Negotiations, and the art of negotiating, are a particularly interesting mix of business acumen and psychology. What I observed is that every negotiation has an optimum outcome which both parties would consider a fair deal, but this is hardly reached. In most cases, one party clearly is the winner of the negotiation, obtaining more advantages that the optimum would entitle her, and vice versa. Why is that?
The answer I gave myself is that in each negotiation there’s a strong(er) and weak(er) side and such imbalance, once determined who is who, inevitably create opportunistic behaviour and leads to divert from the optimum, sometimes consciously, sometimes unconsciously.
Dynamics in negotiations
The assumption underlying my model is that both sides are interested in a positive outcome of the negotiation. Neither is doing that out of chartable act or as gamble. Both are committed in reaching an agreement, whose terms need to be discussed upon.
As said, there’s always a weak vs. a strong side. Such status doesn’t always follow an economic/financial logic: sometimes it can even just be a result of psychological traits of the negotiators. The ability of good ones is to turn their position into a strong one even when starting with disadvantage. It can also be that the sides switch position during the process and, again, this depends on the ability of the negotiator.
I also start from the assumption that each party is able to recognise the optimum ex-ante, meaning they both have a clear idea of what would be “fair”, which doesn’t always perfectly coincides, but it’s often pretty close. In an ideal scenario, each negotiation could be concluded by simply expressing the own honest idea of “fair deal” and then address the gap between them. We both know this hardly happens.
Divergence from the optimum
Simply put, being on the strong side creates an incentive to take additional risks, while being on the weak side just increases the risk adverseness. If you think about that, it’s very intuitive. Having bargaining power, or even just perceiving you have more than your opponent, increases risk-taking behaviours, because you feel that the other party has more to lose than you do. Such perception creates an incentive to diverge from the optimum, simply because you feel you can get more out of it. Not because you perceive it as “more fair” for you: but simply because business is opportunity and having bargaining power allows you to be greedy.
On the other hand, once the weak side has been determined as such, it is eventually forced to succumb to the risk-taking attitude of the other party and accept a below-optimum agreement, even when the other party has more to lose from a failure of the negotiations.
Let’s make an example.
Party A and Party B. We define Party A as the strong one. The distribution of the outcomes in the case of fair deal and their respective probability is as such.
W = Winning (i.e. the parties reach an agreement) and L = Losing (i.e. the negotiation fails). The sum of the benefits of closing the deal is 220 (120 + 100) and we will assume this is a fixed amount. The loss derived from a failure of the negotiation is independent from each other and doesn’t vary. In this situation Party A has more to lose compared to B.
NOTE: this could be the situation between a Corporation (A) and a startup (B).
In this scenario, with the expected outcome of the negotiation for each party is:
A = 120 * 50% - 70 * 50% = 25
B = 100 * 50% - 50* 50% = 25
So the deal is fair. Now let’s assume Party A recognises its stronger position and tries to push for a redistribution of the benefits. In a situation where both parties are equal, the distribution % of the outcomes should be as such follows.
If the parties were equal, then the % of closing the deal should drop for A (because B is less likely to accept 70 instead of 100) and increase for B (because A is much more likely to accept 150 instead of 120). As we said, the loss remains the same for each party, but the % of that happening moved in the opposite direction compared to the winning probability. The expected outcome for each party is now:
A = 150 * 25% - 70 * 75% = -15
B = 100 * 75% - 50 * 25% = 40
So, if the parties were equal, why would A push her luck with a clearly “unfair” proposal, thus lowering the chances of reaching an agreement and, conversely, increasing those of losing?
The answer is: because the parties are not equal. If A believes to be stronger, and B is convinced (or accepts) to be weaker, the the % distribution of the outcomes shouldn’t change and we have a situation like the following.
A = 150 * 50% - 70 * 50% = 40
B = 70 * 50% - 50 * 50% = 10
In this case A clearly has an incentive to diverge from the optimum of a good deal. And business-speaking: why making a concession when the other party would accept something below-optimum?
Why would B passively accept? Because B thinks more of their losses (-50) instead of A’s (losses)!
Truth is, B doesn’t know how much A would lose from the deal, but like A assumes B has more to lose, B should realize, or at least trust, that A actually has larger expected losses if it misses out on the deal!
The consequences of below-optimum agreements
I’m a big fan of the concept of fairness, as much as it can be a subjective matter. Nonetheless, I do believe the very concept of long-lasting business relationships finds its fundaments in the research of mutual understanding of “fairness”. While pursuing an opportunistic behaviour can lead to financial gains today, it might prevent the other party from doing further business in the future. If we were all to make an effort in our negotiations, it will more than pay off in terms of the mid- to long-term business relationship.
PS. I came up with this model entirely on my own, as much as it’s likely to resemble game theory models and the likes