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  • The Economics of Business Organizations TEACHER: Hello, Student. As you know we are now going to discuss The Economics of Business Organizations. I’ll appreciate that you begin this Module by mentioning a couple of matters you’d like to know about this subject.

    STUDENT: Let’s see. In connection with the internal organization of firms, I’d like to discuss if some forms of organization are more efficient than others. I’d also like to know what activities are best done within a single firm, and what activities are best done within independent firms that then trade with one another.

    TEACHER: Very well. We’ll also talk about a new perspective on why firms exist, which is based on the idea that firms provide an organization that is able to co-ordinate the resources of a diversity of employees, each of whom has specific limited knowledge. This new approach is known as the knowledge-based or resource-based theory of the firm.

    Now, let’s begin by taking a look at firms as organizations.

    When we were talking in earlier Modules about how firms made decisions on output and pricing, how did we assume these decisions were made?

    STUDENT: We assumed the existence of one central decision-making unit for all the firm's output and pricing choices.

    TEACHER: That's correct; we actually made that assumption. But in real life, a firm’s managers have different motivations, interests and opinions. To reach final decisions, some way to coordinate these conflicting interests must be found.

    One way to reach this objective is Co-ordination by coalition.

    R. M. Cyert and J. G. March conducted a very influential study in the 1960s.(A behavioral Theory of the Firm – Englewood Cliffs, NJ – Prentice Hall).

    The authors consider the firm’s decision making as the outcome of a process of bargaining between a set of involved parties whose objectives differ. Can you think of a categorization of these employees?

    STUDENT: You mentioned managers before, but it can be argued that firms contain many individuals with different roles and goals. Apart from managers, I can think of workers, shareholders, and customers. Obviously there is no particular coherence of interest within groups.

    TEACHER: Correct. The outcome of the interaction of these different individuals is perceived to be an organizational coalition, in which every individual has to make some compromise over objectives, since not all can be simultaneously satisfied.

    STUDENT: But Teacher, internal compromise does no look as the best way to identify the optimal price, product mix, rate of asset utilization, and rate of innovation, does it?

    TEACHER: A sharp observation, Student. It is a fact that firms in which political processes (akin to those in a coalition government) determine outcomes will typically exhibit organizational slack in the sense that they will not be maximizing profit or the value of the firm. This type of firms can survive in spite of being slack (or sub-optimal, using a more sophisticated word) and not maximizing profits as long as the outcome is satisfactory for all parties involved.

    STUDENT: This approach looks somewhat dated to me. It may have worked nicely in the 1960s, but then company riders, hostile takeovers, shareholder’s revolts, etc. etc. appeared on the scene.

    TEACHER: Quite true. While the Cyert and March analysis had great plausibility in the 1960s, it is hard to reconcile with the business environment of the 1990s and the early 21st century. In short, the strong focus on value maximization has made the concept of organizational slack unacceptable at least for public corporations.

    STUDENT: And it is easy to guess that the basic issue is how to achieve a structure within which internal conflict is resolved and the overall goals of the firm are pursued by all parts of the organization.

    TEACHER: We can give such a structure a name: incentive compatibility.

    This is a structure within which individuals have an incentive to perform not only in their own interest but also in the overall firm's interest.

    STUDENT: Nice definition. How can it be implemented?

    TEACHER: A modern version of the Cyert and March approach is based upon identifying the interests of various groups of stakeholders. Remember who the main stakeholders are?

    STUDENT: Sure. The stakeholders in a firm are all those who have a direct economic interest in the firm's results; mainly employees, suppliers, shareholders, and customers.

    TEACHER: Correct. Successful firms have to build their success on a constructive alliance of all interested parties. No firm can succeed in the long term without a high-quality and motivated management, productive employees, and satisfied customers and suppliers.

    STUDENT: Are you not leaving out the all-important shareholders? A firm needs capital and the stock market is a vital source of it; and managers can get fired by shareholders.

    TEACHER: You are right about the vital importance of shareholders, and I am not leaving them out; I only wanted to stress that if a firm has bad relations with any of the groups mentioned before, it will not serve the value-maximizing objectives of shareholders.

    Now we’ll discuss the three basic business structures that have categorized firms in the 20th and are still valid in the 21st century.

    * In a unitary form (U-form) of business there are several departments that perform different functions, but they all report to the chief executive (or the office of the CEO), who is responsible for the overall running of day-to-day operations.

    * In a multi-divisional form (M-form), specific product groups are formed into separate divisions, each with its own functional departments. Every division has its own general manager who is responsible for the day-to-day running of the division. The CEO of the firm is responsible for co-ordination of the activities of the divisions and for providing strategic focus for the business.

    * In a portfolio form (P-form), the main company (the Group, or Holding) is made up of a collection of several wholly, or partly, owned subsidiary companies. Each of the companies within the group has its own chief executive, who is responsible for the day to-day running of that business, and each of these subsidiary companies may itself be U-form or M-form in structure. The Group has a CEO responsible for deciding the strategy of the entire group, including deciding which businesses should remain in the Group portfolio and which others might be acquired. There is a board of directors for the group, usually referred to as the 'main board', and there is a board for each subsidiary company.

    STUDENT: My guess is all companies that started small and grew organically (that is by expanding the existing business rather than taking over other businesses) started out with a U-form structure. And it is a fact that many small businesses today also have such a structure.

    TEACHER: Correct. The M-form structure was first introduced into General Motors in the 1920s by Alfred P. Sloan, in order to handle the problems of running a large manufacturing concern. Other large US companies, such as Du Pont, Standard Oil, and Sears, also reorganized along these lines in the inter-war years. This structure proved to be a considerable success and was widely imitated.

    But by now almost all large public companies have gone further than the M-form structure -although parts of the business may be in this form. These firms are collections of many subsidiary companies and we can consider them as having a P-form structure.

    STUDENT: You are mentioning the facts. Can we look now into the economic reasons for this evolution of structure?

    TEACHER: We’ll do precisely that, right now.

    U-Form Structure

    The unitary form of structure is the natural place to start for any small business. In a start-up manufacturing business the product might, for example, be produced in a small plant. As the product’s sales grow, additional staff will be hired. The business has to have accounts, so the services of an accountant will be hired. At first, the accountant might be part time, but if growth continues, there will be a finance department. Similarly, someone will have to take charge of sales, and eventually there may be an entire marketing department. Having taken on all these new staff, the firm will need a personnel department to handle hiring and firing and terms of employment, etc.

    This chart illustrates what the organizational structure looks like in a U-form business:

  • Employment: The Supply and Demand for Labor TEACHER: Hi, Student. Economists frequently classify inputs into three categories: labor, capital, and land. The problem of this simple classification is that each category contains an enormous variety of specific inputs.

    When we speak of labor we must keep in mind that the category includes a great deal more than the organized labor. Since trade unions get a lot of press coverage, we may forget that in the US only about 20% of the labor force belongs to trade unions. This percentage is much higher in other parts of the world, of course. Student, will you give me a few examples of "labor" other than factory workers?

    STUDENT: Sure. A secretary who works at Unilever, an account executive at Merrill Lynch, my dentist, a University professor like yourself... etc., etc., etc.

    TEACHER: Correct. In advanced economies, about 2/3 of the people an economist would call "labor" are not factory or farm workers; they are the so called "white collar" workers –clerks, salespeople, managers- or service workers (such as waiters, hairdressers, or lawyers).

    STUDENT: And it is common knowledge that people in these different types of labor earn very different wages.

    TEACHER: Exactly. Average earnings vary considerably from one industry to another. For example, recent data in the US show that if we standardize the wages of construction workers at 100 points, workers in manufacturing averaged about 88 points, and workers in retail trade averaged only 38 points.

    STUDENT: I am certain that we will investigate the reasons for these differences in wages, aren’t we?

    TEACHER: Not only that, we will also be concerned with the total price of labor, which includes a great many forms of remuneration other than what we usually call wages.

    As said, economists include as labor the services performed by professional people (such as lawyers, doctors, and professors) and self-employed businesspeople (such as electricians, mechanics, and barbers). The money such people earn is considered a particular sort of price of labor, even though these amounts are often called fees or salaries rather than wages.

    STUDENT: I have been looking at some "time series", that is, wage earnings over time, and have seen very substantial differences in the same industries and for the same type of labor over a period of say, 10 years. In general, wages show important increments.

    TEACHER: Naturally it is important to distinguish between money (nominal) wages and real wages. The real wage depends on the price level for goods and services as well as on the magnitude of the money wage. In many cases, if the time series is adjusted to inflation, real wages did not rise at all, an din many cases they fell.

    The Equilibrium Wage And Employment Under Perfect Competition

    Let’s begin by discussing the determinants of the price of labor under perfect competition. Student, please remind me about the basic assumption we made of the prices of products and inputs of firms under perfect competition.

    STUDENT: No problem for me, Teacher. We assume that firms take the prices of their products, as well as the prices of all inputs, as given, and we assume that owners of inputs take input prices as given.

    TEACHER: Correct. In this case, what determines how much labor an individual firm will hire at a specified wage rate? Once we answer this rhetorical question of mine, we can derive a firm's demand curve for labor. Incidentally, what do you think a demand curve for labor would be?

    STUDENT: Not very differently from the firm’s demand for other inputs, a firm’s demand curve for labor is the relationship between the price of labor and the amount of labor utilized by the firm.

    TEACHER: Exactly. It shows, for each price, the amount of labor that the firm will use. And it is reasonable to assume that a firm will utilize the profit-maximizing quantity of labor. Before we continue, let me remind you of a basic concept, the marginal product of labor. Or maybe you remember it?

    STUDENT: I do. The marginal product of labor is the additional output resulting from an extra unit of labor. And before you ask me, I also remember the concept of diminishing marginal returns, Teacher.

    TEACHER: Excellent. Let’s assume that we know the firm's production function and that labor is the only variable input. Given the production function, we can determine the marginal product of labor when various quantities are used. Student, what would you do if as a businessperson you notice that hiring an additional worker would yield you a revenue higher than the wage you’d have to pay to that worker?

    STUDENT: For purely economic reasons I’d hire that worker; and I’d continue doing so until –as a result of diminishing returns- an additional worker would cost me more than the revenue that worker would yield.

    TEACHER: I was going to ask you how many workers should the firm hire if it wants to maximize profit, but you have already answered the question; it should hire more workers as long as the extra workers result in at least as great an addition to revenues as they do to costs.

    STUDENT: Let me put it in other words: profits are at maximum when the value of the marginal product of labor is equal to the price of labor.

    TEACHER: What you just said shows me that you understand that the value of the marginal product of labor is the physical marginal product of labor multiplied by the product’s price. And I see you also realize that to maximize profit, the value of the marginal product of labor must be set equal to the price of labor. Can you tell me why?

    STUDENT: Because if the value of the marginal product is greater than labor's price, the firm can increase its profit by increasing the quantity of labor used; while if the value of the marginal product is less than labor's price, the firm can increase its profit by reducing the quantity of labor used.

    TEACHER: It is now a simple matter to derive the firm's demand curve for labor. We can also easily understand that many firms, not just one, are part of the labor market, and therefore the price of labor depends on the demands of all of these firms.

    The market demand curve for labor shows the relationship between the price of labor and the total amount of labor demanded in the market.

    STUDENT: Obviously it shows, for each price, the amount of labor that will be demanded in the entire market.

    TEACHER: The market demand curve for labor, like any other input, is quite analogous to the market demand curve for a consumer good, which we discussed previously. But can you tell me at least one important difference between the demand for labor and the demand for a consumer good?

    STUDENT:: Naturally, the demand for labor and other inputs is a derived demand, since inputs are demanded to produce other things, not for their own intrinsic value.

    TEACHER: Yes, and this is the reason why the price elasticity of demand is higher for some inputs than for others. It is apparent that the higher the price elasticity of demand for the product the input helps produce, the higher the price elasticity of demand for the input.

    STUDENT: Now that you have showed me the market demand for labor curve, it is not difficult to guess what comes next, is it?

    TEACHER: That’s right, we will now discuss the market supply curve for labor. As we have seen, a product's price depends on its market supply curve as well as its market demand curve. This is also true for labor. Obviously, the market supply curve for labor is the relationship between the price of labor and the total amount of labor supplied in the market. Now let me ask you something, Student. Suppose your salary or wage is increased constantly. If you could decide how much overtime to work, would you work more or less overtime?

    STUDENT: Well, at the beginning of that process I would probably work more overtime, since it would be more worthwhile for me to do the extra effort. But after a time, as I made more money working my regular hours, I’d work less overtime in order to have more leisure time.

    STUDENT: A flawless description of how the market supply for labor behaves. When individuals supply labor, they are supplying something they themselves can use; the time that they do not work can be used for leisure activities.

    Due to this, the market supply curve for labor, unlike the supply curve for inputs supplied by business firms, may be backward bending, particularly for the economy as a whole. That is, beyond some point, increases in price may result in smaller amounts of labor being supplied, as shown on the graph.

    As you so well illustrated with your attitude in response to a constantly increased salary, the reason for the shape of this curve is that as the price of labor increases, workers become richer. And when they become richer, they want to have more leisure time. The consequence is that they want to work less.

    STUDENT: But Teacher, is there no contradiction between the assumption that the supply curve of labor or other inputs to an individual firm is horizontal under perfect competition and the fact that the market supply curve for the input may not be horizontal?

    TEACHER: We have to distinguish between the view of a single firm and what happens in the market as a whole. For example, an unlimited supply of unskilled labor may be available to any firm in a particular area at a given wage rate. But the total amount of unskilled labor supplied in this area may vary with changes in the wage rate due to variations of the aggregate demand for workers.

    STUDENT: I see. This is similar to the sale of products. A particular firm under perfect competition rightly believes that it can sell all it wants at the existing price. However, the aggregate amount of the product sold in the entire market can be increased only by lowering the price.

    TEACHER: Exactly, and by how much, depends on the price elasticity of the product. Now let’s turn to the equilibrium price and quantity of labor. The price of labor (or wages) under perfect competition is determined by supply and demand in essentially the same way that a product's price is.
    The price of labor will be at equilibrium at the level where the quantity of labor demanded equals the quantity of labor supplied. As seen on the graph, the equilibrium amount of labor utilized is given by the intersection of the market supply and demand curves

    Naturally, since labor is not an homogeneous input, these curves will be different for different types of workers in different geographical locations at a given point in time. Let’s compare the market for computer programmers and that for unskilled labor.

    We can see in this graph that the demand curve for the services of programmers is to the right of the demand curve for unskilled labor. Also, the supply curve for the services of programmers is far to the left of the supply curve for unskilled labor.

    I’ sure you can easily explain this difference, Student, can’t you?

    STUDENT: The reason is that relatively few people are trained computer programmers, while practically everyone can do unskilled labor. In other words, programmers are much more scarce than unskilled laborers.

    TEACHER: Exactly. It is then easy to understand why computer programmers receive a much higher wage rate than do unskilled laborers. The previous graph illustrates that the equilibrium price of labor for programmers is much higher than that for unskilled labor. This is a rather permanent situation, Student. Can you tell me why?

    STUDENT: Well, the reason is that unskilled workers lack the training and often the ability to become computer programmers.

    TEACHER: That’s right. Computer programmers and unskilled labor are examples of non-competing groups. Wage differentials can be expected to persist among these groups because people cannot move from the low-paid to the high-paid jobs.

    But apart from this fact, there is an element that distorts our elegant analysis; and that element are the labor (trade) unions. You know what the labor unions are, don’t you, Student?

    STUDENT: Of course. The unions are organizations of workers with power to collectively negotiate wages and other non-monetary compensations with employers.

    TEACHER: Correct. The perfectly competitive model does not apply to these workers. Unions arose because workers recognized that acting together gave them more bargaining power. In short, unions increase wages.

    Unions have considerable power, and we must include them in our analysis if we want our models of the labor market to be accurate.

    From an economic theory point of view, the union may try to shift the supply curve of labor to the left, with the result that the price of labor will increase. How can the union reach this end? Unions have frequently forced employers to hire only union members, and then restricted union membership by high initiation fees, reduction in new membership, and other devices. In addition, unions have favored legislation to reduce immigration, shorten working hours, and limit the labor supply in other ways.

    STUDENT: Reminds me of the very long apprenticeship periods common in the middle ages, which were also designed to restrict the supply of craftsmen allowed to practice a trade.

    TEACHER: Same idea, indeed. Medieval trade unions were very powerful. To be allowed to be a shoemaker, an aspirant had to work for maybe 10 or more years as an apprentice in a union member’s shop, practically without pay.

    The union may also try to shift the demand curve for labor upward and to the right. To cause this shift in the demand for labor, the union may resort to a practice known as featherbedding; it may try to restrict output per worker in order to increase the amount of labor required to do a certain job.

    STUDENT: Yes, I remember that for decades the railroads had to man diesel engines with firemen (stokers), the workers needed to keep the fire going on obsolete steam locomotives.

    TEACHER: There are many examples. The linotype operators at large newspapers violently resisted the use of computers; the prestigious US newspaper Herald Tribune closed due to this situation. And airlines were forced for years to man cockpits with navigators, a job made obsolete by satellite technology.

    Unions also try to shift the demand curve by helping the employers compete against other industries or by encouraging the passing of legislation that protects the employers from foreign competition by instituting high tariffs.

    STUDENT: And what can you tell me about collective bargaining?

    TEACHER: Collective bargaining is the process of negotiation between the union and management over wages and working conditions. Representatives of the union and management meet to work out an agreement or contract. Obviously the main pressure element the union can use in these negotiations is the strike.

    STUDENT: In many parts of the world minimum wages are fixed by federal governments or state governments. What effect do these have on the demand and supply of labor?

    TEACHER: Minimum wages, as well as the many types of payroll taxes that exist, interfere with the market mechanism.

    Minimum wages and payroll taxes shift the supply curve of labor to the left, obviously increasing the price of labor and displacing the equilibrium point to a lower level of employment. Basically minimum wages only affect the market for unskilled labor, while payroll taxes affect a much wider range of workers.

    STUDENT: Defenders of the minimum wage argue that the level of poverty is decreased by these regulations. But of course, the contrary argument is that unemployment is higher than it would be in the absence of a minimum wage.

    TEACHER: Depending on each country’s capacity to enforce labor regulations, in many cases minimum wages are not observed by employers. As workers in these cases become part of the underground economy, less taxes are collected. Also, because these workers do not contribute to social security schemes, they are not protected by them. And finally, employers that respect the regulations are subject to an unfair competition.

    On the other hand, a reasonable level of social security contributions is justified, since if well run these schemes provide unemployment insurance as well as health and retirement benefits, which are valuable elements in a modern society.

    Let me finish by saying that the tide is now working against all types of manipulation of the free demand and supply for labor. Globalization, the constantly increasing freedom of international trade, creates a pressure towards equalization of the price of labor all over the world. The differences in wages among countries are still very large; but the tendency towards a confluence is very clear. Real wages in the US and other developed countries have not grown for a long time, while real wages in a large number of developing countries from China to Korea to Mexico have been constantly increasing.

  • Introduction to Economics and Business STUDENT: Hello, Teacher. Yes, I know what's coming up now! For several coming Modules you are going to lecture me about "Microeconomics"!
    And I also know that "Macroeconomics is the study of how the economy functions in broad outline", because you lectured me on that one before. You have also told me before that "Microeconomics is the part of economics dealing with the activities of individual markets and firms".

    TEACHER:. Good for you. I see that you remember my previous lecture on the subject of economics very well.

    STUDENT: Yes, and I also remember having asked you "why should I, as a business person, be interested in macroeconomics"? Now, I will ask you this... why should I, as a business person, be interested in microeconomics?

    TEACHER: Simply because economics is a very relevant subject if a business person is to understand the environment in which he or she operates. A skill that may help the business to be successful, of course.

    STUDENT: You mean to say that to be a good business person I need to be a good economist?

    TEACHER: Not exactly. A deep knowledge of economics is neither necessary nor sufficient for being successful in business. However, a good grounding in economics will help you to analyze business situations much better. Now let me ask you something? Do you know what kind of science economics is?

    STUDENT: I remember something like "the dismal science".

    TEACHER: That was ages ago, when Malthus made very negative forecasts about what would happen as population increased faster than food production. No, the answer I was hoping for was "economics is a social or behavioral science". And this is so because basically economics deals with how people behave in different circumstances. By the way, you know who Malthus was, don't you?

    STUDENT: Thomas Robert Malthus (1766-1834) was an English economist, sociologist, clergyman and pioneer in modern population study. Malthus argued that poverty and distress were unavoidable because population, when left unchecked, increased faster than the means of subsistence.
    And getting back to your definition of economics, what it means is that what economists do is theorize on behavior. Is that all?
    TEACHER: After congratulating you for your encyclopedic knowledge, let me tell you that economics is a social science that tries to explain the behavior of the economy; more exactly, the behavior of the economic agents which are, after all, people. Naturally since economics is not an exact science, economists develop theories which are sometimes called economic models.

    STUDENT: And why and when are these models useful to a business manager?

    TEACHER: Economic models are simplifications of the real world. They may be useful in explaining how the world works. Of course, the ultimate test of how useful economics is to business is... does it really explain or accurately predict what is going on in the real world?

    STUDENT: Fine. And so which is the subject we will discuss in this first Module of microeconomics?

    TEACHER: We will outline some of the key topics that are of interest to both economists and business persons. Later you and I will discuss them in greater detail.

    To begin with, let me state that all business firms operate within a market. Would you attempt to define what a market is?

    STUDENT: Sure. A market is the environment in which suppliers and demanders of a given product or service interact. And let me add that this interaction determines what is produced and consumed and in what quantities.

    TEACHER: A very good "economic" definition. Obviously you mean that this "determination of what is produced and consumed and in what quantities" is reached via the price mechanism, the result of the interaction of suppliers and demanders in the market.

    STUDENT: Sure. And I may add that this is why any business person must have a very good understanding of the markets in which he or she operates. But I have a question. Do all activities of a firm actually take place in a market?

    TEACHER: Not necessarily. A key question for managers of firms to be asking all the time is: should we be doing activity X within the firm, or should we buy it the market from another firm? In other words... should we make it or purchase it?

    STUDENT: So, an activity conducted within a firm is an alternative to a transaction in the market.

    TEACHER: Exactly. While firms always operate in some market, they also perform internal activities, and one of the key economic issues managers face is to decide which transactions should be internal to the firm and which ones should be left to the market.

    STUDENT: I see; and it seems to me that lately there has been a strong tendency towards "farming out" functions.

    TEACHER: True. From administrative tasks to manufacturing, more and more functions are contracted in the market. EDS and IBM have dramatically increased their taking over of IS activities from firms; and farming out manufacturing to "toll producers" has also increased very much.

    The theory of the firm

    But allow me to expand on the subject of markets, and mention "the theory of the firm". When we discuss how markets work, we are primarily interested on the determination of the price and quantity sold of specific products.

    * The theory of the firm will be used to study the supply decisions of firms.
    * Consumer demand theory will help us to generate predictions about how demand will change in response to changes in key economic variables, such as the price of the product and the incomes of consumers.

    The Economics Of The Firm

    While in a large economy decisions are made by an enormous number of participants, many of which are individuals, one of the key economic decision-making units is the business firm. Can you imagine why this is so?

    STUDENT: Well, the business firm is an economic actor that hires workers, buys inputs, and produces some product that it then sells in the market. Of course, a firm may be organized in many different ways from a legal point of view; sole proprietorships, partnerships, corporations, etc.

    TEACHER: True, but from the economics point of view the firm is an entity in itself that is conceptually separate from its owners and workers.

    STUDENT: And what is the conceptual difference between the word 'firm', and others such as 'business', ‘enterprise’, 'company', 'corporation', etc. ?

    TEACHER: Conceptually, there is no difference at all, according to the broad definition given above. When I use the word 'firm' I will be referring to this broad definition. Obviously, sometimes I will refer to specific types of firms, since in fact there are important legal (although not economical) differences between a partnership and a corporation, for instance.

    Now please allow me to discuss...

    The elementary theory of the firm

    We call it the elementary theory of the firm because in order to simplify the "model", we discuss a single-product firm; usually the product is assumed to be a manufactured one.

    STUDENT: Is this not an over-simplification?

    TEACHER: No, because the principles involved can be applied to any firm. What is it that any firm typically needs in order to manufacture any product?

    STUDENT: I’m sure it needs plant and equipment, and workers to operate the equipment and for ancillary tasks. It must also buy inputs, such as components, raw materials, energy, etc.

    TEACHER: Right. How would you, in general, call the plant and machinery a firm employs?

    STUDENT: You are obviously referring to land, buildings, machines, tools, vehicles, etc. This is often referred to as capital or capital goods. But I am a bit confused. There is no question that land, buildings, etc., are capital. But we also often speak of capital when we talk about money in the bank and other financial assets.

    TEACHER: Good point. In the theory of the firm "capital" will generally be used to refer to physical capital, such as plant and equipment. Of course the word capital is also validly used to mean financial assets, such as "working capital", which is not invested in physical capital. But again, in the theory of the firm we will in general use it meaning physical capital

    STUDENT: Fine, now I understand. But I have another question. Since the theory of the firm is based on a single-product firm, does this mean that economics can not deal with multi-product firms?

    TEACHER: Economics can deal perfectly well with multi-product firms. As a matter of fact, these firms are an important topic in the branch of economics known as Industrial Organization. Don’t worry, we will discuss this matter in one of the following Modules of this Subject.

    STUDENT: Would you please summarize what exactly the theory of the firm is about, in practical terms?

    TEACHER: Sure. In the theory of the firm, we analyze how the technology used in production, combined with input prices, affects unit costs as the volume of output is changed. We also discuss how the demand for the firm's product changes at various prices.

    STUDENT: Sounds great. And what is the usefulness of all this analyzing?

    TEACHER: The importance of all this is that, given the cost structure at different levels of output and the market demand at different prices we can conclude what level of output will maximize the firm's profit.

    STUDENT: A precise way to put it, Teacher.

    TEACHER: Thanks. And since I mentioned "market demand", let me tell you that the choices available to firms in the markets they sell to are very much influenced by the competition in those markets.

    STUDENT: Easy to agree with; and I’d add that, to some extent, the firms may also be constrained by the competition in the markets where they purchase their inputs.

    TEACHER: True. Competition in the market a firm sell in may be more or less intense depending upon the availability of similar or superior products, potential substitutes, and the number and characteristics of competing firms. There are basically three types of markets from the point of view of the structure of the competition.

    Perfect competition

    Under perfect competition, there are many firms in the market producing an identical product and none of the firms is sufficiently large to influence the market price. Can you think of an example?

    STUDENT: I guess they are not too many examples for manufactured products, but in general producers of commodities such as those of grains, crude oil, etc. operate under perfect competition. An let me add that you forget one conditions, which is that for a market to operate under perfect competition all buyers and sellers must be constantly informed of the prevailing price at which transactions are taking place.

    TEACHER: Good observation. Not let’s describe...

    Imperfect Competition

    The most common structure in which firms operate is imperfect competition. In this type of market there are a finite number of competing suppliers, each selling differentiated products that can, to varying degrees, be substitutes for each other. What type of situation do you think firms face in these types of markets?

    STUDENT: I guess most firms will have to make decisions about how much to produce and at what price to sell.

    TEACHER: Correct. And also of course they have to worry in varying degrees about what the competition is doing. Now let me ask you ... what type of competition do you think would be in extreme contrast to perfect competition?

    STUDENT: This is the M word: monopoly!


    TEACHER: Right, monopoly. This is a situation where there is only one producer of a product; the single producer faces no competition from other local producers and the product can not be imported.

    A monopolist has the power to set not just output but also the price of the product.

    STUDENT: Nice situation for any business to be in!

    TEACHER: Sure. No other suppliers can take market share from a monopolist. But while monopoly may be good for the firm involved, it will generally be bad for consumers, because the monopolist will tend to charge higher prices than those that would prevail under a competitive situation.

    STUDENT: Naturally, I’m sure this is why most countries have regulations to prohibit monopolies, or to control them when they can not be avoided –cases like water, electricity or local telephone service.

    TEACHER: The latter are examples of "natural" monopolies, where under prevailing technologies consumers would have to pay more if several firms were competing in the market, than they pay if a well regulated monopoly is allowed. The key word is "prevailing technologies"; long-distance phone service used to be a natural monopoly years ago, but this is no longer so due to modern communications technology.

    The basic condition for a monopoly to operate is the existence of some barriers to entry, like those given by patent protection.

    But let’s return to the commonest type of market, imperfect competition. This type of market lies between the two extremes of perfect competition and monopoly, and involves a range of different cases. In general, imperfectly competitive markets involve products that, actually or in the mind of the buyers, are similar but not identical. Can you think of another condition?

    STUDENT: There are a limited number of potential producers, each of which can influence the others by its own behavior; changing output, prices, advertising, etc.

    TEACHER: True. The most common cases of imperfect competition are oligopoly and monopolistic competition.


    Oligopoly exists where the market is dominated by a small group of competing firms. Most large firms operate in this type of markets. Just as an example, let me mention the PC (Personal Computer) industry. Here each firm is greatly affected by what its close rivals do in terms of product prices and innovations.

    Monopolistic competition

    In this type of markets there are many firms but in general their products or services are differentiated. The restaurant business is a good example, especially if we exclude large chains. Each individual restaurant not belonging to a chain, has a small share of the market as in perfect competition; but the difference is that the restaurant has some discretionary power on the prices it charges. Why do you think this is so?

    STUDENT: Because, in contrast to perfect competition markets, here the products are not exactly alike. Restaurants are differentiated by physical location, the type of food they offer, the quality of food and service, ambience, prestige, etc. I am sure this is why they have some price fixing power, but it certainly is a limited one. At some point customers will be willing to travel farther for a meal and/or accept other types and qualities of food and service.

    TEACHER: Exactly. Now let’s discuss the following theme: What determines the behavior of the business firm?

    Motivation Of The Firm

    What do you think is the best answer to that question?

    STUDENT: I’d say, as a first approximation, that a firm attempts to maximize profits. Let me add that profits are defined as the difference between the firm's revenue (or gross income) and its costs.

    TEACHER: That all firms attempt to maximize profits is not an unreasonable assumption indeed, since most businesses appear to be interested in making money. The decisions a firm should make in order to maximize its profits are determined by the current state of technology.

    Technology, Inputs, And The Production Function

    Technology is the total knowledge available concerning the production of certain goods or services. Firms are limited by the current state of technology. In making its decisions, the firm must take this into account.

    Input is anything the firm uses in its production process; machines, energy, raw materials, labor, etc.

    The Production Function

    For any final product, the production function is the relationship between the quantities of various inputs used per period of time and the maximum quantity of the product that can be produced per period of time.

    Now, Student, in analyzing production processes we suppose that all inputs can be classified into two categories. Can you guess what these two categories are?

    STUDENT: I sure can try. Some inputs are fixed (such as the machines available at a certain point in time) and other inputs are variable; those whose quantity can be changed during the relevant period. In the latter category we may mention, with natural limitations, labor and raw materials.

    TEACHER: Good. Whether an input is considered variable or fixed depends on the length of the period under consideration. The longer the period, the more inputs are variable, not fixed. In general we can define two time periods: the short run and the long run.

    The short run is defined as the period of time in which at least one of the firms inputs is fixed. Since the firm's plant and equipment are among the most difficult inputs to change quickly, the short run is generally understood to mean the length of time during which the firm’s land and equipment are fixed.

    The long run is that period of time in which all inputs are variable. In the long run, it is assumed that the firm can make a complete adjustment to any change in its environment.

    Average Product Of An Input

    In order to determine which production technique -that is, which combination of inputs- a firm should use, it is necessary to define the average product and marginal product of an input.

    The average product of an input is the total output divided by the amount of input used to produce this amount of output. Example: In an eight hour shift a machine can produce 800 units of product; the average product of the machine is 100 units per hour.

    The marginal product of an input is the addition to total output due to the addition of the last unit of input while other inputs used being held constant. Example: assume that a machine makes chocolate tablets which are then put into cases by hand. With the same machine and ten workers putting tablets into cases we can produce 1000 filled cases per hour, an average of 100 cases per worker. If we add one worker, we can produce 1090 cases per hour. The marginal product of a worker is 90 boxes per hour.

    STUDENT: Why is it that the additional worker only adds 90 cases of product, while the average of the first ten workers was 100 cases each?

    TEACHER: Ah, this is because you have the infamous law of diminishing marginal returns working against you! Which is perhaps the best-known, and certainly one of the least-understood, laws of economics

    In short, the idea is that if equal increments of an input are added, the quantities of other inputs being held constant, beyond some point the resulting increments of product will decrease. That is, the marginal product of the input will diminish. The reasons for that general law to apply are different in different situations. In our example we can assume that the chocolate tablets coming out of the machine move on a conveyor belt from which the workers take them to put them into cases. As you put one more person to work on the same conveyor belt, the workers will possibly have less space to work efficiently. It is also possible that the 11th. worker is less trained and efficient than the first ten. By the same token, if you add a twelfth worker it is likely that the marginal product of this additional person will be less than 90 cases per hour, an so on.

    Now we are in a position to answer a very important question; what is the optimal input combination to maximize profits? In other words, assuming that the firm is going to produce a particular quantity of output, what combination of inputs should it choose to maximize profits? Any comment?

    STUDENT: Well, obviously to maximize its profits the firm must minimize the cost of its output.

    TEACHER: Yes, this seems obvious enough. OK, the let me tell you now that "the firm will minimize cost by combining inputs in such a way that the marginal product of a dollar’s worth of any one input equals the marginal product of a dollars worth of any other input used".

    STUDENT: Now is does not sound so obvious. Can you explain what this means?

    TEACHER: Sure. Going back to our chocolate tablets example, let’s assume that the firm could either change the speed of the machine –consuming more or less energy per hour- and/or change the number of workers operating the packing line.

    Within the practical limits of the machine and the space available for workers, the firm will combine speed of the machine and workers in such way that the additional cost of producing one more case is the same whether machine speed is increased or a worker is added.

  • Negotiation Basics What is "Negotiation"?

    Let’s define a very simple situation. A has something B wants and is in a position to deliver it; and B has something A wants, and would also be able to deliver it. These are the necessary conditions for any type of negotiation; if either of these conditions are not met, there is no point in conducting any negotiation.

    The more basic form of negotiation is barter. Let’s assume that:

    * A has shirts and B wants shirts. A is in a position to deliver shirts
    * B has pants, and A wants pants. B is in a position to deliver pants

    A negotiation may now begin, with a lot of components.

    To name just a few of them:

    * Quality of the merchandise
    * "Terms of the exchange": how many shirts for how many pants? Or, in a monetary environment, "price of the goods and payment terms".
    * When and where will each party will deliver?
    * In case of differences, who will be the arbiter?

    On the other hand, if A is not interested in pants, and/or B does not care for shirts, there will be no reason for any negotiation to take place.

    The same is true if, regardless of both parties having something the other party wants, one or both of them is not in a position to deliver the goods.

    One of the most distinguished authors in the subject, Gavin Kennedy, defines negotiation as "the management of movement, because without movement no negotiation can succeed". A very concise and to the point definition. Incidentally, the only books on Negotiation we will mention as recommended reading, are Kennedy’s "Everything is Negotiable" , "The Perfect Negotiation" and "Pocket Negotiator". If you are specifically interested in the subject, they are highly recommendable.

    What Kennedy’s definition implies is that to enable a negotiation to take place, both parties must be flexible. They very likely have an ideal target (get as much as they can for as little as possible) but they must be willing to settle for less in order to close a deal.

    If one of the parties is not flexible, there is no possible negotiation. If you go to a fixed price store (Wal-Mart, for instance) to buy something, you find out Wal-Mart’s price for the item and you either purchase it or you don’t. There is no room for negotiation, because Wal-Mart is not "flexible"; their position is "this is the price, take it or leave it".

    Usually in any negotiation both parties have an ideal target and a minimum point at which they are willing to deal (which of course they will carefully hide from their counterpart). For the negotiation to end with a deal, there must be some overlapping of both positions.

    A simple example:

    * You want to purchase a bike and are willing (secretly) to pay up to $100 for it.
    * You go to a store and tell the seller you are willing to pay $80 for the bike (your "bid")
    * The seller asks for $120 (his "ask")
    * If the seller is willing (in secret) to finally sell it for say $90, a deal may be closed at any point of the overlapping bid and ask positions: between $90 and $100.

    The final price will be closer to $90.- or to $100 depending on the negotiating skills of both parties.

    Effective Negotiation

    What is the meaning of "effective" in this context? Some people think that negotiating effectively means using whatever tricks, bluffs and ploys serve their purpose to obtain what they want from the other party, giving away nothing or as little as possible of their own goodies the other party may want.

    This is not a realistic approach for serious professional business negotiators. Bluffs and tricks usually create a negative reaction. The "Machiavellian" approach is best left to unserious amateurs.

    STUDENT: What do you mean by "Machiavellian"?

    TEACHER: Machiavelli was an Italian statesman, historian, diplomat and political theorist. His famous treatise The Prince (written in 1513, published 1532), is a handbook for rulers. Though admired for its incisive brilliance, the book has long been widely condemned as cynical and amoral, and "Machiavellian" has come to mean deceitful, unscrupulous, and manipulative.

    Anyway, the purpose of this course is not to teach you tricks and ploys to trap the people you negotiate with.

    STUDENT: No? And why not?

    TEACHER: Because as a businessperson you will usually negotiate with peers, not with gullible neophytes. These people will not be easily tricked. And many times your negotiations will be repetitive with the same party and you will not want to antagonize them by using bluffs and tricks which will jeopardize a mutually beneficial long-term relationship.

    STUDENT: Then what is this course about?

    TEACHER: This course is about realistic, effective techniques for getting the best possible results in serious, professional negotiations.

    We will also teach you all known tricks, ploys and traps etc. But not to induce you to use them in serious negotiations. The aim is to prepare you for what the other party may throw at you, because "a ploy identified is a ploy neutralized". And we will also describe the basic types of tricky and difficult negotiators you may encounter, and help you to learn how to deal with them.

    STUDENT: Are you serious about your statement that "tricky" negotiators always fail? Because there are many seminars about negotiation which endorse these strategies.

    TEACHER: Seminars are good business for many people conducting them. They are mostly advertised in flight magazines, and aimed at business people coming back from frustrated negotiations. More often than not participants walk away from this type of seminar happily convinced that they have become skilled negotiators... only to fail again next time.

    Naturally there are situations were being tricky pays off. When the deals are "one time" transactions –as opposed to repetitive- and one of the parties is a professional conducting several negotiations every day, and the other is an amateur negotiating once every five years or so, the chance of tricks paying off is high. Typical examples are car, real estate and time-sharing transactions.

    On the other hand, over the years people selling those goods have earned a reputation of being tricky, and nowadays even inexperienced buyers enter into negotiations very suspicious of the other party. Not being skilled negotiators, this extreme self-protective attitude may lead them to reject proposals which are in fact advantageous for them. Which in turn means the seller fails; the reputation of being a tricky negotiator, even if not a fact in a particular case, may work against him or her.

    Planning a negotiation

    A basic condition you should meet before entering into any negotiation is doing some planning. Naturally the time and effort devoted to this planning must be proportional to the importance of the negotiation. If you are going to purchase a bike, you need less planning that if you are going to purchase a new home. But in all cases some planning is very useful.

    Planning consists basically of:

    * Making the best possible estimate of which facts you don’t know about your counterpart and the products and services you are interested in.
    * Determining which of these facts you are not able to find something about.
    * Getting as much information as possible about those facts you are in a position to find out about.

    Establishing objectives

    First question to put to yourself: Why do I want to negotiate? In other words, what is my objective in this negotiation?

    Once you know exactly what you want to get from a negotiation (your goal), you must be as sure as possible of what the other party can do for you to help you reach your goal. Your counterparts in a negotiation are your adversaries because your interests are different; but at the same time they must be your collaborators, because without them you can not reach your goal.

    Simple, obvious (and almost stupid!) example: if your goal is adding a garage to your home, your counterpart in negotiating the construction must be a building contractor, not a car mechanic!

    And naturally the remarks made above work both ways; your potential counterparts must believe that YOU can satisfy all or at least most of their own goals. Continuing with example of the addition of a garage to your home, you may identify a very good contractor, but if this business person does not think you can satisfy his own minimum goal (as say getting $4,000 for building the garage) there will be no possible negotiation.

    STUDENT: I notice you used the plural of "goal", "goals". Would you please elaborate?

    TEACHER: All negotiations except the simplest ones, will contain different elements. Your main goal may be to get a nice garage added to your home; but you will also have sub-goals for cost, timing of starting and finishing the job, automatic or manual door for the garage, etc.

    Once your objective is clear to you, and you have identified a suitable counterpart you think will be willing to negotiate with you, you should establish, for your main goal and for all the sub-goals, a MinAO (Minimum Acceptable Objective) and a MaxDO (Maximum Defensible Objective).

    Understanding what a MinAO is easy. As for the MaxDO, it is your estimate of the maximum benefit for yourself you can realistically expect your counterpart may consider acceptable.

    Your mix of MinAOs and MaxDOs will be your "opening environment"; you will enter negotiations offering your MaxDOs. Naturally your different sub-goals will have different priorities, but we will talk about this later on.

    In our example the MinAO for the main goal may look easy to establish; you will not settle for anything less than a well built garage of a certain size.

    But for the sub-goals, your may define a MinAO for total cost (say, no more than $5,000), having it completed for next winter, etc. To keep it simple we will stick to one single goal, cost.

    STUDENT: Pretty easy. But how about establishing a MaxDO?

    TEACHER: You are right, the MinAO is exclusively your own decision, but in order to establish a MaxDO, you must have some information or insight about your counterpart.

    In our example, obviously if you attempt to begin negotiations with a MaxDO of paying $1000 for the garage and make this opening offer, you may be asked to leave the contractor’s office at once, maybe with some use of force involved. The MaxDO must be realistic, and as said before, you need as much information as possible to estimate a realistic level. In our example you may find out how much the contractor charged for comparable jobs, or the average going rate per surface unit (square foot or meter, depending on where you live). If you know of a case when the contractor charged say $3,000 for a comparable garage, you may realistically think that a MaxDO for cost might be this amount.

    STUDENT: Let me see if I understood.

    You will make an appointment with the contractor, show him a plan (blueprint) of the garage which you took from a specialized magazine, and tell him:

    * That you want a garage added to your house as explained in the plan
    * That you have a budget of $3,000 (your MaxDO for price) without revealing that you actually might settle for up to $5,000 (your MinAO).
    * The contractor may be interested in the job and at this point negotiations may start; or else the contractor will show no interest and you will have to look for someone else to build the garage.

    TEACHER: Your got it right. I love to have clever students!

    STUDENT: Oh yes, and I’d love to have clever teachers, too!

    TEACHER: I won’t comment on that. But since your are such a wise person, please answer the following question. If I were willing to accept no less than $10 an hour for teaching a clever person like yourself, but would start our negotiation demanding $20 an hour... which would be my MinAO and which my MaxDO?

    correct answer : MinAO: $10 MaxDO: $20

    STUDENT: OK, but if my MinAO is paying you no more than $5 an hour, then what?

    TEACHER: There is no chance of a successful negotiation (reaching a deal). There is no "overlapping". For a negotiation to be successful, as explained before in different words, your (the buyer's) MinAO must be higher than my (the seller's) MinAO. Since the former is $5 and the latter $ 10, we would never reach an agreement unless one of us or both changed our objectives enough for them to "overlap". For example, if you decide to change your MinAO to $9 and I to change my own MinAO to $8, then our negotiation could succeed at a price of between $8 and $9.

    Planning a Strategy

    For some types of negotiations (say, selling time-sharing on a resort hotel) standard strategies have been developed by the sellers based on experience and are applied to every counterpart. There may be slightly different approaches for mature couples and for newlyweds, but all people in the same "category" will be faced with the same strategy.

    In serious business negotiations a strategy must be "tailor made" for your counterpart. In order to develop, apply and if necessary change a successful strategy, you need to prepare yourself for this particular negotiation.

    * Be as much informed as possible about the subject of the negotiation, even if your counterpart is the specialist. When you deal with your contractor he is obviously the specialist, but the more you know about construction jobs the better. It will prepare you to understand his arguments and make it easier for you to recognize fallacious arguments. Indicating, even subtly, to your counterparts that you are well informed on the subject matter of the negotiation, will also win their respect.

    * Know as much as possible of you counterpart values and beliefs. This is a very large array of information and you will never know all there is to know. But try hard. Talk to people who have already negotiated with this person or group, and if possible with people inside the organization they belong to. One example: finding out about your counterpart’s situation and ambitions in his own organization, you may use as part of your strategy stressing how closing a deal with you may help them in their career. It does not sound so nice, but you may also "scare" your counterpart about the risk of dealing with your competition. But be careful and subtle, because of what is explained on the following paragraph.

    * Know as much as possible of you counterpart values and beliefs. This is a very large array of information and you will never know all there is to know. But try hard. Talk to people who have already negotiated with this person or group, and if possible with people inside the organization they belong to. One example: finding out about your counterpart’s situation and ambitions in his own organization, you may use as part of your strategy stressing how closing a deal with you may help them in their career. It does not sound so nice, but you may also "scare" your counterpart about the risk of dealing with your competition. But be careful and subtle, because of what is explained on the following paragraph.

    Forecast future consequences

    If you enter into a one-time negotiation, you will probably not worry too much about what will happen in the future.

    But if as it is frequent in business negotiations you are entering or already committed to a long-term relationship, each of your possible moves must be evaluated considering the probable effect not only on the specific negotiation you are engaged in, but also in a valuable long-term relationship with your counterpart.

    A customer with the urgent need of a specific good may agree to pay your outrageous price for a time: but he will probably look for a substitute good and/or another supplier.

    Let me tell a real life example. The subsidiary of the American company K&H in a certain country enjoyed a quasi-monopolistic position in the local market of a certain branded food product. They manufactured the product locally and were protected by heavy tariffs from competitive imports of similar products. Every time K&H negotiated with its customers (wholesalers and supermarkets) they behaved in a way the latter interpreted as abusive; but since the consumers wanted the product and the points of sale had to have to product available, they had to give in most of the times. H&H felt very secure in its position because for a competitor to build a plant in this country would have meant a considerable investment. They did not worry too much about possible future consequences of their negotiating behavior with its customers.
    But at a certain moment the tariff barriers were almost eliminated, and imports of the same product from a neighboring country became competitive in price.

    K&H paid dearly for their use of strong arm negotiating tactics in the past. It’s customers were more than happy to deal with the new competitor. No doubt that K&H would have lost market share and price in any case, but if they had built good will over the years with their traditional customers, the entrance of the new competitor into the market could have been resisted more effectively.

    Defensive Planning

    Certainly your counterparts are doing the same as you are supposed to do. They are trying to find out things about you to define a strategy for the negotiation process.

    Defensive planning means identifying your own weak points and decide what (if anything!) you can do to avoid your counterpart finding out about them. Ask yourself questions like: How important is it for me to reach a deal in this negotiation? What actions from the counterpart may hurt me?

    Sometimes the best strategy resulting from defensive planning is to clearly tell your counterparts about some of your weak points, especially if you think they already know about them or are likely to find out. This may position you in the mind of the others as a good faith negotiator, which in turn may be a strong point during the negotiation.

    OK, now we may hold a session of questions and answers. But you may want to review this Module before we start with it.

    Question 1
    What is the basic condition for two parties to enter into a negotiation?

    Each of the parties must be in a position to deliver a good or service the other party wants

    Question 2
    Gavin Kennedy, defines negotiation as "the management of .... what?

    Gavin Kennedy, defines negotiation as "the management of movement"

    Question 3
    Do you agree with the statement "when a customer purchased a good in Wal-Mart, it was a successful negotiation? If not, why?

    There is no negotiation for customers at a fixed price store. The store, of course, negotiates with its suppliers

    Question 4
    You are willing to pay up to $100 for a good and are negotiating with a seller who is ready to sell it for as low as $70. At what price can the deal be closed?

    Between $70 and $100, depending on the negotiating skill of the participants

    Question 5
    What is the rationale of this course teaching you ploys, tricks and bluffs if their use is discouraged?

    To prepare you for what the other party may throw at you., because "a ploy identified is a ploy neutralized"

    Question 6
    Are tricky negotiators never successful?

    Sometimes they are successful, especially when the deals are "one time" transactions

    Question 7
    Which is the basic thing you should do before entering into a negotiation?

    Before entering into any negotiation doing some planning is crucial

    Question 8
    What is it you are doing when you ask yourself: "Why do I want to negotiate?"

    Establishing your objectives

  • Negotiation : Streetwise Tactical Ploys Possibly the subject of the largest number of seminars and courses being offered today is "Successful Negotiation Techniques" or some similar title. Also many books can be found on the shelves of any bookstore, written by authors of very different backgrounds, from academicians to business executives. The reason for the high demand for these seminars, courses and "how to" books is obviously the perceived need of possessing, and the perceived possibility of acquiring the very valuable skill of being a successful negotiator.

    Since negotiation can be defined as an art and not a science or a technology, it is natural that the advice given at seminars and found in books differs very much.

    According to the basic approach taken, the type of advice given can be grouped into three differentiated schools of thought:

    * Streetwise Tactical Ploys (STP)
    * Principled Negotiation, and
    * Negotiation as a phased process

    In this Module of the Effective Business Negotiation course we will discuss the first of the three approaches:

    Streetwise Tactical Ploys (STP)

    This system was probably practiced since prehistoric times, but in modern times it was first promoted by Chester Karass of the Center for Effective Negotiation in Southern California.

    Since it is natural to perceive at first sight that our counterparts in a negotiation are our rivals or even our enemies, it is not surprising that the promotion of the STP method was very successful, especially during the 80´s.

    Karras belonged to the academic world holding nothing less than a Ph.D. in negotiation behavior from the University of California. But he also had considerable "real world" experience acquired as an executive of Hughes Aircraft. He published a first book targeted at an academic audience (The Negotiating Game) in 1970.

    But in 1974 he published a second book (Give and take: The Complete Guide to Negotiating Strategies and Tactics), targeted to a wider audience. It was very successful, because many people felt that their counterparts in past negotiations had taken advantage of them and were desperate for some way to stop being street dumb. They wanted to be able to defend themselves from the plots of their streetwise adversaries and come out on top in their negotiations.

    The STP approach is still quite popular, and very expensive; and professional seminars concentrate in teaching the ploys supposed to help attendees to "defeat" their adversaries. The STP approach defines negotiations as duels where the "strong" will always defeat the "weak". And to evolve from a weakling to a strong fighter, you need to know these ploys. You can then use them yourself in your negotiations and defeat your adversaries.

    STUDENT: Very nice, but what if your counterpart happens to have attended a seminar of the same kind and also knows about the ploys of the STP approach?

    TEACHER: This is a good point. The value of knowing the STP ploys lays more in the fact that you will be able to recognize them and defend yourself against them, than in using them yourself against your counterpart.

    STUDENT: As you wrote on the previous Module, "a ploy identified is a ploy neutralized".

    TEACHER: Exactly, because practically for any ploy there is a defense or counter. This is why it is important for any negotiator to be able to recognize ploys when used by a counterpart.

    On the other hand, while knowing the STP is a necessary condition to be a successful negotiator, it is not sufficient in most cases. Admittedly, you can sometimes use them yourself against some "street dumb" counterpart, but there seems to be a scarcity of this type of negotiator, and in most cases your counterpart will belong to the streetwise species.

    Also, in complicated, long term and repetitive negotiations the use of ploys and counter-ploys is useless and tends to create hard feelings between the negotiators.

    STUDENT: Which is the best approach, then?

    TEACHER: Have a little patience, please. First let me tell you about those famous ploys you ought to know about in order to recognize them and defend yourself.

    Karass did not claim to invent them, but he standardized and popularized three basic ploys: The Bogey, the Krunch and the Nibble.

    The Bogey

    According to Karass, this ploy is simple, effective and ethical. We can also call it "the poor boy approach", because it consists in claiming you as prospective buyer love your counterpart’s product or service (be it a piece of candy or a tractor) but that you can’t afford it (because your parents cut your allowance or because the giant corporation you represent is stingy and you have a very restricted budget).

    The meaning of these statements is that the seller will make a sale if he comes down in price to the buyer’s price range. The promoters of the Bogey claim that it tests the seller’s asking price credibility. They also claim that the seller may be inclined to review his or her estimate of the buyer’s economic possibilities. And eventually, in trying to justify the asking price, the seller may come forward with information which can be useful to the buyer. To quote Karass, "before long it is discovered that some things in the original price can be trimmed away, others can be changed and still others can be adjusted by the buyer himself to meet the budget. Each party has helped the other reach its overall goals".

    Actually most of the times the Bogey works it will mean a confirmation of the fact that all prices are padded in advance in order to be protected from the buyer’s possible use of the Bogey.

    This writer has perceived a seller’s trick Karass did not describe. We may call it "the seller’s voluntary Bogey". This trick usually disarms the Bogey before the buyer uses it, or at least makes it more difficult to propose.

    STUDENT: Give me an example, please.

    TEACHER: Sure. Let’s assume I am trying to sell you a car. I would tell you: "Dear Student, the regular price of this car is $10,000. I already sold three today at this price. But I know you are a student, and I am sure you are on a tight budget. I will give you my best possible price at once; for you, only $ 9,500. And I hope my boss will not fire me for this. And of course, you have to close the deal today".

    The Krunch

    At this point in our negotiations you (the buyer) might resort to the Krunch, the second of the most popular proposals of Karass.

    The buyer tells the seller: "You have to do better than that to close a deal with me".

    In our example, the car salesperson, after a lot of protestations, will come down say to $ 9,000 for the car. You may be happy to see that the Krunch worked and accept the lowered price. But most probably the car seller has anticipated your possible use of the Krunch and has padded his price. It is very likely that he could give you a better deal.

    STUDENT: You mean the Krunch never works?

    TEACHER: Most of the times it is self-defeating, because the sellers anticipate it and the buyers may be tricked into believing their use of the Krunch got them the best deal when it actually did not.

    STUDENT: Let me draw attention to a weak point in your reasoning. If sellers have already padded their prices in preparation for these ploys, it becomes necessary to use them in order to get a better price. It would be silly to accept the first, padded price of the seller. Even (and especially) if we think the seller has padded the price in preparation for them, we MUST use the ploys.

    TEACHER: Certainly, in the type of negotiations illustrated, such as purchasing a car (especially an used car!). Not necessarily in serious, repetitive business negotiations.

    The Nibble

    The third ploy Karass mentions as useful is the Nibble. I assume you already know what it is.

    STUDENT: Oh, come on, writer, you have to do better than that to teach me!

    TEACHER: Fine, I see you just applied a variant of the Krunch to me! I will give you a good explanation, but please be aware that I had anticipated your ploy and was ready to give you a good explanation anyway!

    Nibbling means "to take tiny bites at something", as in "fish nibbling at the bait".

    According to Karass, the philosophy of the "nibbler" is "if I can’t get a dinner, I'll be happy with a sandwich". Karass argues that the Nibble pays; while it may not do much for the nibblers ego, it helps their pocketbooks.

    Karass says "buyers nibble on sellers and sellers nibble on buyers. Sellers nibble by making over shipments, by supplying slightly inferior merchandise, by not performing promised services, by delivering late, by adding special charges".

    "Buyers nibble by paying bills late, by taking discounts not earned, by requesting special delivery or warehousing services, by asking for slightly better quality than contracted for, by demanding extra reports, certifications or invoices, by getting free engineering charges and by requesting extra consulting and training help for nothing".

    The Nibble may work in some special instances, but it is the source of a lot of conflict. A nibbler is soon recognized as such and this will surely damage the business relationship. As Kennedy says, "ultimately this kind of behavior is self-destructive". This is true, because the use of these type of tricks creates hard feelings and participants tend to get angry with each other. This may be acceptable in a disarmament treaty between potential enemies who already hate and are angry at each other anyway; but it is deadly in business relationships. Most business people will accept and even admire a tough negotiator, but once an agreement is reached, they will expect the other party to respect the terms of the deal.

    STUDENT: I have prepared myself a little for these classes, and I browsed through a book by Kennedy. He asks the following question, which I will put forward to you: "How do we stop the cycle of ploy-counter ploy by those who are trying to do business together".

    TEACHER: I can’t tell you how to stop it, but I can tell you why it should be stopped or not started at all. Because most of the time people who use these ploys and simultaneously keep on the defensive can not advance in complex negotiations. Ploys and counter ploys mean constant confrontation between negotiators and a total lack of confidence in their counterpart’s good faith and fairness. To quote Kennedy again, "Only by addressing each party’s interests, through debate and proposals on issues and positions, is it possible to secure a lasting and implementable deal". And we want to stress "implementable". Many times negotiators finish a negotiation with a deal they are very happy about because they are sure they got the upper hand, only to discover later that it can not be implemented. Many times this is only discovered after both parties have wasted a lot of time, money and energy.
    STUDENT: I’ll buy this, especially because I was involved in such a deal. A well known hardware supplier I used to work for sold a powerful computer to a large wholesaler. Both parties tricked each other in some ways. Basically the buyer exaggerated his capability and commitment to adapt his manual procedures to a computer, and the seller started to nibble at the support he was willing to give to the conversion effort. Soon a period of continued confrontation began, resulting in delays. As may happen with computer hardware, this specific model became obsolete before installation and the contract had to be re-negotiated. This was used by the buyer as a pretext to cancel the contract without penalty; in the process both parties lost a lot of time, money and effort.
    TEACHER: Good real-life example. In this case, obviously the parties did not address each one’s interests.
    Aim High ("shock them with your opening offer")

    This is Karass’ advice: aim high, do not be modest with your opening offer. This is valid for buyers and for sellers. The reasoning behind this streetwise injunction is that the party using it will make the other believe he or she has a lot of bargaining power, this not being actually true.

    In other words, the maxim means "go ahead and bluff". Because if you actually had a lot of bargaining power, as, for example, being a monopoly supplier of a scarce good, you wouldn’t need Karass’ advice. You would just use your power and force your counterpart to deal with your terms.

    Followers of this method are convinced that, as Karass claims his research proved, behaving as if you had power and "aiming high" will increase your chances of getting a good deal. The experiments conducted by Karass are supposed to show that negotiators aiming low are frequently "losers", making large concessions and settling for a mediocre deal; while negotiators aiming high are frequently "winners", making smaller concessions and getting better deals.

    The idea is that "a high unexpected demand or offer can succeed rather than lead to a deadlock because the initial high demand is likely to structure the other negotiator’s expectations" (Kennedy, "Pocket Negotiator").

    STUDENT: Let me tell you something that happened to me when I was in my early teens, and we may try to see how it relates with the subject of this Module.

    Once I saw a nice stereo in the window of a store selling used goods (I now suspect some were stolen). I didn’t have any money, but I wanted to have a look at the equipment. So, I walked into the store and said I was interested in the merchandise. The owner let me listen to it and told me the price was $300. I wasn’t going to purchase it at any price, simply because I had just enough money for the fare back home. But being reluctant to confess it, I decided to make a ridiculous offer assuming that the seller would reject it and then I would walk out with my ego intact. I decided that $30, compared with the asking price of $300, was low enough. Showing regret, I told the owner that I loved the stereo, but that I had only $30 and that I would be ashamed to make such a low offer. The owner looked at me in surprise and told me: "Why, is $30 not money". There I was: the guy was ready to give me for $30 a good he had previously told me was worth $300, and I did not have the $30. I don’t remember the excuse I used to get away, but I always remember the incident as an interesting practical learning experience.

    TEACHER: Interesting story. Let’s try to see what happened. To begin with, the owner seems to have used the "aim high" approach, thinking he could convey that he had power over you, a young inexperienced person fascinated by a shining stereo device. He certainly had padded his price a lot, just in case you were not as stupid as you looked (sorry!) and came out with the Bogey.

    STUDENT: Yes, and then I responded with a "fake Bogey" telling him I had only the imaginary $30.

    TEACHER: Sure, and we can also say your false counteroffer was also a "aim high" (in this case you being the buyer an "aim low") countermove, and an unintentional bluff. The owner may have felt that you had "power" because he actually believed your statement that you had only $30, because of you being so young. In his mind this gave you the power of refusing any higher price, even if you thought the price was fair.

    But I feel that the best part of this anecdote is the conclusion we may draw that many times the limits of a negotiation are wider that the participants think at the entry point. And that even an experienced negotiator as the owner of the store surely was, after using a "aim high" ploy, may be persuaded to reduce his price considerably when confronted with a believable Bogey and/or a "aim low" countermove by the other negotiator.

    STUDENT: Also, I think this episode shows how some of the "streetwise" ploys can be self-defeating. After this experience I never returned to that particular store even when I actually had money, because I concluded that a seller asking for $300 for a good he was prepared to sell for $30, was the type of person I would not want to deal with.

    TEACHER: OK, now we may hold our customary session of questions and answers. But you may want to review this Module before we start with it.

    Question 1
    What is the name of the negotiation approach based on the theory that "negotiations are like duels where the strong will always defeat the weak"?

    Streetwise Tactical Ploys (STP)

    Question 2
    If the opinion of experienced negotiators is that streetwise ploys are not effective in serious business negotiations... what is the use of learning them?

    The value of knowing the STP ploys lays more in the fact that you will be able to recognize them and defend yourself against them.

    Question 3
    Define The Bogey in your own words.

    Basically, claiming that the prospective buyer loves the seller’s product or service but that he or she can’t afford it. This is supposed to induce the seller to lower his or her price.

    Question 4
    You quote the price of a product to a prospective customer and he or she tells you: "You can’t be serious. You certainly have to lower this price a lot if you expect me to even consider buying from you". What type of streetwise ploy is the buyer using on you?

    The Krunch

    Question 5
    How would you call a negotiator who thinks "if I can’t get a dinner, I’ll be happy with a sandwich"?

    A "nibbler".

    Question 6
    What does it mean that a deal must be "implementable"?

    That it should be capable of being successfully completed

    Question 7
    "Shock them with your opening offer". What is the name of the maxim recommending this behavior?

    Aim High

  • Negotiation Practice: Principled Negotiation In Module II of this course we mentioned that the three basic competing approaches to good negotiation practice are

    * Streetwise Tactical Ploys (STP)
    * Principled Negotiation
    * Negotiation as a phased process

    In Module II we described the Streetwise Tactical Ploys (STP). We will now continue with the next approach.

    Principled Negotiation

    In 1982 Roger Fisher and Bill Ury of Harvard University published "Getting to Yes without Giving in", a bestseller about negotiation. The proposals made in this book can be called "Principled Negotiations". The view on negotiations proposed in the book is almost the opposite of the Streetwise Tactical Ploys method. At least it is radically different, from its basic assumptions to the practical tactics it suggests.

    The theoretical basis of Principled Negotiations is that "issues and controversies are decided on their merits rather than through a haggling (dickering) process. Under Principled Negotiations you are supposed to look for mutual gains wherever possible, and where your interests conflict, you should insist that the result be based on some fair standards independently of the will of either side. The method of principled negotiation is hard on the merits and soft on the people. It employs no tricks and no posturing. Principled negotiation shows you how to obtain what you are entitled to and still be decent. It enables you to be fair while protecting you against those who would take advantage of your fairness".

    STUDENT: Very nice and clean sounding. It suggests that in negotiations you can get what you deserve. While the motto of most the Streetwise Tactical Ploys Seminars is "get what you negotiate, not what you deserve". I guess they actually mean that by negotiating effectively you can get more and not less of what you deserve!

    But I see a couple of problems here. How is it possible to define what each party "deserves"? And how does this approach deal with real life realities like the relative power of the parties?

    TEACHER: Your points are very valid and we will discuss them later on. But to confirm your reservations, at least in relation to political negotiations, let me tell you a real story. When Mexico, after 70 years of a One Party government system evolved towards a multi-party political environment, the newly democratically elected President appointed a famous writer as Foreign Minister, obviously as a gesture to the country’s cultural world. A reporter interviewed the writer and asked him what was the basic difference between the academic world and the world of politics. The writer answered: "I was used to an environment where issues are debated and decided on the basis of who is right. In politics issues are decided according to power, alliances and pacts, not on who is right."

    But we shall go on describing the Principled Negotiations approach and then discuss its merits with you. It may not be perfect, but it certainly has its merits.

    Haggling has no basis in principled negotiations. They should be avoided because they tend to create antagonism between the parties.

    STUDENT: I notice a strong cultural bias here. This may be true in a certain business environment or for specific people. But remember my experience (Module II) when the seller of the stereo set asked for $300 and I counter-offered $30. He could not understand why I said I was ashamed of making such a low offer. He said "Why, is $30 not money". He was not offended nor antagonized.

    TEACHER: Yes, but you decided not to visit that store again; you actually made a judgment and defined the other party as disreputable. And this is another of the reasons why the proponents of principled negotiations do not like haggling: because it is disreputable. Anyway, I concede your point. Haggling, in certain circles, is the normal way to negotiate. It is not only accepted but expected. Let’s go on.
    The four components of Principled negotiations are:

    * People: separate the people from the problem
    * Interests: focus on interests, not positions
    * Options: generate a variety of possibilities before deciding what to do
    * Criteria: insist that the result be based on some objective standard.

    As you can see, in many aspects the contrary of the streetwise method.

    People: separate the people from the problem

    It is important to separate the issues themselves from the people who hold opinions on those issues. Obviously people are an important part of a negotiation. They can be a part of a negotiation problem. Or they can be the single problem.

    STUDENT: Easier said than done. How do you go about this "separation"? Does it mean you accept the issues and opinions of the other person but not the person itself? And is it implied that the solution is to get that person replaced by some other more acceptable individual?

    TEACHER: Obviously you rarely have the power to do the latter. What the principle of "separating the people from the problem" means is that you should separate them in you own mind.

    Your counterpart in the negotiation may hold a view you disagree with.

    He or she may insist that your company must deliver separately to 20 of his company’s points of sale. You are prepared to deliver to a single distribution center. This is a problem.

    Now let’s assume the other person is a bigot, supports a political party you despise, and in general expresses opinions which you consider biased and wrong. But this fact is not part of the negotiation nor of the specific problem of the delivery process you and your counterpart disagree on.

    You have to separate the person from the problem in your mind. The (in your personal opinion!) negative qualities of the other person should not be part of the problem. You should not let your dislike of your counterpart and of his or her views be reflected in your movements in the negotiation. Quietly but firmly you should insist on your reasons for wanting to deliver to a single central warehouse. Do not show your irritation at the other person’s views on politics, economics or any other subject. This also applies to any other characteristic of the other person, no matter how irritating they can be to you. Concentrate on the problem, not the person.

    STUDENT: I do not disagree with the advice. But sometimes it is hard to apply. Once I was negotiating an important sale with a man I really did not like for several reasons, but I kept trying to separate him from the problem which was the delivery schedule. At the time there was one of those little wars somewhere, and this person said the war was good and would bring great benefits. I asked him what he thought about the victims of the conflict. And he answered: "Come on, we are talking about only two to three thousand dead, about the same number of people a large theater can contain". At this point I could not stop myself from saying; "Would you feel the same way if it was your own son or daughter instead of other people’s sons and daughters that were among those ‘few’ dead?" He took offense and quickly found an excuse to reject my whole proposal, in spite of having agreed to it previously.

    TEACHER: As much as I can understand how you felt, and while I agree with your opinion, I must tell you that you did not act as a good negotiator should. You did not separate the views of your counterpart on matters not related with the problem, from the problem itself. You could have worked out your disagreement on the delivery schedule if you had separated it from the other person’s valuation of human life versus economic advantage, an issue not related to the problem under discussion.

    But let’s advance to the following principle.

    Focus on interests, not positions

    The most effective way of solving a problem in negotiation is to avoid putting too much stress on positions as compared with interests. Fisher and Ury call people who do that "positional bargainers"; these people attach great importance to their positions in a negotiation. For them positions are all-important and they defend them vigorously. This is usually done by attacking the other party’s positions. The result is usually a stand-off. Neither side will move and both expect the other to yield.

    STUDENT: Reminds me of two car drivers meeting on a very narrow road. Unless one moves to the shoulder of the road and lets the other pass, they will be locked in place, each one expecting the other to yield.

    TEACHER: Exactly. In fact one assumes that the interest of both drivers is to proceed to their respective destinations. But if their position is "I won’t move, you have to let me pass", then both are "positional bargainers". They give their position so much importance that they will act against their own interests. Kennedy says that "neither side will move but both sides expect the other to move first. Not moving at all is a strange form of bargaining, so it is more correct to describe this as positional posturing rather than bargaining".

    STUDENT: Let me see if I grasped the differences between interest, position and issues. My interest in my negotiations with a customer is to close one or more profitable deals. An issue under discussion might be payment terms. And positions would be if I insisted on payment within 7 days, and/or my counterpart demanded 60 days.

    TEACHER: Good example. According to Fisher and Ury, interests and not positions should become the focus of negotiation. This is good advice because as in your example of the two drivers, negotiators often neglect interests and come to a stand-off because they maintain their positions with total inflexibility.

    But eventually issues and positions must be negotiated; the idea is that they should be considered without forgetting the all-important interests. This will allow actual bargaining to take place; movement and flexibility on issues and positions while focusing on interests. In your example your basic interest is to close a profitable deal, and we assume that your counterpart’s interest is also to close a deal advantageous for him or her. If both parties focus on their interest, the issue of payment terms and the positions on the credit terms would be solved. At least movement and bargaining would be possible.

    Options: generate a variety of possibilities before deciding what to do

    The third component suggests that the negotiator should encourage his or her counterpart to work together to invent or discover options and possibilities for mutual gain.

    To be able to do this it is necessary that both parties recognize that in most negotiations there is not a "zero sum" situation in every issue. "Zero sum" means that whatever one party gains the other party loses. In other words, the pie has a fixed size, and if one party takes a larger piece, the other party gets a smaller piece.

    If both parties recognize that "the pie can be made larger" by inventing options for mutual gain, there is a good chance that these options can be found.

    One technique often used is "brainstorming". We can describe this method in a few words: "Everyone offers ideas while everyone postpones criticism and judgment".

    Basically the brainstorming procedure is based on the following sequence:

    * Participants express their thoughts trying not to suppress any idea that comes into their minds.
    * All ideas are written down without anyone commenting on them.
    * Only when the brainstorming session is completed (usually a time limit is fixed at the start) are the options reviewed, discussed and judged.

    Normally most of the ideas are rejected but many times interesting options for mutual gain can be discovered. Naturally the brainstorming process can also be performed separately by the parties within their own organizations and promising options can be later brought to the negotiating table.

    Within the framework of the third component of Principled Negotiations we should also mention the good practice of helping your counterpart to find solutions to his or her problems. A creative negotiator can imagine being in the position of the other person and cooperate in finding solutions to the other person’s difficulties.

    STUDENT: You are so good at telling real life stories; can you mention a case where a brainstorming session was successful?

    TEACHER: No problem. Some time ago I was negotiating with a customer and we could not agree on the price. He was very firm on it; he behaved as a "positional bargainer" on this. I went back to my office and called a meeting of medium-level managers from all departments. We did a brainstorming session. Among the many suggestions a good one appeared. The option was: "Offer them to share logistics". The suggestion made sense because both firms produced goods of the same kind but not competitive, and their factories and distribution centers were not far from each other. We knew that the trucks we rented many times were not loaded to capacity when moving goods from factory to distribution center. Possibly our customer had the same problem. It was worthwhile to explore this option.
    I met with my customer again and suggested that if they accepted our price, we would be ready to share transportation facilities. A quick study showed that by doing this both companies could save a lot of money in transportation costs. The customer realized that my proposal would make him more money than reducing my price. The deal was completed and led to a long term relationship of mutual benefit.

    STUDENT: Was it really that easy?

    TEACHER: Well, not exactly. Of course our proposal was the subject of a "sub-negotiation" on how the savings in transportation would be shared. But this is another story! Let’s move to the next component.

    Insist that the results be based on objective standards

    The key here is: what is actually a really objective standard? Of course, the idea is wonderful. But its practical application is very difficult. Parties have very different views on how to define "objective".

    STUDENT: Well, laws and regulations are objective standards. They do not depend on the wish of the parties.

    TEACHER: Sure, but there is a lot of room for disagreement on many matters not subject to laws or regulations. And in these cases the parties will have to agree first on what are the objective criteria. And even after they agree on the criteria, they must agree on a way to settle disputes on facts.

    Kennedy says that the "universal application (of this component) is doubtful". But still the advice is very useful in assuring that an agreement is implementable. The fact that an agreement contains specific objective criteria and a specific arbitration system is very important. This is especially true in respect of the technical or chemical specifications of products.

    STUDENT: I see a story coming!

    TEACHER: If you insist. One large multinational food company I worked for made a deal with the former Soviet Union to export a large quantity of dehydrated chicken broth manufactured in South America. The agreement did not contain specific objective data like maximum acceptable bacteria count. The agreement referred to samples which would be used as basis of comparison for the inspection of shipments. Apparently this was an objective criteria. But dehydrated chicken broth contains a lot of salt. And bacteria do not like a salty environment, and so the bacteria count on the samples diminished substantially as time passed. When the bacteria content of the samples was compared with recently produced dehydrated chicken broth, the soviet inspector argued –rightly- that the bacteria content was much higher than the sample, and did not allow the product to be shipped. There was a long delay in implementing the agreement and the matter was only resolved after a lot of haggling and confrontation.

    Best Alternative to a Negotiated Agreement: BATNA

    According to Kennedy, " besides the four components, principled negotiation’s main contribution to negotiating practice has been that of a negotiator’s BATNA".

    BATNA means that a negotiator must have a clear idea of the best that could happen if he fails to reach a deal. The best, not the worst.

    Let’s go back to the dehydrated chicken broth case. After the soviets rejected the product before shipment, the producers came up with their BATNA, which was to sell the product in their home market. Since they would have to repack the cubes (in general South Americans can not read food labels written in Russian), this had a certain cost. They compared this cost with the penalty the soviets demanded for accepting the "below standard" produce. As long as their BATNA was better than the deal offered by the Soviets, they continued the negotiations, insisting that the penalty was excessive. Finally the Soviets made an offer topping the seller’s BATNA.

    STUDENT: And the sellers quickly agreed, of course. Right?

    TEACHER: Wrong. When you have an offer on the table better than your BATNA, this is not the end of the negotiations. To the contrary, it signals that from that point on you can keep negotiating for a better deal. As long as your counterparts' offers are below your BATNA, you do not actually "negotiate" because you can not "move"; all you can do is insisting that the position of your counterpart is unacceptable. And if eventually you do not get a better offer you will have to abandon negotiations, because your BATNA is better than the best you can get from a deal at this moment.

    Take the Questions and Answers Session whenever you are ready

    Question 1
    Which is the missing word in this statement: "the theoretical basis of Principled Negotiations is that "issues and controversies as decided on their .......... rather than through a haggling process".


    Question 2
    Consider the statement that you should "get what you negotiate, not what you deserve". Does it reflect the Streetwise Tactical Ploys or the Principled Negotiations approach?

    The Streetwise Tactical Ploys

    Question 3
    You are in the middle of an important negotiation. You and your counterpart disagree on the way your product should be packaged. And your counterpart also keeps annoying you by making negative comments on the racial group or faith you belong to. Which of the components of the principled negotiations approach should you apply in this case?

    Separate the People from the Problem

    Question 4
    You are dealing with a prospective customer and you have already agreed on price and delivery schedule. But your counterpart is demanding a 5% discount on cash payment and tells you that unless you accept this demand, there is no deal. You know that the deal would be advantageous to your counterpart even if you did not grant the 5% discount. What is the other party doing wrong according to the Principle Negotiations approach?

    The other party is focusing on a position (the "non-negotiable" 5% discount) instead of focusing on interests (your mutual interest in closing the deal). Your counterpart is acting as a "positional bargainer".

    Question 5
    We said that "in most negotiations there is not a ‘zero sum’ situation in every issue". What does ‘zero sum’ mean?

    "Zero sum" means that whatever one party gains the other party loses.

    Question 6
    The writer tells us a story of a negotiator who offered his counterpart the sharing of transportation facilities.

    1. Which of the components of the Principled Negotiation approach was applied in this case?
    2. And which method was used to discover this proposal?

    1. The generation of options and possibilities of mutual benefit.
    2. Brainstorming

    Question 7
    You are about to enter into a negotiation. You have decided the best thing you could do if you can’t reach an agreement. What do we call this "best thing you could do" if your negotiation fails?

    Best Alternative to a Negotiated Agreement: BATNA



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