SCARCITY CAUSED BY TIME RUNNING OUT: DEADLINES
A second tactic that triggers a sense of scarcity is a deadline. Kravis used this technique to match the board’s use of the competitive auction. The goal of a deadline is simple: to create the sense that time is running out on the opportunity. Here today, gone tomorrow.
Henry Kravis was one of only a few people in the world with the financial clout and credibility needed to raise the $20 billion-plus to buy RJR. His rivals in the RJR deal were untested. By setting a firm deadline, Kravis sent a signal to the board that his participation should not be taken for granted. His goal? To stop the auction and obtain a quick, favorable decision.
Deadlines are most effective when they are linked to events in the outside world that the parties do not control. In many corporate merger negotiations, one of the firms may have a quarterly reporting deadline to disclose “material corporate developments” to securities regulators. Neither side wants to disclose the merger talks in this regulatory filing because disclosure might tip off others that the target firm is for sale. This would raise the price to the buyer and cause the seller’s management to lose control of the deal. The regulatory deadline thus becomes a highly credible deal deadline.
The scarcity effect is doubled if a credible deadline combines in the other party’s mind with scarcity based on high demand. The combination of competition and a deadline sounds like this: “You have until noon tomorrow to accept our offer, after which time we will sell to [or buy from] the other party who has expressed interest.” Research shows that concession rates skyrocket in both amount and frequency as the negotiating parties perceive that they are under a deadline imposed by stiff competition.
Kravis was not able to get this double-whammy effect from his deadline both because there was no credible outside event dictating his deadline and because he did not have another company he planned to buy for his $20 billion-plus if he walked away from the RJR deal. The RJR board, on the other hand, did have another buyer. It could have maximized the effect of this leverage by imposing a deadline of its own, but it realized that a deal of this unprecedented size required more rather than less time to manage effectively.
A final way negotiators introduce a vision of scarcity through deadlines is to set time limits on certain elements of an existing offer. When the time runs out, these terms “explode,” leaving a less attractive offer on the table. Firms recruiting at business and other professional schools sometimes give the students deadlines for accepting employment offers that include favorable terms such as cash bonuses or priority in selecting job sites if students accept right away.
The overall offer of employment is still good after these “exploding” terms disappear, but students short on cash take the extra benefits very seriously. They see real money disappearing if they delay their decision. In more complex deals, “exploding” terms can include favorable interest or financing rates, preferential delivery terms, and so on.
The overall effect of threats to withdraw special benefits is the same induced by a deadline for the whole deal: Here today, gone tomorrow. You had better “Act Now.”
SCARCITY CAUSED BY WALKOUTS
Perhaps the most dramatic method of inducing a scarcity effect is to give the other side a “take it or leave it” ultimatum and then, when the other party protests, get up from the table and walk away. Nothing quite matches the emotional punch of watching a deal you want literally walk out the door.
All walkouts look spontaneous, but many are pure theater. If the other side is relatively naive and eager to do the deal, an experienced, competitive negotiator can use a walkout to play on its fears, dramatizing the need for quick capitulation. Walkouts also underline the importance of especially important issues.
There were no walkouts at the end of the RJR deal, but examples are easy to find elsewhere. Donald Trump has walked out of deals so often that the “Trump walkout” is a trademark of his style. Deal maker Wayne Huizenga’s colorful career, chronicled in The Making of Blockbuster, is also littered with walkout stories.
In the early 1980s, for example, Huizenga and his partner Steven Berrard were about to pay $4 million for a company owned by a family in New Orleans. The closing was at a law office. The last issue on the table was $100,000 in cash residing in a company bank account. Huizenga told the family that the $100,000 would be his after the closing, and they replied just as emphatically that the money would stay with them.
“OK boys, let’s go home,” said Huizenga, packing his briefcase. No one moved. “Let’s go, I said!” Huizenga barked and led his team out of the room and down the hall.
“Wayne, are you crazy? Over one hundred thousand dollars?” pleaded Berrard as they walked away.
“They’re never going to let us get to the elevator,” said Huizenga. Just then, the family’s lawyer popped his head out of the door and called for them to return. Huizenga got his money.
To summarize, the scarcity effect is an emotional response, not a rational one. Manipulative negotiators use it to inject urgency and even panic into an otherwise reasoned process. Sometimes they are telling the truth—there really are other offers, a lot of demand, and a real deadline. Other times they are bluffing, hoping you will push the panic button and close the deal. It is always a matter of judgment—informed by your understanding of the leverage situation—that tips the balance in the tense moments when you must decide to yield or stand up to an attempt to push your panic button.
Back to the Barbarians
With our knowledge of the scarcity effect, let’s return to the law office where Henry Kravis is negotiating with the RJR board over his deadline. Should Kravis stick to his deadline or grant an extension? There is no outside force dictating the deadline, so the answer depends heavily on Kravis’s analysis of his leverage. Which side, Kravis or the RJR board, has the most to lose if Kravis walks away at this point?
Let’s reason it out. If Kravis sticks to his deadline and walks out, he keeps his money but loses his chance to win the “deal of the century.” The board, on the other hand, still has a buyer and the deal can still be done at a record-setting price. So Kravis faces scarcity, but the board does not.
At 1:15 P.M. (fifteen minutes after their original “drop-dead” deadline) Kravis’s group called in Atkins as well as a member of the board’s special committee, Charles Hugel. Kravis agreed to extend his deadline to 2 P.M. if the board would agree to pay KKR $45 million. This money, $1 million per minute, would cover part of KKR’s expenses if it failed to win the contest.
The board was consulted. It agreed. The advisers scribbled the terms on a yellow pad. Everyone signed. The board had until 2 P.M. to consider KKR’s $106 offer.
Closing Factor 2: Overcommitment to the Bargaining Process
Before we press on to see what finally happened to Kravis in the RJR case, let’s look at a second psychological phenomenon that came into play that day in 1988. Psychologists call it overcommitment.
Overcommitment derives from our human desire to avoid admitting failure or accepting loss when we have invested heavily in a prior course of action or decision. The more time someone invests in an initially sensible activity, the more committed he or she becomes to seeing it through, even though the decision may no longer make sense.
Let’s begin with a simple, nonnegotiation illustration of overcommitment. Imagine you are at an amusement park and hear about a popular “splash and crash” ride. When you arrive at the ride there is a line, but you decide to give it a try. You have stood there two or three minutes, not moving much, when a park employee announces that the waiting time will be an hour and a half. Do you stay in line or go do something else?
Now imagine the same situation, but this time the employee announces the news after you have stood in line for forty-five minutes. The employee tells you that the line will take an hour and half to clear for people just entering it and for you it will take an additional forty-five minutes. Do you stay in line for the extra forty-five m
inutes or drop out and do something else?
Research on overcommitment suggests you are more likely to quit the line in case 1 than in case 2, even though the total waiting time is identical. Why? Because in case 2, you have invested a full forty-five minutes that you will “lose” by dropping out of line. In case 1, you “lose” only a few minutes. Once you have made an initial, significant investment in waiting, you are inclined to invest more time to achieve a realizable goal.
Leveraging Loss Aversion
Psychologists, casino owners, and Wall Street stockbrokers have all profited for years from this well-documented human quirk of loss aversion. People who play slot machines often feel an urge to “get back to even” once they start to lose money. They keep pouring in tokens, throwing good money after bad. Inexperienced investors are reluctant to sell their losing stocks, hoping that these unlucky investments will turn around and bounce back to the break-even point. So they sell their winners and hold their losers, exactly the opposite of what many professional portfolio managers do.
How does this self-defeating psychological quirk apply to negotiation? As we invest increasingly significant amounts of time, energy, and other resources in the actual negotiation process, we become more and more committed to closing just the way the person in the amusement park line becomes increasingly determined to get to the ride as more and more time passes.
The overcommitment phenomenon can occur spontaneously even when the other side is acting in good faith. But manipulative opponents can string negotiations out solely for the purpose of getting us overcommitted. They spring their trap just before the closing by apologetically introducing a last-minute demand that is “essential” to the agreement. “We’ve come so far,” they plead. “Don’t let all this time and effort be wasted.” Rather than face the loss of an unsuccessful negotiation, we may be more inclined to give them at least some of what they want and save the deal.
Overcommitment, in combination with the contrast effect discussed in Chapter 9, explains another common closing tactic used by slick negotiators that is called the nibble. The “nibbler” modestly requests small favors just before a deal closes. In the context of a lengthy and complicated negotiation, most people do not want to spoil either the deal or the relationship by quibbling over such small items. They often make the requested concessions. By nibbling at all their contracts, however, professional negotiators can add as much as 3 to 5 percent in additional value to their deals over a year’s time.
The antidote to overcommitment and nibbling is obvious. If you know you are negotiating with a nibbler, hold something back to give away at the end. If the other party is less familiar to you, keep your eye on your goals, make sure the other party is just as invested in the negotiation process as you are, and do not respond sympathetically to last-minute demands. We would be outraged if someone tried to charge us extra money to get on the amusement park ride after we had patiently waited for an hour with our ticket in hand. You should have the same attitude about last-minute requests in negotiation. At the very least you should insist on a reciprocal concession.
A Final Look at Kravis and RJR
Now back to Kravis. Just prior to the 2 P.M. deadline, Shearson submitted a new junk bond bid, this time for an astronomical $112 per share. Kravis responded by waiving his deadline and submitting a final cash bid of $108. During the next seven hours, the parties jockeyed for position and measured the ever-increasing risks of bidding at levels no investment banker had ever seen before. And time took its toll on the KKR team, which became increasingly committed, some would say overcommitted, to closing the deal.
In the end, the board gave Kravis one last chance to top Johnson’s $112 junk bond bid. After tense consultations with his team, Kravis placed his highest and last offer of $109 per share (more than $25 billion in all) on the table. The board ultimately determined that Johnson’s speculative junk bond bid for $112 and Kravis’s more reliable bid for $109 were essentially equal. At 9:15 P.M., the board decided in favor of KKR based on KKR’s greater credibility and experience in raising money of this magnitude.
It was a sweet victory for a fierce competitor. But you can now be the judge of whether Kravis played his hand wisely. Which factor played the greater role in determining the final price—bargaining dynamics or business analysis? The combination of Kravis’s competitive spirit, the scarcity effect, and overcommitment had a lot to do with the way the deal worked out. The conventional wisdom today is that Kravis paid too much for RJR.
Softer Closing Tactics: Shall We Split the Difference?
The closing tactics we have covered arise in a number of consumer and business settings, but let’s be honest—they are the exception in most of our lives. By far the largest number of our negotiations relate to people and firms with which we have ongoing relationships. Competitive tactics such as deadlines and other scarcity effect ploys may have a role in relational negotiations, but “softer” closing techniques are the rule when the relationship matters. We don’t tell people we want to work with to take it or leave it and then walk away.
In true Relationship situations, closing is simple. Your goal is to assure the other party of your goodwill. Accommodate; then close quickly and amiably.
In a Balanced Concerns situation in which both the stakes and the relationship matter, closing is more complicated. You want to leave the other side feeling good, but you must also be careful to achieve your fair share of the substantive benefits from the deal.
In either case, there are some reliable, softer tactics that can help you close most relationship-sensitive negotiations. Let’s look at them.
Perhaps the most frequently used closing technique is splitting the difference. Bargaining research tells us that the most likely settlement point in any given transaction is the midpoint between the two opening offers. People who instinctively prefer a compromise style like to cut through the whole bargaining process by getting the two opening numbers on the table and then splitting them right down the middle.
Even in cases in which the parties have gone through several rounds of bargaining, there often comes a time when one side or the other suggests that the parties meet halfway between their last positions. In situations in which the relationship between the parties is important, this is a perfectly appropriate, smooth way to close.
Why is splitting the difference so popular? First, it appeals to our sense of fairness and reciprocity, thus setting a good precedent for future dealings between the parties. A split is very much like the fifty-fifty sharing of money in the ultimatum game discussed in Chapter 4. Each side makes an equal concession simultaneously. What could be fairer than that?
Second, it is simple and easy to understand. It requires no elaborate justification or explanation. The other side sees exactly what you are doing.
Third, it is quick. For people who do not like to negotiate or are in a hurry, splitting the difference offers a way out of the potentially messy interpersonal conflict that looms whenever a negotiation occurs.
Splitting the difference is such a common closing tactic that it often seems rude and unreasonable to refuse, regardless of the situation. This is taking a good thing too far, however. There are at least two important situations in which I would hesitate to split the difference.
First, you should be careful that the midpoint being suggested is genuinely fair to your side. If you have opened at a reasonable price and the other party opened at an aggressive one, the midpoint is likely to favor the other party by a big margin. So don’t split the difference at the end if there was a lack of balance at the beginning.
Second, when a lot of money or an important principle is on the line and relationships matter, quickly resorting to splitting may leave opportunities for additional, creative options on the table.
Think back to Benjamin Franklin’s meal deal in Chapter 7. How would a split-the-difference solution have looked? Ben would have eaten some vegetarian meals and some nonvegetarian meals; ditto for the apprentices.
Both would have been unhappy half the time. Instead of this “nobody wins” outcome, Ben took half the cook’s fee and started preparing all his own meals, and everyone was happy all the time.
When the gap between offers is too wide to split, another friendly way to close is to obtain a neutral valuation or appraisal. If the parties cannot agree on a single appraiser, they can each pick one and agree to split the difference between the two numbers given by the experts.
Another innovative closing technique is something called a postsettlement settlement. Howard Raiffa of Harvard University has advocated that parties try to move from good agreements to better deals in which they seek that bit of extra value they may have left on the table.
Under Raiffa’s approach, the parties reach an agreement that works for everyone. They then agree—with or without the help of an expert—to continue searching for trade-offs and ideas that might make one or both sides better off without making either one worse off. If they cannot agree on an improvement to their agreement, they return to their original deal.
My own research suggests that this technique, which sounds good in theory, is hard to implement in practice. I was so taken with Raiffa’s idea that I helped to develop a computer program that would assist parties search for better deals after they concluded a negotiation. I was surprised by what I discovered: People showed little interest in the postsettlement settlement phase we offered them.
Why did Raiffa’s appealing idea not interest them? First, by the time they finished a hotly contested, complex deal, they were tired and wanted to stop. Enough is enough, they seemed to say. Second, during the negotiation process, they changed their views about what was important to them, and it was hard for our postsettlement settlement system to keep up with these rapidly changing preferences. Finally, they worried that the other side might back out of the original deal based on what happened during the postsettlement settlement process. Best to leave well enough alone, they told us.
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