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Rational Decisions in

Negotiations
• Two parties need to reach a joint decision
but have different preferences.
• They negotiate.
• Eventually they achieve a mutually
agreeable outcome.
Two-party negotiations
• Game Theory: given absolute rationality, it
provides the most precise prescriptive
advice available to the negotiator.
• However:
– It relies on a complete description of all
options and outcomes. This may be infinitely
complex.
– It requires that all players consistently act
rationally.
Decision-analytic approach
• One must assess three key issues:

• Each party’s alternative to a negotiated


agreement
• Each party’s set of interests
• The relative importance of each party’s
interests
(1) Alternatives to a negotiated
agreement
• What is our best alternative to a
negotiated agreement (BATNA)?
• The value of a negotiator’s BATNA is the
lower bound (minimum) for the outcome
we require of a negotiated agreement.
• We should prefer an agreement over
impasse if the agreement exceeds
BATNA.
• We should decline any agreement below
our BATNA
(2) The interests of the parties
• There is a difference between the parties’
stated positions and their underlying
interests.
• Positions: the demands from the other
side.
• Interests: underlying issues that could
matter. Negotiators are not always fully
aware of them.
• A focus on deeper interests could form
more reasonable bargaining platform.
(3) Relative importance of each
party’s interests
• To be fully prepared to negotiate, we must
become aware of how important each
issue is to us.
• The best agreements are reached by
trading off relatively unimportant issues for
more important ones.
• One must recognize ahead of time which
tradeoffs are more and less attractive.
Claiming value in negotiation
(Отстояване на искания)
• An expert is being recruited by a company.
All is agreed but the salary.
• The company has offered $90,000. The expert
has counteroffered $100,000.
• Both believe they have made fair offers; both
would very much like an agreement.
• The expert (while not verbalizing it) would take
any offer over $93,000 rather than lose the offer.
• The organization (while not verbalizing it) would
be willing to pay up to $97,000 rather than lose
the candidate.
Bargaining Zone
Recruit’s Company's
Company's Recruit’s
minimum maximum
initial offer initial offer
point point
$90,000 $100,000
$93,000 $97,000

• A positive bargaining zone exists.


• A key negotiation skill is to determine the other party’s
acceptable limit and make an offer close to it.
• E.g. the Company offers $93,100 and states that it is
final. Or, the Recruit could try to convince the Company
that he/she would not go below $96,900.
• Trades would not take place unless it were
advantageous to the parties concerned. Of
course, it is better to strike as good a
bargain as one’s bargaining position
permits. The worst outcome is when, by
overreaching greed, no bargain is struck,
and a trade that could have been
advantageous to both parties does not
come off at all. (Benjamin Franklin)
Creating value in negotiation
(Намиране на изход; създаване на
стойност)
• Complex negotiations may involve several
disputed issues.
• Camp David, 1978: Egypt and Israel tried
to negotiate the control of the Sinai
Peninsula. It appeared that the two sides
had directly opposing goals. Egypt wanted
the return of Sinai in its entirety. Israel had
occupied it since the 1967 war, refused.
Neither side found the proposal of splitting
the Sinai acceptable.
Negative bargaining zone
Israel’s Egypt’s
100% to 100% to
minimum minimum
Israel Egypt
point point
?
?

• In one dimension, resolution looks


impossible.
• However, the existence of multiple issues
and the development of a creative trade
made an agreement possible.
• As the negotiations proceeded, it became
clear that Egypt and Israel had
incompatible positions, but compatible
interests.
• Israel’s underlying interest was security
from land or air attack.
• Egypt wanted sovereignty over land, part
of it for thousands of years.
• There existed two issues, not one.
Sovereignty and military protection were of
different importance to the parties.
The solution
• The solution traded off these issues.
• Israel returned Sinai in exchange for
– (1) a demilitarized zone within Sinai
– (2) new Israeli air bases
A: Giving the land and its total U (Egypt)
control to Egypt. A
D
B: Israel keeping the land and Egypt’s
total control over it. min. point
C: Compromise of giving C
each party half of the land.
B
D: The eventual resolution.
Israel’s U (Israel)
min. point
• Egypt and Israel realized the existence of
a positive bargaining zone by considering
each other’s interests, not just their stated
positions.
• Thus, it was possible to develop an
agreement by trading off the issue that
each country cared less about for the
issue that each country cared more about.
The case of El-Tek
• El-Tek is a large conglomerate in the
electrical industry with sales of over $3.1
billion. It is a decentralized, product-
oriented organization, in which the various
divisions operate autonomously. To
preclude competition for sales to external
customers, divisions are chartered to sell
their products to specific customer groups
outside the organization.
• Recently, the Audio Division (AD)
developed a new magnetic material, called
Z-25. The corporate charter prevents AD
from selling it outside El-Tek. AD can sell
the invention within the conglomerate, as
well as use it to enhance its own products.
• AD made this assessment – it can earn $5
million from Z-25 in the next two years:
$1.75 million from selling magnets
internally to El-Tek; $3.25 million from
product improvements to their own (AD)
components, not available to their
competitors.
• The Magnetic Division (MD) in El-Tek
could generate far more income for El-Tek
if it sold Z-25. MD has better
manufacturing capabilities and a vast
outside market.
• MD believes it could earn $14 million over
the same two-year period from selling Z-
25 magnets.
• Without Z-25, MD would use their own
alternative product, and expect to earn a
profit of only $4 million.
AD and MD negotiate:
MD’s payment to AD for magnet rights
AD’s MD's
MD’s AD’s
minimum maximum
target price point point target price
$2 million $5 million $10 million $12 million

• Claiming value: People think hard about the offers but neglect
their min/max points (BATNAs). AD can make $5 million
anyway. MD can make $4 million without Z-25. MD is
indifferent b/n no deal and paying $10 million (of the $14
million).
• Any agreement b/n $5 million and $10 million will lead to a
joint surplus of $5 million to El-Tek. With no deal AD earns $5
million, MD earns $4 million, a total of $9 million. With a
successful deal, both AD and MD have $14 million to divide.