Corporate Strategy

Corporate strategy boils down to the broadly coordinated and highly focused initiatives that will have substantial impact on revenue growth or cost containment.  Your mission is to determine the essential actions to take in an atmosphere of limited labor and capital resources.

As you plan to embark on a new strategic direction, spend adequate time thinking how the chess board is going to evolve at least a few moves forward.  Ask yourself how your employees, your customers, and your competitors will react.  In some instances, you may need to add anticipated supplier and government reactions to your analysis.  As a good steward of your company and the planet, comprehend the environmental and social impact of your actions.

Many successful strategic directions that you can take, any of your competitors could replicate.  If it makes sense after careful consideration to travel that path, then by all means do so,  picking the low hanging fruit first.  Ultimately, however, the greatest strategies take your company in a direction that reinforces your strengths in such a way that competitors cannot follow.

Identify the major levers that drive your business

The best way to identify to the strategic objectives that matter, is to determine the major levers that drive your business.  Some levers, like the cost of commodity inputs including labor, are mostly out of your control.  Other levers can be tuned through concerted action.  In most organizations, the primary drivers are incremental investment in initiatives that drive growth, in contrast to those that affect operational effectiveness or cost.

Regardless of your organization size, you have a responsibility to continually evaluate where your business is performing well and where it is not.  Larger enterprises can do this using business intelligence dashboards that sit on top of data warehouses.  Smaller companies have enough information to do this as well.  You should explore how your business is doing in various major customer firmographic or demographic segments.  You should know which of your products are growing, which are declining, and how much of the total available market you have captured.

If you sit through a business school course on corporate strategy, you would likely learn about four major ways to grow.  These include investing large sums of money in vertical integration, diversification, product innovation, or geographic expansion.  Rather than retread this well traveled landscape, I encourage you to think about major drivers that rely more on effective coordination than they do on expenditure.  There are at least three places to find initiatives with that kind of profile.

The first is how you bring your products to market.  Major levers there are actions that you can take to either retain or to upgrade existing clients.  By way of example, if you crunch client retention statistics in the information services business, you find a pretty obvious result.  Engagement drives retention.  If a client spends time reading a document, then he or she renews at a higher rate.  If he or she takes the time to meet with you face to face, the rate grows higher.  Booking a hotel room and getting on an airplane to attend your conference, boosts retention even higher.  On top of total engagement, there is a strong recency bias at play.  You can find a window of time toward the end of a contract period that has the greatest impact on renewal.  In your business, collect a lot of data and hire a statistician to tell you what matters to your clients.

In addition to optimizing retention and upgrades, another product direction you can take is selling existing products to new buyers and new products to existing buyers.  Though geographic expansion is one example of the former, there are many other avenues such as expanding in a focused way into new vertical markets.  The worst thing you can do is sell a new product to a new buyer.  Avoid that strategy at all costs.

The second place to find low-cost, high-reward strategic initiatives is in sales effectiveness.  This topic is covered in depth in another chapter in this book.  Among the various knobs to turn, hiring and compensation will have the greatest effect.

The third place to explore is your marketing activities.  Finding new ways to generate and pre-qualify leads can have an amazing influence on your revenue growth.  Most sales professionals abhor cold calling, so apply an automation process such as Webinars that filters the leads.  In addition, systematically measure customer loyalty so that you can maximize promoters and minimize detractors.  Remember, if you ask customers for feedback, then you must ensure that you have allocated the time and money to fully address or at least empathetically respond to their concerns.

Launch strategic initiatives in a coordinated fashion

After you have identified a reasonably comprehensive set of growth levers for your business, it is time to get down to brass tacks.  Since new strategic initiatives involve human beings that have constrained capacity for change, the number one thing is to focus.  To keep yourself honest in the selection process and in measuring outcomes, rank order projects by forecasted return on investment multiplied by expected probability of success.  In the end, you should land preferably one but as many as three critical initiatives.

The most important decision that you will make is assigning a single, fully focused, and fully accountable project leader.  Broad executive support all the way up to the CEO is critical to success.  However, “C”-level executives should not be project leaders unless the project is their sole focus.  Working in concert with the larger team, the project leader should have full decision making authority over the required training, tools, and management systems that need to be created to inspect and correct as the program marches forward.

Successful kick-off meetings are crucial to coordinating large projects.  A strong statement of the problem that motivates the emotional and the rational brain will help promote commitment.  Additionally, participants will want to know the concrete business objective so that they know what they are fighting for and when they are done.  When the meeting is over, important stakeholders should have a clear understanding of the scope of the project, the work-streams they own, and the expected timeline for progress.

With a major project, define a series of project phases.  In many instances, you can implement changes as each phase is completed.  This is a variation on the valuable ‘execute and iterate’ theme.  In other cases, you have the option to develop in phases and then release all at once.

Right size your budget to succeed

To succeed, major strategic initiatives need adequate capital and labor resources that have to come from somewhere.  To make room, you have three options.

The first is to ask yourself if there is anything on the plate that you can do differently and more efficiently.  Since you are likely to be busy and too close to your own processes, this is at least one area where outside consultants can add value.

The second is to ask if new initiatives have to be so big.  In many circumstances, you can find ways to reduce scope that have minimal impact on the ultimate return on investment.  Reducing scope has the added benefit of increasing the probability of success.

The final task is exploring if you can make the plate bigger.  For most companies, this is the last avenue pursued since it requires raising capital.

Recap

Here are the concepts you can immediately apply to become a talented business strategist:

  • Identify the major levers that drive your business
  • Launch strategic initiatives in a coordinated fashion
  • Right size your budget to succeed

Mergers and Acquisitions

In the nine year period spanning June 2001 to June 2010, International Business Machines Corporation (IBM) acquired 92 companies for in excess of $25 billion dollars.  If you are lucky enough to work for a juggernaut that averages ten acquisitions per year, then you can probably skip this chapter.  However, the rest of us are unlikely to have a finely tuned merger machine humming away at corporate headquarters. Instead, acquisition due diligence and post-merger integration will likely be tackled by a cross-functional team of smart, well intentioned people who at least want to look like they know what they are doing.

The statistics on merger success rates are sobering.  This has been true for decades, as evidenced by everything from Harvard professor Michael Porter’s 1987 assertion that fifty to sixty percent of acquisitions result in failure to McKinsey & Company’s 2004 calculation that only twenty-three percent of acquisitions have a positive return on investment.  If you define success by a lower standard, that acquired companies continue to operate within the acquired company or as a divestiture, then the prognosis does improve a little.  Unfortunately, that yardstick measures mere Pyrrhic victories.

If you are thrown into the M&A battlefield, there are a few vital recommendations that will improve your odds of survival and give you a fighting chance at success.

Choose acquisition targets that extend your core value proposition

Integration challenges grow exponentially with deal size and business focus relative to your existing organization.  Consequently, you are likely to realize the best results by acquiring smaller firms that reinforce or extend your existing strategy.  This means that you must identify the concrete, incremental value proposition the target company brings.

Logically, the most fruitful acquisitions involve purchases that increase production or sales capacity.  A close second are deals to acquire a new product that you can sell to your existing customers.  Be very honest with yourself about the capacity of your existing sales force to absorb the new offering.

Things get significantly harder when the value proposition involves buying into a new channel to sell your product.  After all, if those prospective customers had found your product valuable, you probably would have built a way to access them a long time ago.  Finally, you should avoid pure diversification plays, unless you work for a holding company with financial engineering expertise and low-cost access to capital.  Offering a new product to a new set of customers amounts to nothing more than gambling with your investors’ money.

The concrete value proposition for the acquisition should be translated into rigorously quantified drivers of value creation.  These drivers will typically include a schedule for cost reduction, financial engineering including tax benefits, and revenue projections.

Anticipate and manage acquisition risks

All acquisitions carry risk. However, risk alone should not be a deterrent.  Rather, you have an opportunity and an obligation to identify key risk factors and develop plans to mitigate them.  During the acquisition process, most people take a functional approach, an excellent start.  Specifically, you may create teams to explore issues around merging information technology, production, sales, human resources, legal requirements, and so on.  Unfortunately, too many buyers ignore the softer risk factors that fall between functional gaps.  Crucially, really get to know the cultures of both companies and what is likely to happen when they intermix.  This will enable you to proactively address issues that arise.  For example, your company might be dominated by a fact-based decision making culture.  If you acquire a people-focused culture, then do not expect your new colleagues to be swayed by purely rational arguments.  They will need time to build trust and are likely to drag their feet in sharing developing problems; so, motivate, inspire, and prove yourself trustworthy.

In addition to the softer side of internal issues, you should similarly plan for external reactions to the acquisition.  How will your customers react?  How will their customers react?  What is your brand strategy?

Engineer your post-merger integration strategy

If there is one recurring theme in engineering successful acquisitions, it is planning, planning, planning.  As articulated earlier, proper planning includes integration milestones and goals that span functional and ‘softer’ cultural and customer issues.  Since you cannot anticipate every eventuality, establish a clear escalation process for unforeseen problems.  For that to be effective, you will need to reserve financial and intellectual capacity for frequent problem solving and future investments.

During acquisitions, it is vital to provide clear and unambiguous leadership by selecting the new management team early on.  The team should include a passionate, execution driven integration leader with past merger experience, strong incentives, and comprehensive decision making authority.  Even if you do not have a leader with past merger experience, all hope is not lost.  In that instance, you should pony up the extra money to bring in outside consultants to help engineer the details.

In all service-based businesses, and even most manufacturing businesses, the key asset that you are purchasing is people and their associated intellectual capital.  Since acquisitions are a time of turmoil for the acquirer and the target, one of your most important early responsibilities is to give  everyone affected clarity on their new roles, responsibilities, and reporting structure.  You want people to spend as little time as possible worrying about their job security and their sense of purpose in the combined enterprise.  Though the leadership team may feel it has a respectable idea of what is going on, everyone else has the impression, rightly or wrongly, that they do not have enough information.  Hence, plan to repeatedly communicate the post merger strategic vision to employees.

Though words are by far the most important, money also matters.  Remember to provide incentives to retain key employees across all important functions in the target.  A useful best practice is to define a three tier structure.  The first tier includes the ten to fifteen percent of star talent who should have the strongest courtship and retention incentives.  Bear in mind that not all management is star talent.  Moreover, many major contributors work in individual contributor roles.  The second tier includes the dedicated bunch who are collectively, but not individually, key to the ultimate success of the merger.  Finally, the third tier includes people that you expect to part ways within a well specified amount of time in order to realize cost savings.

This degree of over-communication should extend beyond employees to your customers.  Customers on both sides of the aisle will grapple with uncertainty.  Competitors will take advantage of this ambiguity and your higher than normal level of distraction by intensifying their marketing activities.  Anticipating this, develop a clear strategy to retain existing customers.  Also, be realistic that customer attrition rates – especially at the target company – are likely to degrade.

During the due diligence phase, you established a measurable set of value drivers.  Those defined what great looks like for the purchase.  As the integration proceeds, institute formal tracking of the acquisition’s performance against those goals.  In most instances, a monthly review with the company operating committee and quarterly review with the board of directors is sufficient.  Beyond keeping everyone honest, these reviews keep people focused on what needs to be accomplished.

Recap

Here are the concepts you can immediately apply to become great at acquisition due diligence and post-merger integration:

  • Choose acquisition targets that extend your core value proposition
  • Anticipate and manage acquisition risks
  • Engineer your post-merger integration strategy

Pricing Strategy

If you have ever called a large company customer service hotline and reached a live human being, then you probably heard the representative furiously hammering away at their keyboard.  In service industry parlance, they are logging a ticket that includes your contact information and your complaint into a sophisticated help desk software application. For many years, the expense of such systems meant that only the largest companies could manage customer relationships this way.  However, in recent years, the Internet has served as a great equalizer allowing small and midsized business to get in on the action too.  Serving them are a host of smaller help desk software vendors that provide lower cost but still reasonably powerful Internet-based solutions.

On the evening of May 18, 2010, one of these emerging players found themselves in an epic (for them) pricing pickle.  The 5,000 or so loyal customers of Zendesk, whose motto really is ‘Love Your Help Desk’, received an email from CEO Mikkel Svane.  The communication began innocently enough extolling a set of new features inspired by customer feedback.  The next few paragraphs delivered the shocker.  Though Zendesk’s smallest customers with only one license would see no price change, everyone else would experience a minimum fifty percent and maximum two hundred percent increase!  The customer uproar was, understandably, swift and scathing.  Smelling blood in the water, competitors immediately went into attack mode.  Not realizing the gravity of the situation, Mr. Svane commented innocently on a prominent social network that “I hope all the new sexy Zendesk features don’t drown in today’s noise.”

In one badly calculated pricing action, Zendesk shattered the trust of their loyal early adopters.  Though the company ultimately did the right thing by grandfathering pricing indefinitely to all existing customers, the damage was already done.  The company survived, albeit with mud in the eye.

Pricing strategy is as much art as it is science.  However, a few key guidelines will get you pointed in the right direction.

Start high

Unless you are selling a pure commodity, you should strive to launch products with high initial pricing.  Many people, particularly small business owners, make the mistake of overestimating the impact that low introductory pricing will have on demand.  In most circumstances, your earliest customers will be willing to pay more to get first crack at the unique benefits of your offering.  Moreover, high pricing may actually stimulate demand by signaling that you are providing a premium product.  If you miss the mark on the high end, then it is easy to adjust and lower prices.  However, if you price too low at the beginning, then you may find yourself in the no-win situation that Zendesk faced.

Avoid radical pricing changes

It is important to get pricing as close to right as possible at initial launch.  Radical changes to pricing strategies almost always end in disaster.  A major change is likely to have one of three inevitable outcomes.  Those clients that can pay less will take advantage of the opportunity.  Those clients that must pay the same will continue on unaffected.  Those clients that you expect to pay more will not.  If you are lucky, those in the final bucket will simply give you a mouthful.  More likely, many will vote silently with their feet and  abandon you for your competition.  The net result of all three behaviors is that you will lose money.

Certainly, there are exceptions to every rule.  In some rare circumstances, there may be a significant untapped buying center that is unable to purchase your product without pricing strategy change.  Most examples of this are of companies that offer variations of their products packaged in lower quantities or with reduced features.  For instance, when Tide laundry detergent was launched in India in mid-2000, its manufacturer needed to adapt to lower household income relative to the United States.  To address the opportunity, Tide was offered in a variety of sizes including single use packets targeted at rural areas.  For most companies employing such a strategy, the price of the ‘inferior’ product should be less attractive on a relative basis as compared to the larger, full-featured offering.

Factor in costs, customers, and competition

Though you must be careful not to anchor yourself, the first thing that you should consider when setting a price point is your average total cost.  Average total costs should factor in not only the variable cost of your given good or service, but also the fixed costs that you incur in the course of running your company.  Average total cost establishes a minimum price point that is the dividing line between life and death for your business.

Once you establish a price floor based on costs, it is time to consider your customers.  When prospects think about buying from you, the first thing they consider is the potential value they can realize.  However, customers typically will not pay the full value they expect to gain from your offering.  They require compensation for the risk they take in buying from you.

To make this more concrete, consider a purchase decision that companies face every day.  Most businesses, whether selling to consumers or to other businesses, spend considerable dollars to buy lists of prospects that are fed into direct marketing campaigns.  Though figures vary widely, a typical response rate to an unqualified prospect campaign is about one percent.  However, just getting a response is only a small part of the battle.  Of prospects that respond to a phone, post mail, or email offer, perhaps five percent of them will actually make a purchase. If the product sells for $2,000, then the value of the contact information for a single unqualified prospect is $2,000 times one percent times five percent.  That works out to a value to the customer of just one crisp dollar.

Since the list buyer made a number of assumptions based on typical industry standards, their willingness to pay would be a decent amount lower to account for the very likely possibility that response rates and conversion rates will turn out lower than expected.  Recalling the work of Kahneman and Tversky from the chapter on change management, most people require a factor of two times return on investment. Hence, in this example, the list buyer’s willingness to pay for an incremental unqualified set of contact information is likely a mere fifty cents.

Now that you have considered your costs and your customers’ willingness to pay, there is one more thing to factor in to your pricing decision – the dreaded competition.  Though companies hate to admit it, there are generally a few competitors lurking in their waters that offer a more or less fungible solution.  This is true for both goods and services.  To keep yourself in business, you should carefully monitor your competitor’s list prices as well as their realized effective prices.

When most people perform competitive analysis in the context of pricing strategy, they stop at examining external competition.  However, to avoid devastating errors, you should also look at the impact that a new product or pricing action will have on other offerings in your portfolio.  Take care to set a price that will not cannibalize your existing business.

Recap

Here are the concepts you can immediately apply to become a skilled pricing strategist:

  • Start high
  • Avoid radical pricing changes
  • Factor in costs, customers, and competition

Statistical Uncertainty

Despite having developed a strong mathematical aptitude, I entered the final year of my undergraduate education in electrical engineering with great trepidation.  My nemesis was a final unmet graduation requirement to complete a course in statistics.  I excelled in solving math problems that had a single, unambiguous answer.  Unfortunately, I simply could not wrap my head around the idea that some problems had infinite, fuzzy solutions.  In the end, I satisfied the requirement with a difficult sounding class that thankfully had very little pure statistics.  That course was called “Introduction to Probability and Random Signals.”

Life, luckily, was not about to let me off so easy.  A few years later, I was on the verge of matriculating into business school.  I am guessing that that faculty at the University of Chicago Booth School of Business knew about people like me and were not about to let us slink past with merely an introductory statistics class under our belts.  Every soul that walked through their doors had to pick their poison – either “Business Statistics” or “Applied Regression Analysis”.  Determined to start with my head held high, I purchased an introductory statistics textbook and worked every problem from cover to cover in the summer before I started school.

A funny thing sometimes happens when you face and conquer your greatest fear.  In my case, I rapidly developed a passion for statistics and went on to major in econometrics and statistics.  To my great surprise, I was granted a statistics scholarship that covered a healthy chunk of my tuition.  Apparently, there are not a lot of statistics geeks, even in a very quantitatively focused business school like Booth.

I offer that background merely to acknowledge my statistics bias.  But, though you certainly do not need to excel in statistics to succeed in business or in life, knowing a few rudimentary concepts is extremely valuable.

Embrace Uncertainty

The greatest epiphany that I had was to embrace rather than fear variability.  Uncertainty surrounds us in nature, at home, and in business.  Absolute randomness is rare.  Rather, seek to understand the expected outcome and the range around it (usually wider than you think)

This concept has worked its way into the professional world in the form of the very useful 80-20 rule.  In 1941, management scholar Joseph Juran studied the work of Italian economist Vilfredo Pareto.  Pareto had observed that 80% of the land in Italy was owned by 20% of the population.  Juran honored the economist by formally coining the concept as the Pareto Principle.  (Not much has changed; the top 20% of households in the United States hold 85% of the wealth.  In fact, the top 1% command nearly 35% of private wealth all by themselves.)

The amazing thing about the 80-20 rule is that it allows you to stop digging when you can account for 80 percent of virtually anything.  It only gets better, because you can get to that level of understanding by doing only 20 percent of the work that you would need to do to get to a total and complete answer.  Unless you are a brain surgeon or a civil engineer, this rule of thumb is an risk-free and immense productivity booster.  To be able to stop when you only have eighty percent of the answer requires that you embrace uncertainty; switch from thinking in terms of yes or no and instead merely accept that an outcome is likely or unlikely.

Take calculated risks

The only way to excel in business and in life is to take calculated risks.  In fact, the more risks you take the better, since you will not only learn from your mistakes but will also have better odds of securing at least one big win.  Nothing ventured, nothing gained.

As you venture forth, it is critical to understand that people systematically overestimate risk.  Factors you should correct for that magnify perceived risk include: limited control, human made rather than natural phenomena, limited information, dreadful outcomes, lack of familiarity, and direct awareness.  Moreover, we ascribe greater risk to children than to adults engaged in the exact same activity.

Indulge me in one very personal example.  As a father, I am deathly concerned that one or both of my children will experience a severe spinal cord injury.  This fear nearly caused me to quash my daughter’s love of participating in recreational gymnastics.  But, consider a few facts and figures.  In the United States, there are estimated to be 40 cases of spinal cord injury per million people per year.  Of these, only 16% are caused by sports and recreation accidents.  Researchers in Japan provide the final piece of the puzzle.  Among Japanese spinal cord injuries associated with sporting activities, 6.6% result from gymnastics.  That means that the annual chance of a person experiencing a spinal cord injury in gymnastics is less than 1 in a million.  To put this into perspective, the odds of dying in a motor vehicle accident in the United States are fully 340 times greater at 144 in a million.  Based on the data, my fear of recreational gymnastics was completely overblown.  In fact, it is really my daughter that should be worried about me.

Beware of assuming that correlation implies causality

In May 1999, a study published in the popular scientific journal Nature nearly put the night light industry out of business, much to the chagrin of frightened infants and toddlers everywhere.  In the article, University of Pennsylvania Medical Center researchers studied the amount of ambient light that 479 subjects were exposed to during their nighttime sleep.  For children from birth to two years of age, myopia – or nearsightedness – was far more prevalent in children who slept with a night light rather than in darkness.  Moreover, those children whose parents left the room’s light fixture on were even more likely to have eye problems later on.  Parents of children with glasses must have been feeling extremely guilty for having used nightlights.

The researchers cited similar findings in studies with young chickens and outlined the likely developmental processes impacted by excessive light exposure at an early age.  Though they carefully hedged their bets, the researchers teetered on the brink of implying causality when they reported: “Although it does not establish a causal link, the statistical strength of the association of night-time light exposure and childhood myopia does suggest that the absence of a daily period of darkness during early childhood is a potential precipitating factor in the development of myopia.”

Fortunately, a year later, Ohio State University researchers spared millions of innocent children from the boogie man.  In a larger study of 1,220 children, Karla Zadnik and her co-authors determined that ambient light during sleep does not cause nearsightedness.  Instead, it turns out that nearsighted kids simply have nearsighted parents who are more likely to leave a light on than parents without vision problems, to light their own path in the middle of the night.  The cause is genetic.  In other words, the researchers of the initial study had found simply a correlation between ambient light and myopia, but not a causality, and thus had engendered needless guilt in many myopic parents.

Even very smart and well-meaning people fall into the trap of assuming that correlation implies causality.  To contend against this, in each instance look for three other explanations.  The first is an external cause.  This is what was at play with the genetic cause that explained the relationship between night lights and nearsightedness.  The second is known as reverse causation.  For example, you might notice there are more police at larger crime scenes and incorrectly conclude that police cause crime.  The third explanation is mere coincidence.  Some humorous examples of this are concluding that the growth of social networking websites or hybrid automobile sales fueled the 2009 economic recession.

Recap

Here are the concepts you can immediately apply to  take charge of statistical concepts :

  • Embrace uncertainty
  • Take calculated risks
  • Beware of assuming that correlation implies causality

Negotiation

The first step to becoming a deft negotiator is realizing that everything can be negotiated.  In many situations, such as employment agreements and home purchases, virtually everyone knows that they can and should negotiate the price.  In other transactions, including buying clothing at a department store or booking a hotel room, most people are conditioned to accept the formally printed sticker price without batting an eyelash.

In general, people expect the price to be negotiable on expensive transactions, but accept the price on inexpensive ones.  This phenomenon is rooted in two considerations, one valid and one not.

The first consideration, perfectly valid, is that there is a tradeoff between negotiation and time.  Though it would not make sense to negotiate for a week to get a twenty percent discount on a $50 item of clothing, it does make sense to spend the time if you are buying a $500,000 home.

The second, unfounded, consideration is rooted in the ubiquitous human behavior of conflict avoidance.  Many people require a minimum amount of expected benefit before they will even begin to negotiate.  This minimum amount is required to compensate them for the stress of engaging in perceived conflict.  If you view every opportunity to negotiate as a pleasurable learning experience, then the threshold quickly drops to zero.  In fact, people invest good time and money to enter such conflict when they take a negotiation class.

Putting the factors of the very real time tradeoff and the unjustified conflict fear together, you can see that it makes sense at least to try to negotiate for that $50 piece of clothing.  If you expect to get $50 or more of value out it, then the worst that can happen is that the sales clerk will not budge on the price.  It is worth thirty seconds to figure this out no matter how wealthy you are.

Keen negotiators also know that price is not the only attribute in the mix.  You can negotiate most elements of a transaction, including timing, quantity, quality, and additional services.  You should concentrate on the manageable set of factors that matter to you and to the party with whom you are negotiating.

Though everything can be negotiated, it does not mean that everything should be.  If you do negotiate literally everything, you friends will desert you and your significant other will leave you.  As in all things, find the balance.

The following tips, with practice, rapidly will turn you into an incisive negotiator.

Gain an information advantage before you start negotiating

The single greatest factor that separates good (and sadly poor) negotiators from great ones is the effort spent gaining an information advantage before the formal negotiation even begins.  Within your given time constraints, your mission is to gather as much intelligence on both tangible and intangible data.

Imagine that you have found a home that you want to purchase.  Most people begin their quest by researching tangible data.  For example, at what price have comparable properties sold for in the recent past?  How much did the seller originally pay for the house?  Are home prices generally increasing or decreasing? Is the property in move-in condition or is it in need of substantial repairs?  How long has the house been on the market?  It is also critical to establish the value of the purchase to you which is generally independent of information related to the seller.

While information-gathering, you also need to explore the world of the intangible.  To do that, get inside the seller’s mind.  What is his or her situation, needs, motivation? Is the seller under contract to purchase another property already?  Is the house being sold by a relocation company that will absorb a lower price?  What does the seller know about you and how will he or she use that information?

The more that you can find out about your counterparty (and the less you disclose about yourself), the better off you are.  However, there is one caveat:  you should clearly understand the motivations of any party providing you with information.  In a house transaction, for example, you should expect your broker to be generally honest and ethical, but less than fully transparent.  Assuming your broker gets a percentage of the transaction, his or her incentive is to close as fast as possible and at as high a price as possible.  You know the score going in; rely only on unbiased sources for information and heavily discount, if not completely disregard, everything else.

Determine your reservation price and know your best alternative to a negotiated agreement

To be a skillful negotiator, you must determine your reservation price before you commence formal negotiations.  If you are buying, the reservation price is the maximum price that you will pay.  If you are selling, the reservation price is the minimum price that you will accept.  Good negotiators say to themselves: “I would like to pay around $10.”  Great negotiators say to themselves: “I will pay at most $10 and will walk away for even a penny more.”

The reservation price is your antidote to emotional involvement in the transaction.  It provides a clear signal that tells you when to disengage.  You need to determine a precise reservation price prior to negotiating.  Once you start a negotiation, you should change your reservation price only in exceptionally rare circumstances.  Remember, you came into the negotiation with an information advantage drawn from unbiased sources.  The negotiation process itself and your counterparty (especially in a zero sum or ‘winner-take-all’ transaction) are far more likely to provide you with information that is a wolf in sheep’s clothing.  If you hit your reservation price, then stop negotiating, period.  You always have the option to cool off, gather additional information, and come back to the table with the same or a different counterparty.

The reservation price is not affected by tangible and intangible information about your counterparty.  Rather, the reservation price is wholly dependent on the value of the transaction to you and on your next best alternative.  The value of the transaction to you is the easy part.

The real secret sauce lies in engineering your best alternative to a negotiated agreement.  In other words, put diligent effort into building your Plan B.  If you want to buy a house, negotiate for two properties with different sellers instead of one.  Although you will certainly improve the transaction price with every additional provider you throw into the mix, two is typically the right number to balance economic gains against time and effort.   Finally, you should know when ‘do nothing’ is the best alternative.

Shape the game

The three strategic levers in negotiating are information, time, and power.  By shaping the game, you gain control over time and power.  In almost every circumstance, you can limit your sense of urgency, determine the issues on the table, and select your counterparty.

Carrying on with the home purchase example, imagine that your goal is to occupy a property by the start of the next school year, to minimize the disruption to your children.  You can control the sense of urgency, by starting your information-gathering process in the winter and conducting your negotiation in the spring. Determine the issues such as price, occupancy date, financing, and so on.  Finally, based on the information that you have gathered, choose which sellers to negotiate with and which ones to avoid.

Decide who will make the first offer (usually you)

If you are a moderately experienced negotiator with an information advantage in a one-off interaction, then you should make the first offer.  Moreover, your offer should be as aggressive and extreme as possible, just shy of being offensive.  That guidance applies to most situations that you will encounter.  If you lack either the experience or the information advantage, then you can be safe allowing the other party to make the first offer, as long as you develop some defense against a powerful psychological weapon.

To understand the logic behind who should make the first offer, you need to understand the tradeoff between the psychological impact of anchoring and the information benefit of receiving the first offer.

In virtually any context, people become powerfully psychologically anchored to the first number they hear, no matter how arbitrary.  If I were to ask a group of one hundred reasonably educated people in what year America gained its independence from the British, the average group response would be close to 1776, since most people know this fact.  If I then asked the group when the Magna Carta was signed, the average answer for the group would be a lot closer to 1776 than the true answer even though the events have little to do with each other.  (In case you forgot, the Magna Carta was originally issued in 1215 by English barons determined to protect their rights by limiting the powers of King John.)  Anchoring is so powerful that even subject matter experts aware of the bias cannot, on average, protect themselves against its influence.  (If you think you can, then you are guilty of overconfidence bias – but that is a horse of a different sort.)

To drive the point home, consider an experiment conducted by Michael Cotter of Grand Valley State University and James Henley of The University of Tennessee over a seven year period between 1999 and 2006.  During the study, which involved 1621 total sessions, students were paired up and then asked to conduct ten separate negotiations with at least one day elapsing between each session.  The researchers found that during the initial negotiation, the individual making the first offer captured on average 55% of the pie.  Because most of us conduct a single negotiation with a person and then move on, it clearly pays to make the first offer.

There are, however, times when you will negotiate with a person repeatedly and the advice for that scenario is slightly different.  In their experiment, Cotter and Henley found that in subsequent negotiations between the same parties, the person that waits to be the one that makes the counter offer actually does a little bit better – claiming 52% of the pie on average.  What is going on?  The short answer is that the counterparty in the initial negotiation has learned to defend against the anchor and actually benefits from the information contained in the first offer.

The best way to defend against an anchor is to consider disconfirming information.  Such disconfirming information might be reasons why the anchor is wrong, assumptions about the other party’s best alternative to a negotiated agreement, and considerations of other issues up for negotiation that are unrelated to the anchor.

Given the power of anchoring, it is easy to see why you would want to make the first offer in a negotiation in a one-off negotiation when you have an information advantage.  In doing so, you will gain the benefit of anchoring the other person and prevent them from doing the same to you.  Moreover, your information advantage will allow you to make an opening offer that is extreme, but just short of obscene.  That way, you set yourself up to gain the largest possible value relative to your reservation price.

By making the initial proposal, you gain the anchoring advantage, but give up the information benefit of waiting for your counterparty to make the first offer.  For example, you might think that $420,000 is an extreme first offer for the house you want to buy.  However, there is always the chance that the seller will lead off with an even lower price.

Nevertheless, despite the information lost from not hearing your counterparty’s initial offer, the anchoring effect on both you and your counterparty is so incredibly powerful that you should make the first offer in a one-off negotiation whenever you have an information advantage gleaned from other sources.  The information advantage will give you confidence that your initial proposal is extreme but not crass.  Hence, there will be little benefit from waiting to receive the first offer.  If, however, you do not have the confidence in your information, then let the other party make the first move, do your best to ignore the anchor, and come in with an even more extreme counter-offer.

Be reticent and patient

Extremely adept negotiators are masters at using silence and patience to their advantage.  Most people are uncomfortable with quiet in any social situation, including negotiations.  At the very least, limiting your own chatter will prevent you from divulging information that you meant to keep to yourself.  However, the most important reason to be reticent is to allow the other party to ‘talk themselves’ into the deal.

In my own experience, I will make a crisp and clear offer or counter-offer and then settle into a relaxed and patient silence.  Nine times out of ten the person with whom I am negotiating will ultimately say “O.K., we can do that.”  Being patient allows you to be silent, thus downplaying any sense of urgency.  In general, the person that has the most time fares best.

Read their body language, control your own

As in all forms of interaction, body language during negotiations reveals far more than words.  Though not a lie detector, a non-verbal signal can be a powerful stress detector.   If you spot signs of stress during a negotiation, then you have reliable evidence that your counterparty may lack full confidence in his or her last position and there is still ample room to negotiate.

To negotiate expertly, you must, at a minimum, be mindful of your own body language.  Strive to control unwanted revelatory ‘tells’ that will benefit the other party, rather than attempting to consciously display specific physical patterns that you think may give you the upper hand.

Identify opportunities for mutual value creation

When I enrolled in a negotiation class during business school, I fancied myself a brilliant negotiator merely looking to sharpen the point on my skills.  And indeed, during the first few sessions, I excelled at winner-take-all, zero-sum negotiations where the sole issue on the table was price.  In the fourth class, I fell flat on my face.

In that fateful negotiation, I failed to notice that I was in a win-win scenario with multiple issues on the table that could be optimized for mutual value creation.  Adept negotiators seek out issues to trade before and during the negotiation.  For this to work, you need to identify factors to negotiate that have asymmetric value to you and to your counterparty.  For example, a home seller might be willing to take a lower price if you commit to a faster close.

The best negotiation levers are those issues which you know are important to the other party but not important to you.  Very specifically, concentrate on the factors that are important to the other party.  In general, it is best to maintain the perception that factors that are essential to them are also significant to you.  This allows you to make greater gains as you trade concessions.  Of course, if an issue is obviously of little value to you, then full transparency is the best course of action to maintain your credibility.

Recap

Here are the concepts you can immediately apply to be a great negotiator:

  • Know that everything is negotiable
  • Gain an information advantage before you start negotiating
  • Determine your reservation price and know your best alternative to a negotiated agreement
  • Shape the game
  • Decide who will make the first offer (usually you)
  • Be reticent and patient
  • Read the other party’s body language, control your own
  • Identify opportunities for mutual value creation