Thirty Three Percent of Negotiators Do Worse Than Their Own Reservation Price and Ignore Their Own BATNA

If the parties to a negotiation had perfect information according to Nash’s Equilibrium Theory of Negotiation, then the outcomes should be entirely predictable.  If the parties to a negotiation acted entirely rationality, then every negotiation should result in an agreement within the zone of possible agreement (“ZOPA) and every negotiation that does not have a ZOPA should result in the parties walking away.

But the fact is that many parties don’t act rationally and they do deals that are outside either their own reservation price and BATNA or that of the other side.

The thing is, behavioural patterns influence negotiator’s price negotiations far beyond the rational.  This means that even if you have an approximation of the other side’s BATNA and reservation price, you can extend the ZOPA in about 25%-33% of the cases simply by relying on human nature.

There is research that shows in a controlled experiment of 161 simulated merger situations, 25% settled where there was no ZOPA.  This means that one or both parties agreed to a deal that was worse than their reservation prices and that they ignored their BATNA.  Even more strangely, 8% did not settle, even though the deal was within their ZOPA.  When you put these two things together, you get 25%+8% = 33% of negotiations that did not reach a rational outcome in line with their previously determined reservation prices.[1]

[1] Bruner, F., Applied Mergers and Acquisitions Wiley p775

Creating Value: The Zone of Possible Agreement

The zone of possible agreement (“ZOPA”) is the “contract zone”  – the place where you can get the deal that you wanted – at least the deal that you would be happy with. The ZOPA is the third of the first three key concepts in negotiation, the first two being the best alternative to a negotiated […]

Creating Value: Negotiation and Your Reservation Price

Your reservation price is the least favourable point at which you will accept a deal.  The reservation price is derived from your BATNA, but it is not the same thing. The BATNA is what you are going to do when you walk away from a deal.  The reservation price is the least favourable point at which […]

The Worst Way to Sell a Business

How many times is this scenario played out in Australia every year:

  • A successful business owner is approached by a trade buyer with an attractive offer to buy the business. The buyer invites the owner to lunch and they establish a great rapport. The buyer explains his plans for expanding the business, the purchase price he is prepared to offer and the type of deal he envisages. They agree to see their accountants later that week. In the mind of the business owner, she has a deal, subject to some further paperwork to stitch it all up.
  • The next week, the buyer’s advisors email a 27 page due diligence questionnaire. The business owner and her CFO start work on answering the questions and assembling copies of the documents. The answers they send, however, raise more questions with the buyer’s accountants, who ask more questions. The owner and the CFO begin to spend most of their working day on the stream of questions – and the business starts to suffer. The buyer then instructs lawyers to prepare the documents, and the lawyers send even more questions and more requests for documents. Now three people are working full-time in the business finding  documents,  scanning  them and answering even more questions.
  • The  buyer  becomes  frustrated  with the delay. The business owner becomes frustrated with the perceived lack of trust from the buyer. The buyer’s lawyers, advisors and accountants have by now have set up in a conference room at the business premises and they are frustrated – sending even more requests for information that isn’t clear, documents that can’t be found and financial projections that are yet to be done.
  • Soon, angry words are exchanged or the deal simply goes cold. The original enthusiasm of the buyer has now dissipated and he has moved on to a new project. Months have been wasted, the owner’s team is exhausted and there is no deal anywhere to be seen.

The temptation is to think that because you“have had an approach”, you now don’t need professional advisors to package and market the business, as the deal is as good as done. The problem is, these ad-hoc approaches almost always end in failure because there is no structure in place to keep the deal moving forward to a successful conclusion.

 

Creating Value: BATNA and Nash’s Game Theory

“The usual haggling process is based on imperfect information, the hagglers trying to propagandize each other into misconceptions of the utilities involved. Our assumption of complete information makes such an attempt meaningless.” This is John Nash theorising on negotiations and negating the usual asymmetry of information by simply assuming that each party has perfect information. […]