compiling the report, thinks he should focus on the sale. With this insight, Brad proposes another way to share responsibilities: Brad will complete the report when it’s Frank’s turn to do so, as long as Frank gives Brad two hours’ notice and a share in any commission Frank earns as a result of being able to continue pursuing a sales lead.
Trade-offs — “ reducing or forgoing one or more desirable outcomes in exchange for increasing or obtaining other desirable outcomes in order to maximize the total return or effectiveness under given circumstances.”
Since resources tend to be scarce, anyone that uses the resource has to make a decision about how to use it. Suppose, for example, that you are a drink manufacturer. To produce a beverage, you have to use some scarce resources: the plastic for the bottle, the workers’ time, a machine to fill the bottles, etc. If you choose to make one bottle of water, you have chosen to not make a bottle of soda . Your scarce resources force you to make a choice and a trade-off producing one product or another.
Or here’s a great sign on trade-offs
Best Alternative to a Negotiated Agreement (BATNA) — “The most advantageous alternative course of action a party can take if negotiations fail and an agreement cannot be reached.”
Let’s illustrate BATNA by using an example. In the first scenario, let’s say that you are a buyer who goes to a supplier to purchase some badly needed parts to complete a project. The supplier senses your urgency; his eyes begin to gleam with anticipation. You want the lowest price possible while he wants the higher price. But you have no fall-back position. The supplier has what you need, so guess who decides what the price will be?
On the other hand, say you go to the meeting prepared. Before arranging the meet, you set up talks with 2 other suppliers who are ready and able to handle all your needs, but they currently don’t supply you. When you meet with the first supplier in this second scenario, you simply suggest in your efforts to fill your shortfall you are in the midst of engaging two new possible suppliers to solve your problem. You have a BATNA, and the negotiation suddenly become more amenable as you have an alternative course of action.
Zero-sum vs Non-zero-sum — “A zero-sum game is a mathematical representation of a situation in which each participant’s gain (or loss) of benefit is exactly balanced by the losses (or gains) of the benefit of the other participant(s)- its win-lose…In contrast, non-zero-sum describes a situation in which the interacting parties’ aggregate gains and losses can be less than or more than zero.” (related: win-win — “A win–win strategy is a conflict resolution process that aims to accommodate all disputants.”
Prisoner’s Dilemma — “A standard example of a game analyzed in game theory that shows why two completely ‘rational’ individuals might not cooperate, even if it appears that it is in their best interests to do so.”
Advertising is sometimes cited as a real life example of the prisoner’s dilemma.
When cigarette advertising was legal in the United States, competing cigarette manufacturers had to decide how much money to spend on advertising. The effectiveness of Company A’s advertising was partially determined by the advertising conducted by Company B. Likewise, the profit derived from advertising for Company B is affected by the advertising conducted by Company A. If both Company A and B chose to advertise during the same month the advertising probably cancels out, sales remain constant, and expenses increase due to the cost of advertising. Both Company’s would benefit from a reduction in advertising. However, shouldCompany B choose not to advertise, A could benefit greatly by their advertising, and the other way round. Nevertheless, the optimal amount of advertising by oneCompany depends on how much advertising the other undertakes. As the best strategy is dependent on what the other Company chooses there is no dominant winning strategy. But both Company A and B would be better off were they to advertise less or not at all.
In this example, around the world, cigarette manufacturers have endorsed the creation of laws banning cigarette advertising, understanding that this would reduce costs and increase profits across the industry. By accepting the prisoner’s dilemma and both “losing”, both win. For example, in the early 1970’s the US government and tobacco companies reached an agreement whereby cigarette packets would carry a warning label and television advertising would be banned. After the laws went into effect, during the first year profits (on average) for cigarette companies increased by $91 million due to the $63 million decrease in advertising expenditure (source).