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Love Thy Neighbor (Negotiation – Reservation Pricing)
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Love Thy Neighbor (Negotiation – Reservation Price)
Click Here to Download Data (MS Excel 2010+)
A fictional case study by Gregory Taketa. Negotiators and Financiers can enjoy this simple, quickly applicable case of using a financially beneficial asset literally next door: your neighbor! Here, we explore how a lousy water user in a drought (i.e. a Californian) can save money by striking a mutually beneficial deal with a water-conserving neighbor. The frightening thing is that you really can implement this deal within 24 hours!
Bad news: you’re in a drought.
Worse news: you suck at water conservation. You use more than 100 gallons of water daily than your neighbor.
Worst news: the more water you use on average per day, the higher the rates. There is significant pressure to make the highest water users pay outrageously higher rates than their more efficient peers.
But wait! A flash of inspiration: what if you just pay your more virtuous neighbor to use some of their water? Their rates would not go up much higher, and you would rather pay those rates than the nasty ones the Utility Company meant for you.
[End Preview – Please Download the CASE PDF & CASE DATA XLSX near the top of this article to become great at Quantitative Negotiations]
DEAL DECORATOR: Negotiations are not about “agreement”
Any average Joe can tell you that negotiations are about securing agreement so that the other party can do something you would not do by yourself. The classic example is that you negotiate the purchase of a house because you certainly don’t want to build the house on your own.
That definition is too narrow! Way too narrow! I’ll tell you why:
Suppose you employ 2 sales reps: Abe & Babs (the beauty of seeing this in writing is that you wouldn’t confuse their names as easily as if they were spoken).
Abe has a 90% closing rate. Babs has a 10% closing rate. Wow, Abe must be far better than Babs, right?
Abe does close 9 out of 10 sales, but each of those sales is barely above the reservation price (the minimum the sales rep would accept). Abe is instructed by his manager never to go below $1,000, which is the variable cost of the solution. Abe accepts offers at $1,010 for 9 times for a total of $90 operating profit.
Babs does close 1 out of 10 sales, but she refused 8 of those fellows who bid low at $1,010. The 9th caught on and offered $1,100 because he really needed Babs’ help. Babs agreed, and she scored $100 operating profit.
Traditional thinking teaches us to be like Abe: An offer of $1,010 provides $10 incremental profit, so the rational choice is to take it. It’s better than making nothing, which is the direct alternative. Most people would have found Babs to be ludicrous in refusing a deal in the positive ZOPA (zone of potential agreement), since she missed out $10 profit 8 times.
What Abe doesn’t realize is that his agreement with 1 person affects his agreements with others. Since the 1st buyer got the solution cheap, he referred Abe to like-minded people. They might have needed the solution more badly, but it doesn’t matter: they have been educated to bid low based on the first person.
Babs educated her buyers differently. She knew that people talk, and money talks. When the 1st 8 found that Babs would refuse a low bid, the 9th buyer, who was very desperate and could not be so price-sensitive, decided to offer a higher price. In Babs’ specific case, her 1 big profit trumped Abe’s 9 small profits.
This is not to say that Babs’ method always beats Abe’s. It depends on the situation. But Babs saw the big picture and got better results.
Being the better negotiator here was not about securing agreement but doing what seemed best for herself in the long-term.
So a more expansive (and common-sensible) definition of negotiation would be: doing what is best for yourself by helping selective others in selective ways, while refusing (usually politely) those who cannot produce a win-win in the long run.
Some of you in sales management can see a potential problem: what if Abe’s and Babs’ territories were close to each other? Abe’s low prices could adversely affect Babs’ future trials at charging higher prices with willing buyers. Ironically, Babs’ greatest competitor would not be your company rival but your own sales force! Babs’ actions can benefit Abe’s, but not the other way around. And often your revenues can be killed by your own weakest links rather than your traditional competition.
At this juncture, you could choose to put someone like Abe in a sales force for a tiered, low-priced product (the crimped version), or you might have to transfer him out of sales. Or, if you think he has the potential to change, you can have Abe work with the Deal Decorator to his jalopy-quality sales into a luxury sedan performance!