What negotiation is: interests, alternatives and value

The fourth course of the fall term in the second year of the weekend EMBA at the Lakeshore School of Business in Toronto is Negotiation. The cohort has spent a year and a half learning to analyse companies, value them, market to customers, run supply chains, set strategy and design people systems. Dr. Elise Fournier, who teaches this course, tells them on the first Friday evening that almost none of that work turns into results without a negotiation somewhere along the way. A supply chain redesign is a set of new contracts with factories and carriers. A strategy needs budgets agreed with colleagues who want the money for something else. A people strategy is carried out through offers, raises, collective agreements and, now and then, a difficult conversation with someone who is leaving. Dr. Fournier spent ten years as a commercial litigator, eight as head of procurement negotiations for a mining company that bought equipment, fuel and services on four continents, and the last six teaching and mediating commercial disputes.

She begins with an exercise. Each student writes down the last three negotiations they took part in. Most lists start with obvious ones: Daniel Osei's plant agreement at Northfield Components, which he helped prepare in MBA-601 and which was settled in October; Grace Mwangi's annual terms with a large packaged-food supplier at Fairway Grocers; Leo Brandt's contract talks with a national retailer that wants to license Kestrel Analytics' forecasting software. But the lists soon fill with other entries: a disagreement with a spouse about whose parents to visit at Thanksgiving, a talk with a teenager about curfew, a request to a manager for a project, a call to a cable company. Dr. Fournier's point is that negotiation is not a special event. It is the ordinary way people who depend on each other reach decisions when they want different things and neither can simply impose an answer.

A working definition

Negotiation is a process in which two or more parties who are interdependent, and whose interests are at least partly in conflict, try to reach an agreement that each prefers to what it could get without one. Each element of the definition matters. The parties are interdependent: each needs something the other controls. Their interests conflict at least in part, or there would be nothing to negotiate. And each has an alternative, even if it is a bad one, so agreement is voluntary. A negotiator who forgets the alternative tends to accept bad deals out of a feeling that some deal is required; a negotiator who forgets the interdependence tends to make demands as if the other side had no choices of its own.

Dr. Fournier introduces four building blocks that will organize the whole course. Interests are what each party actually cares about: needs, concerns, fears and hopes. Positions are what parties say they want: a price, a date, a demand. Alternatives are what each party will do if no agreement is reached; the best of them is the best alternative to a negotiated agreement, or BATNA, a term made popular by Roger Fisher and William Ury of the Harvard Negotiation Project in their 1981 book Getting to Yes. Options are the possible agreements the parties could reach, which are usually far more numerous than the first proposals on the table. A fifth element, legitimacy, refers to the standards and criteria, such as market prices, precedent or expert opinion, that parties use to argue that a proposal is fair.

Positions and interests

The classic illustration is two people quarrelling over an orange. Each insists on having it; they cut it in half. One then squeezes her half for juice and throws away the peel, while the other grates his peel for a cake and throws away the fruit. Had they asked why each wanted the orange, both could have had everything they needed. The story is simple, but the pattern recurs in serious negotiations. Positions are often incompatible while the interests underneath them are not.

Grace offers a real example. Last spring her supplier of breakfast cereals demanded a two per cent price increase, citing grain and freight costs. Fairway's position was no increase, because its own customers were sensitive to cereal prices. Talks stalled for three weeks. When Grace finally asked what was driving the request, she learned that the supplier's real problem was the cost of small, frequent deliveries to Fairway's stores. Fairway's real concern was the shelf price customers saw. The parties agreed that the supplier would deliver full truckloads to Fairway's warehouse every week rather than delivering to stores twice a week, which saved the supplier more than the price increase would have brought, and the shelf price did not move. Neither side's opening position had mentioned delivery at all.

Asking about interests is not soft. It is a way of finding where value lies. The questions are simple: why do you want that, what would that do for you, what worries you about our proposal, and what would have to be true for you to say yes. Dr. Fournier warns that people often do not know their own interests until they are asked, and that interests come in layers: substantive interests in money or terms, process interests in being heard and treated fairly, and relationship interests in how the parties will work together afterwards. A deal that meets substantive interests while trampling on process interests is often rejected, or honoured only grudgingly.

Alternatives and the bargaining zone

Every negotiator should know, before talks begin, what she will do if there is no agreement. Fisher and Ury's advice was to measure any proposal against the BATNA rather than against an arbitrary bottom line, because a bottom line fixed in advance can be either too low, leading to a bad deal, or too high, causing a negotiator to walk away from a good one. The BATNA determines the reservation price or reservation value: the least favourable deal a party would accept. For a seller it is the lowest price she will take; for a buyer it is the highest price he will pay. Anything worse than the reservation value is worse than walking away.

When the buyer's reservation price is above the seller's, there is a zone of possible agreement, or ZOPA, sometimes called the bargaining zone. Any price within the zone leaves both sides better off than their alternatives. If the seller's reservation price is above the buyer's, there is no zone, and the right outcome is no deal, however skilled the negotiators. Much of the craft of negotiation lies in estimating where the other side's reservation price lies, while protecting information about one's own.

Leo's licence negotiation illustrates the idea. Kestrel's software would cost the retailer about 140 thousand dollars a year before the retailer's managers would rather build a simpler tool in-house; that is the buyer's reservation price, although Leo does not know the exact figure. Kestrel's costs of serving the client, plus the value of the reference account, mean Leo would rather walk away than accept less than about 100 thousand. The zone runs from 100 to 140 thousand. A deal at 125 thousand gives Kestrel a surplus of 25 thousand over its reservation price and the retailer a surplus of 15 thousand under its own. The total surplus, 40 thousand, is fixed by the two reservation prices; the price only decides how it is shared.

# Zone of possible agreement for Kestrel's annual fee (thousands of dollars)
seller_reservation = 100   # Kestrel would rather walk away below this
buyer_reservation = 140    # the retailer would rather build in-house above this

def zopa(seller_rv, buyer_rv):
    if buyer_rv < seller_rv:
        return None
    return seller_rv, buyer_rv

zone = zopa(seller_reservation, buyer_reservation)
print("zone of possible agreement:", zone, "size", zone[1] - zone[0])

for price in (95, 110, 125, 140, 145):
    seller_surplus = price - seller_reservation
    buyer_surplus = buyer_reservation - price
    ok = seller_surplus >= 0 and buyer_surplus >= 0
    print(f"price {price:4d}: seller surplus {seller_surplus:4d}, buyer surplus {buyer_surplus:4d}, deal beats both alternatives: {ok}")

# If the buyer's alternative improved (a cheaper rival at 95), there would be no zone
print("after a cheaper rival appears:", zopa(seller_reservation, 95))

zone of possible agreement: (100, 140) size 40
price   95: seller surplus   -5, buyer surplus   45, deal beats both alternatives: False
price  110: seller surplus   10, buyer surplus   30, deal beats both alternatives: True
price  125: seller surplus   25, buyer surplus   15, deal beats both alternatives: True
price  140: seller surplus   40, buyer surplus    0, deal beats both alternatives: True
price  145: seller surplus   45, buyer surplus   -5, deal beats both alternatives: False
after a cheaper rival appears: None

The output makes the arithmetic of the bargaining zone explicit. Prices of 95 and 145 lie outside it: one leaves Kestrel worse off than walking away, the other leaves the retailer worse off than building its own tool. Within the zone, every dollar Leo gains is a dollar the retailer loses. The last line shows why alternatives matter so much. If a rival offered comparable software for 95 thousand, the retailer's reservation price would fall below Kestrel's and no agreement would make sense, unless Leo could show that Kestrel's product is worth more than the rival's or reduce his own costs.

Claiming value and creating value

So far the negotiation has been about one issue, price, and the parties' gains are directly opposed. Negotiations of this kind are called distributive: the parties divide a fixed amount, and the main questions are who moves first, how far each concedes and who holds out longer. Haggling over a used car or the price of a commodity are typical cases. Lesson 3 studies the tactics of distributive bargaining in detail.

Most business negotiations involve more than one issue, and the parties value the issues differently. When that is true, they can trade: each concedes on what matters less to it in return for what matters more. Such negotiations are called integrative, and they create value, enlarging the total surplus rather than merely dividing it. In Leo's case the retailer may care most about a fast rollout before the holiday season, while Kestrel cares most about a three-year term that makes its revenue predictable for investors. A deal with a slightly higher price, a three-year term and a dedicated implementation team may leave both better off than a lower price with a one-year term. Lesson 4 develops the tools for finding such trades.

In practice nearly every negotiation is mixed-motive: the parties must both create value and claim it. This produces what David Lax and James Sebenius of Harvard called the negotiator's dilemma. Creating value requires sharing information about priorities, which exposes a party to being exploited; claiming value requires withholding information and making firm demands, which blocks the discovery of trades. A negotiator who only claims tends to leave joint gains undiscovered. A negotiator who only shares may create a larger pie and then watch the other side take most of it. Skilled negotiators manage the tension: they share information about priorities gradually and reciprocally, propose packages rather than single-issue concessions, and keep their reservation values to themselves.

Three ways to settle differences

Dr. Fournier adds a perspective drawn from the dispute resolution research of William Ury, Jeanne Brett and Stephen Goldberg. When people disagree, they can resolve their differences in three broad ways. They can reconcile their interests, which is what negotiation and mediation try to do. They can determine who is right according to some standard, such as a contract, a law or a precedent, which is what courts and arbitrators do. Or they can determine who is more powerful, through strikes, lawsuits used as threats, walking away from a supplier, or a vote. Interest-based approaches are usually cheaper and produce more durable outcomes, but rights and power remain in the background of every negotiation: they shape the parties' alternatives. Lesson 11 returns to this framework when the cohort studies disputes.

How negotiations unfold

Negotiations tend to move through recognizable phases. In preparation, each side clarifies its interests, alternatives, targets and information needs. In the opening, parties establish the relationship, agree on a process and exchange initial proposals. In the middle phase, they explore interests, trade information, generate options and make concessions. In the closing, they settle remaining issues, test the agreement against their alternatives and write it down. Implementation follows, and it is often where the real negotiation turns out to have been decided: vague clauses become arguments, and relationships built during the talks carry the parties through surprises. Lesson 2 is devoted to preparation because, in Dr. Fournier's experience, most negotiations are won or lost before the parties meet.

Negotiation as a management skill

Is negotiation a talent or a skill that can be taught? The research is encouraging. Experimental studies by Leigh Thompson and others show that people who receive training and, especially, who compare several cases that share an underlying principle, transfer the principle to new situations far better than those who simply experience negotiations. Experience alone teaches less than people think, because negotiators rarely learn how much they left on the table. A person who sells a house for the asking price on the first day may conclude that she negotiated well, when in fact she priced the house too low. Feedback in negotiation is noisy and delayed, which is why this course combines frameworks, cases and role plays with structured debriefs.

Dr. Fournier describes how the course will work. Each Friday evening she will introduce the ideas of the lesson. Each Saturday morning the cohort will negotiate a role play in pairs or small groups, with confidential instructions that only one side sees, and then compare outcomes across groups. The comparison matters most. When six pairs negotiate the same case, the range of results shows what was possible, and the debrief shows which behaviours produced the better outcomes. The cases come from the cohort's own work: Northfield's price talks with an automaker, Fairway's supplier terms, Kestrel's licence deal, Lakeview Health's contract with a physician group, Prairie Ridge Energy's wind project with landowners and a nearby community, and, for the capstone, Cedarline Outdoor's new agreements with its main contract factory and with the workers at its distribution warehouse.