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The Importance of Negotiating Power in Pricing: The Principled Negotiation Approach

August 2012 Pricing

At the most recent Business Marketing Conference in Chicago, IL, I listened to the pre-conference address on customer controlled demand management by Integrated Marketing Communications professor Donald Schultz.  The primary take away from the presentation involved the disaggregation of consumer markets based on the increase of customer awareness and network spillover effects.  Knowledgeable consumers armed with information regarding potential purchases from product reviews, existing customer’s opinions, and trial offers are eliminating asymmetric information between buyers and sellers found in the traditional markets and evolving into a segment of their own.  Firm’s standing market strategies may be insufficient in effectively segmenting markets due to the granularity of consumer’s preferences.

Firms are beginning to face more elastic individual demand curves in consumer markets based solely on information availability.  Instead of price derivation through market dynamics, firms are facing pressure on the individual level.  Firms are realizing the difficulties involved with developing price structures that properly allocate customers into segments based on their willingness to pay.  The growing importance of negotiation in determining price on a one-off basis is becoming more prevalent.  Consumer’s latitude in purchasing power has continuously increased over the years due to new means of social interactions.  Firms embracing individualized markets consisting of one consumer and defining the customer’s buying behavior will be better positioned to adapt to the changing business environment.

Essentially, transactions occur between buyers and sellers.  The existence of a market rests on a double coincidence of needs occurring.  A buyer wants a good or services to eliminate a pain point or gain utility.  A seller wants money and is willing to deliver a good or services in exchange for compensation.  A double coincidence of wants defines a market opportunity, not necessarily the transaction.  The transaction will only occur if an agreement on terms can be established.  Such terms include, price, delivery, transaction costs, etc.

Usually the most important negotiation lever and reason for transaction failure is price.  From a positional perspective, buyers tend to demand the lowest price and search for the highest value, where as sellers want the highest price for their offering.  Clearly, each participant in the transaction has defined boundaries.  Consumers are usually bounded from free to their reservation price (Maximum willingness to pay).  Seller’s range of potential agreement prices are from their reservation price (Minimum willingness to accept) and infinity.  Exhibit 1 shows the creation of the Zone of Potential Agreements (ZOPA) based on the intersection of the buyers and sellers behavior parameters.

Exhibit 1: Zone of Potential Agreement

Only when a positive ZOPA exists do transactions have the chance to occur.  If a negative ZOPA exists, when the buyer’s reservation price is lower than the reservation price of the seller, the transaction does not even enter a negotiation.  Price facilitates mutually beneficial exchange (1).  The question at hand asks how price can be used in negotiation to ensure transactions occur.

My recent interest in negotiation strategy according to price has stemmed from several academic articles and one suggested read.  The national bestseller, Getting to Yes: Negotiating Agreement Without Giving In (2), by Roger Fisher and William Ury offers a unique applied approach to understanding how to reach a “wise” agreement.  According to Fisher and Ury, a wise agreement improves both parties relationship by offering a fair and lasting solution.  Determining how to achieve a wise agreement solely by negotiating price will be the objective of the remaining portion of the article.  Firm side negotiating will be the primary focus.

As mentioned in Getting to Yes, price haggling is a form of positional bargaining where both parties defend their opening position and try to agree upon a new position as the end solution.  In the standard price negotiation, the seller’s position is quite higher than their reservation price and in some instances well above the buyer’s maximum willingness to pay.  The initial position of the buyer is usually at a price of zero.  Positional negotiations may lead to solutions but they tend to offer less than desired outcomes due to neglecting both parties’ interest and possibly destroying future relationships.

A principled negotiation, introduced by the Harvard Negotiation Project, hinges on four key principles; (1) separate the people from the problem, (2) focus on interests, not positions, (3) invent options for mutual gain, and (4) insist on using objective criteria.  Applying a principled negotiation tactic to price negotiation allows for a mutually beneficial exchange.

Separate the People from the Problem

People problems usually undermine the effectiveness of wise negotiation outcomes.  A solid relationship between parties based off past interactions or mutual respect is a good starting ground for the onset of the negotiation.  Viewing the other party as a partner instead of an opposing party increases the probability of achieving a wise agreement.  Trying to understand where the other participant is coming from and their side of the story helps develop appreciation and crafting potential offers.  Accepting the presence of emotions and trying to decipher the origination of the feelings and how it ties to the party’s actions provides useful insight.  Most importantly be a listener and truly understand the other party’s statements before developing your own.

When engaged in a price discussion over a potential transaction buyers and sellers need to understand the internal drivers present.  A seller might need to evaluate the buyer and put themselves in the opposite position.  Knowing the buyer might feel hesitant to trust, anxious about spending money, not being exactly certain what they desire, etc. are all possibly emotions.  Communicating price transparency and understanding what the customer desires through words is the key to recognizing potential product solutions.   Sellers demonstrating passion for products and being forefront with intentions seem to make a better connection with buyers.

Focus on Interests, Not Positions

Positions are defined by interests.  Negotiators establish their positions by what motivates them.  Moving away from positional bargaining where it forces people to give up their initial stance, to aligning interests for common benefit is supported.  Parties that leave their founded position seem to experience a losing sentiment.

Business executives negotiating price should learn what drives consumer’s decision of position.  Why does a consumer want to pay well below my reservation price?  Identifying what motivates customer’s choice of position enables firms to help them achieve underlying goals.  Maybe a cost conscience customer has a low willingness to pay position due to not having much income or a wide array of substitutes.  Understanding the value consumers place on a product will ultimately help in negotiating the price.  Taking the time to develop a full scope of the consumer’s buying incentives and how much satisfaction they will receive through consumption enlightens pricing latitude.

Invent Options for Mutual Gain

Fisher and Ury foster idea creation through informal brainstorming events where both sides can think of potential outcomes and not be judged.  During the idea generation process, no one party should criticize the other’s proposals.  An environment teaming with creativity and openness supports the formation of a healthy possibility list.  Once the list is established both parties can evaluate and determine which proposal seems to best fit both side’s interest.  The pairing down of the potential agreement list should be agreed upon by both parties and should be looked as a way to come closer to mutual solution.  Components of a proposal that the other party feels strong about should not be attacked.  Look for solutions that are important to the partner but not as significant to you.  These occurrences can help move closer to a wise decision.

Developing a list of potential outcomes during a price negotiation can take on a variety of forms.  Understanding why consumers offer such price outcomes proves useful in seeing what motivates their purchasing behavior.  For example, a customer might feel an add-on component to a base model increases the value of the entire offering significantly.  Yet the marginal cost of the add-on product to the supplier is almost negligible.  This would be an excellent negotiation starting place.  Demonstrating to the consumer that you are willing to add an extra component to the base at no additional charge for their agreement to pay a non-discounted price for the base is a win-win solution.

Insist on using Objective Criteria

Moving away from subjective reasoning when nailing down an agreement and focusing on an agreed upon objective criteria establishes a benchmark.  Not deviating away from the pre-established objective benchmark when negotiating allows for a focused agenda.  Keeping an open mind to the other party’s suggestions and not allowing exogenous variables to affect decision making is the key to selecting a wise agreement, even if interests are not aligned.

Determining objective criteria for price negotiations takes the form of researching industry norms and previous transactions.  Creating a resolution technique in the event of parties’ interests clashing provides a way to get past the obstacle without losing sight of the end objective.

Conclusion

Negotiation solely on the pricing lever can achieve a wise agreement under the principled negotiation practice.  In order to move past the stigma of price haggling and realize an outcome that is mutually beneficial, value derived from consumption needs to be emphasized.  Value is another means of expressing price and seems to be less confrontational.

When it boils down, consumers want a product that makes their life easier.  Firms want to provide a product to a consumer in exchange for compensation.  The transfer of value from the firm to the consumer for an agreed upon price is the end goal.  Buyers and sellers enter price negotiations in order to agree on the amount of value provided at the appropriate price.

Understanding consumer’s choice behavior based on their desired interests is an excellent starting place for negotiation.  Why is the consumer engaging the seller?  What does the buyer require from the potential product purchase?  Why is the product of value to the consumer?  What comparable alternatives exist to my product?  Answers to these types of questions define a consumer’s willingness to pay and helps better approximate a consumer’s Best Alternative to a Negotiated Agreement (BATNA).  Pushing past customary positions and getting at the heart of value, brings negotiations closer to resolution.

References

  1. Tim J. Smith, Managing Principal of Wiglaf Pricing
  2. Fisher, Roger, and William Ury. Getting to yes: Negotiating agreement without giving in. 2nd ed. Penguin Group USA, 1991. Print.


About the author

Curry W. Hilton is a senior pricing analyst at Wiglaf Pricing and economics lecturer at Elon University. His primary research interest focuses on price segmentation, negotiations, and firm strategy.

Curry W. Hilton
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