1. Make Your Weak Position Strong How to increase your bargaining power when it appears hopelessly weak BY DEEPAK MALHOTRA, TRIAD-TEK, A MIDSIZE IT SERVICES FIRM, is negotiating with a potential customer in the commercial banking industry for a contract that could be worth millions in revenue Competition for the account is likely to be fierce, and Triad-Tek is desperate to sign the deal because it needs a foothold in the customer's industry and has no clear alternatives to the current prospect. The customer has conveyed that cost is a critical issue, and Triad-Tek is busy analyzing how low it can go. Some at Triad-Tek are even considering making a bid “at cost.” Making no profit on a project is rarely a wise move, but the worst-case scenario would be losing the deal altogether. What should Triad- Tek do? A common complaint among managers and executives who attend negotiation courses and seminars is that they don’t learn enough about negotiating from a position of weakness. What can you do when you have a weak BATNA, or best alternative to a negotiated agreement? How should you negotiate with someone who knows that you are desperate for a deal? How can you stop a potential customer from signing a deal with one of your many competitors? There are several things that you can do to increase your bargaining power when it appears hopelessly weak. In this article, | present three key strategies for strengthening your Position: (1) keep your BATNA to yourself, (2) increase the other side’s dependence on you, and (3) team up with other weak parties to increase your strength. 1. Don’t reveal your weak BATNA When I was house hunting recently, | came across a great townhouse and decided to make an offer. | was prepared to pay the list price but didn’t want to offer more than was necessary. When contemplating how much to bid, | weighed a number of factors. In particular, | noted that the townhouse was empty. Clearly, the owners had already moved out and were now paying two mortgages. In other words, their BATNA was weak: if our negotiation ended in impasse, they would be in an unenviable position. This information allowed me to feel more confident about making a lower offer than | would have made if the townhouse had been furnished. In the end, the sellers accepted an offer that was very close to my initial offer (and quite far from the listing price). What should the owners have done to improve their bargaining position? One option would have been to keep some or all of their furniture in the townhouse until it was sold. By doing so, they would have kept their weak BATNA to themselves. In negotiation, a common and costly mistake is revealing your BATNA. This cost multiplies considerably when your BATNA is weak. Very often, however, your counterpart will be unaware of your low-power position. Don’t do him any favors by revealing how much trouble you'll be in if a deal is not consummated. A weak position isn’t nearly so dire if the other side doesn’t know that you lack other options, Page 1 of 9Graduating MBA students often ask me how they should respond during a hiring negotiation if the potential employer asks about their other offers—and they have none. Not answering the question is often not an option. As for lying, that’s not a smart strategy. Instead, you should respond confidently that you have no other offers— yet. By doing so, you'll convey that the lack of a firm offer in hand does not mean that your BATNA is weak. You're expecting a variety of tempting offers, not unemployment. The same dynamic holds true for executives negotiating the sale of a business under time pressure, a critical purchase agreement with a supplier, or the terms of an outsourcing deal with a unique service provider—all potentially low-power situations. In these cases, avoid revealing the sources of your weakness, such as the urgency of a deal, the importance of the purchase agreement, or the service provider's privileged position. You can do so by avoiding the topic, by highlighting the strengths (however few) of your position, or turning the focus from your BATNA to theirs, as I discuss next. 2. Increase the other side’s dependence on you When faced with a low-power position, too many negotiators focus exclusively on their own weak BATNA and fail to consider the other party's BATNA. We tend to obsess about what will happen if talks fall through and overlook the unique value we bring to the deal. Your weak BATNA is less of a concern if your counterpart’s BATNA is weak as well. If you have no good alternatives to doing business with a particular company, that’s a problem. But if that company has no choice but to do business with you, you're on firmer ground. It's important to note that if you truly bring no unique value to the table—if your products or services can be replaced easily—you should not expect to gain from the deal. If you're constantly facing this situation, you don’t need negotiation advice; you need career advice. Fortunately, most negotiators do have something valuable to offer the other side. The key is to figure out what unique or distinct value you bring—or could bring. To the extent that you can increase this value, you are in a position to capture more value for yourself. If you can highlight the other negotiator’s dependence on your firm, product, service, or proposition, you can mitigate the drawbacks associated with bargaining from a position of weakness. Firms that bid for business (such as consulting firms, offshore IT firms, quasi-commodity suppliers, and so on) often complain that they are put in a weak position that allows them to win a contract only by lowering their price. Finding themselves competing in auctions against an unknown number of other bidders, they typically receive unclear signals about how to secure the deal. if these firms push for cost-plus contracts (rather than the often riskier fixed-price contracts), the customer will force them to open up their books and reveal their costs—and thus their reservation value, i.e., the least they are willing to accept. PUBLISH OR PERISH Matt owned the sole newspaper publishing company in his region. It was highly successful, with a large readership and sizable profit. Perhaps not surprisingly, a competitor entered Page 2 0f9the market. Now Matt faced an impending crisis. During his years as the sole newspaper publisher in the area, he had enjoyed the comforts of monopoly power. In his negotiations with customers, he had been in the more powerful position. But with a competitor in the game, Matt’s customers’ BATNA had changed for the better: if they didn’t like Matt's prices, they could negotiate for ad space with the other publisher. Matt didn’t want to simply accept the competition and compete on price. He considered his alternatives: he could leverage his experience and compete on quality, or he could shift his focus to the subset of the customer base where his readership was strongest. Either move would increase his negotiating strength. In the end, he chose a different power move: he raised the capital necessary to buy out his competitor and retained his high stature in the market. Matt overcame a weak position with customers by leveraging his strengths in relation to his competition. How can you strengthen your position in such situations? First, try to understand all the potential customer's needs, interests, and priorities by communicating with the customer at multiple stages. Incredibly, bidders often devote very little time to finding out how a particular customer differs from the “typical” customer. Insufficient information gathering is partly due to the fact that auction formats tend to place too much weight on one issue— price. When this happens, bidders tend to focus exclusively on lowering their costs. But if you discover that the potential customer places a premium on timeliness of project completion or level of support staff, you can gain an edge over other bidders. Another option is to try and work around the constraints of the auction and instead create a format where you can add value on dimensions other than price. For example, you might consider making two or more offers instead of one. One offer might be low on price and service, while the other might be somewhat higher on both. If the customer truly values service, it will appreciate knowing that it can get extra attention from your firm at an additional cost. Customers often are willing to discuss these matters openly and will appreciate your desire to understand their needs. It may also be possible to bid on two separate fronts. You might initiate informal negotiations with the customer even as the formal auction process gets under way. Alternatively, the potential customer might consider a negotiauction —a two-stage process in which an initial auction narrows the field to the most promising candidates, who then are invited to negotiate. (For more detail, see Guhan Subramanian and Richard Zeckhauser’s article “‘Negotiauctions’: Taking a Hybrid Approach to the Sale of High-Value Assets” [Reprint #NOSO28].) In this event, you need not be the lowest bidder on price if you can eat out the competition by leveraging your strength in other dimensions during the negotiation process. More generally, as the bidding firm, it’s critical that you understand your customer's multiple needs, create a distinct value proposition that caters to those needs, and communicate your ability to fulfill those needs. This approach is not simply a cunning bidding strategy but, rather, is exactly what your customer wants! Page 3 0f93. Collaborate with other weak parties Sometimes the best way to increase your negotiating power is to team up with others in your position. As an illustration, consider the logic behind labor unions. When bargaining with management, individual employees are in a weak position. A company negotiating with employees one at a time can credibly threaten to hire someone else if an employee demands too much. At the end of such a process, the market wage prevails. Essentially, the firm has held an auction in which potential employees bid for jobs; those who bid the lowest are hired. By contrast, unions allow employees to bargain collectively and thereby eliminate the source of their weakness. When one person (or team) represents the interests of all employees simultaneously, the firm cannot hold an auction. By negotiating collectively, employees avoid competing against one another; instead, they cooperate. The result is above-market wages. This process creates inefficiency in the market but effectively shifts power and money from shareholders to employees. Not surprisingly, firms often try to block employees’ efforts to unionize. Some, such as Wal-Mart, have traditionally been quite successful in doing so. Oil cartels are another example of collusion aimed at eliminating sources of weakness at the bargaining table. If oil-producing countries were to compete in the marketplace, oil prices would decrease. (The marginal cost of producing a barrel of oil is stunningly low!) Power would belong to consumers, who could play one oil producer against another. By creating cartels in which they make joint decisions regarding how much oil to release to the market, oil-producing countries are able to keep prices and profits—high. Managers can apply this principle in a variety of settings. For example, marketing schemes that promise to match any competitor's offer can actually be a bad deal for consumers. Such schemes eliminate the incentive competitors have to attract customers by lowering price As a result, consumers, who previously could pit one firm against another, lose their power. Similarly, professional associations sometimes limit the number of certifications and licenses that can be offered each year, thereby restricting the number of professionals in their industries. In doing so, these associations eliminate a source of weakness; if consumers had more professionals to choose from, wages would fall. The sidebar “Publish or Perish” describes another story in this vein. Get stronger When you find yourself negotiating from a position of weakness, the best thing you can do is to try and improve your BATNA. If this proves impossible, don’t despair. The three strategies outlined here can provide the leverage you need to strengthen your bargaining position SEND Page 4 of 92. When You Hold All the Cards? Having more power than your counterpart doesn’t mean the courts will let you squeeze every last penny out of the deal. BY GUHAN SUBRAMANIAN CONSIDER THE FOLLOWING hypothetical negotiation scenarios, in which you would seem to hold all the cards: ‘* One of your customers has just landed a lucrative new contract, and you're the only supplier who can add a critical component to that customer’s production process. * You own a controlling interest in a publicly traded company and are seeking to buy out the minority shareholders and take the company private. * You sell umbrellas, and a man in a well-tailored suit rushes into your shop at the start of a downpour. What’s the problem, you might reasonably ask? Concerns about violating your own ethics or harming your reputation might limit your willingness to extract as much gain from the trade as you can, but these factors won't prevent you from at least getting a very good deal. Yet, as | will show in this article, being the more powerful party in a negotiation doesn’t guarantee a free ride. Specifically, legal rules may constrain your actions in three basic ways. First, to protect the weaker party, the courts might second-guess the terms of the deal if they seem too onerous. Second, the courts might read additional terms into the deal that favor your counterpart even if neither party considered these terms when signing the deal. Third, the courts might impose procedural constraints that prevent you, as the stronger party, from abusing your bargaining power. Second-gue: jing the terms of the deal In general, the courts have been unwilling to second-guess the terms agreed upon by a willing buyer and a willing seller. If the outcome of a bargaining process is “unconscionable,” however, a court may intervene. In a famous case from the 1960s, respected Washington, D.C,, Circuit Court Judge Skelly Wright held that a contract term may be unenforceable if the weaker party did not have a meaningful choice between accepting or rejecting a term that was “unreasonably favorable” to the stronger party. The case involved purchases that Ora Lee Williams made from the Walker-Thomas Furniture Company in Washington, D.C. A single mother with seven children, Williams supported herself through public assistance. Over a five year period, Williams paid $1,400 toward $1,800 worth of home furnishings through 14 different contracts with Walker-Thomas, Which sold items on credit. When Williams defaulted on payment for a single item, Walker- Page 5 of 9Thomas attempted to repossess all her purchases, as stipulated in the densely written sales contracts Williams had signed. The trial court and the first appeals court ruled in favor of the furniture company, citing precedent that a person who knowingly fails to read a contract cannot be relieved from a bad outcome. The first appeals court did note its sympathy for Williams, however, stating, “We cannot condemn too strongly [Walker-Thomas’s] conduct. It raises serious questions of sharp practice and irresponsible business dealings.” But once the case got to the Circuit Court, Judge Wright reversed the lower courts’ rulings that they lacked authority to refuse to enforce the Walker-Thomas contract with Williams and sent the case back to the trial court for a determination on whether the contract terms were “unconscionable.” Since Williams v. Walker-Thomas Furniture Company, scholars and practitioners have attempted to apply the doctrine of unconscionability to recording contracts (to protect artists who sign deals when the artists are unknowns), arbitration clauses in employment agreements (to protect employees from process terms that are advantageous to the employer), releases that relieve property owners from liability for injuries suffered on their premises, “shrink-wrap” license agreements (to protect consumers who remove product packaging without any ability to negotiate the terms of the license), and many other arenas. Two strands of the unconscionability doctrine have emerged over the years: procedural unconscionability, or unfairness in the bargaining process; and substantive unconscionability, or unfairness in the bargaining outcome. Both strands allow a court to void certain contract terms or to hold an entire contract unenforceable, and both have implications for your negotiation strategy. The doctrine of procedural unconscionability suggests that you should “play nice” with the other side as a matter of course. Many negotiation experts recommend educating the other party about the importance of reaching any deal if that party’s no-deal alternative is weak. This may be good advice in many situations, but procedural unconscionability indicates that you should avoid threatening (or being perceived as threatening) the other side with no deal. With regard to substantive unconscionability, if the bargaining relationship appears unequal, try to include terms in your contract that explicitly address the question of reasonableness such as, “both parties stipulate and agree that the agreed-upon provisions are reasonable.” Courts don’t have to pay attention to such language, but it may help if the issue of substantive unconscionability were litigated. Reading additional terms into the deal Ina related maneuver aimed at protecting the weaker party to the deal, courts might infer additional terms within the contract or expand common-law notions of fiduciary duty. Consider the famous case of the Page brothers—let's call them “Big Page” and “Little Page” for simplicity—who started a linen supply business in Santa Maria, Calif., in the late 1940s. Big Page was the brains of the operation; Little Page supplied equal capital but deferred to his older brother's expertise. Business was slow for several years, and the partnership lost Page 6 of 9money. Then, an exciting announcement: the Vandenberg Air Force Base was going to be built near Santa Maria. Inevitably, this would be a boon for Page & Page's linen services. Just when they were about to hit it big, Big Page decided to dissolve the partnership and go it alone. While the resulting rift between the brothers was unfortunate, Big Page felt he had a right to walk away from the partnership. But a California trial court disagreed with his reading of the deal, instead ruling that an implied term in the partnership agreement prevented Big Page from dissolving the partnership until it had become profitable. The California Supreme Court reversed the trial court’s ruling but similarly held that Big Page’s right to dissolve the partnership was constrained by his fiduciary duty to his little brother. One might argue that Big Page would never have formed the partnership in the first place if he didn’t have the right to walk away at a moment's notice. But both the trial court and the California Supreme Court nevertheless saw fit to protect the weaker party from the one holding all the cards. When negotiating a contract, keep in mind that the courts can deploy malleable concepts such as implied terms and fiduciary duties with substantial discretion. You can minimize this discretion by thinking through contingencies and by making concepts such as “walkaway rights” explicit—as Big Page would have been wise to consider in his initial agreement with his brother. Imposing procedural constraints Sometimes the courts will be unwilling to get involved in the substantive terms of the deal but will impose procedural constraints on the more powerful party. Consider the case of a controlling shareholder in a publicly traded company—someone who holds more than 1%— who wants to “cash out” the minority shareholders. Under the corporate law of every state, the board of directors and majority shareholders must approve the terms of the offer. But because the controlling shareholder typically controls the board of directors and, by definition, owns a majority of the shares, she can, in theory, cash out the minority shareholders unilaterally, at whatever price she wants. In fact, in the 1960s and 1970s, many commentators expressed concerns that controlling shareholders were cashing out minority shareholders at low-ball prices, well below the fair value of the minority shares. In response, the Delaware courts (which provide corporate law for about half of all U.S. public companies and whose rulings are generally followed in most other states) have imposed procedural restrictions on the way in which a controlling shareholder can cash out minority shareholders. First, the company must set up a special committee of directors who are independent from the controlling shareholder. To shore up its bargaining power, the special committee must hire its own investment bankers and lawyers. The special committee then negotiates with the controlling shareholder over the price the minority shareholders will receive. If the two sides reach an agreement, the deal must be submitted to the shareholders for their approval. Typically, the controlling shareholder can cash out the minority shareholders only if a “majority of the minority” shareholders approve the terms of the deal. While recent twists in Delaware corporate law have provided an alternative route with fewer procedural hurdles (see the sidebar “A Cash-Out Transaction: Cox Communications”), my research indicates that approximately two-thirds of deals still follow the traditional route. Page 7 of 9A CASH-OUT TRANSACTION: COX COMMUNICATIONS On August 2, 2004, Barbara Cox Anthony and Anne Cox Chambers, two sisters who together owned 73% of Cox Communications, announced that they wanted to cash out the minority shareholders of their company. Their initial offer was $32 per share, or a 14% premium to the preannouncement trading price of approximately $28 per share. Following the blueprint laid out by the Delaware courts, Cox Communications formed a special committee of three independent directors to negotiate with the Cox sisters. Over the following four months, the special committee bargained hard: counter offering at $38 per share, walking away from the table at several points, and finally agreeing to a deal at $34.75 per share. In the end, the Cox sisters paid a 24% premium to the minority shareholders, or $1.7 billion in incremental value over the predeal market value of the minority shares, and $675 million more than their first offer. Presumably, the Cox sisters felt the deal made sense, or they would not have agreed to it. Yet, due to a recent change in Delaware corporate law, the Cox sisters had an alternative. They could have unilaterally made a tender offer to the minority shareholders, which would have minimized the special committee's influence in the negotiation. My analysis of comparable transactions suggests that the Cox sisters paid approximately $500 million more than they would have paid had they taken this other route. The lesson: cutting-edge legal rulings may allow you to change the game to your advantage. Don’t abandon your position of strength unless you have to! If the controlling shareholder decides to use her bargaining power to cash out the minority shareholders unilaterally, courts will step in to scrutinize the terms of the deal to make sure they are “entirely fair” to the minority shareholders. The controlling shareholder bears the burden of proving fairness. Needless to say, this is an onerous standard of review, and controlling shareholders often have been forced to pay significantly more to the minority shareholders after a court has intervened in this way. But if the controlling shareholder “plays nice” with the special committee—avoiding threats, giving ample time to deliberate the courts will shift the burden of proof. In this case, the minority shareholders must demonstrate that the outcome of the negotiation wasn't fair to them. Note how this third approach differs from the first two discussed here. Through unconscionability and implied terms, the courts regulate outcomes. With cash-out transactions, the courts seek to regulate the process by which the negotiation takes place. Inall cases, however, the goal of the legal rule is to protect the weaker party from the one holding all the cards. Negotiating from a position of power doesn’t mean that you can squeeze every last penny out of your counterpart. Courts can, and sometimes do, step in to protect the weaker party: by policing the terms of the deal, reading additional terms into your agreement, and imposing procedural constraints on your negotiation. This doesn’t mean you shouldn't seek Page 8 of 9to increase your bargaining power. But if you are successful, be aware that legal rules may constrain the extent to which you can take advantage of your strength. REND Page 9 of 9