The Denver Post |
Published: July 17,2016 at 12:13 am | UPDATED: July 17, 2016 at 12:11 am
I often receive inquiries from owners who are negotiating to buy or sell a business who wonder if they should make the first offer or wait to receive an offer. Conventional negotiating wisdom says that it’s better to wait.
But you may be better off making the first offer yourself.
By sitting back and receiving the opening offer, the argument goes, you’ll gain valuable information about your opponent’s bargaining position and clues about acceptable terms. This advice makes intuitive sense, but it fails to account for the powerful effect that first offers often have on the way people think about the negotiation process. Substantial psychological research suggests that, more often than not, negotiators who make first offers come out ahead.
The dramatic effect of anchors
Research into human judgment has shown that how we perceive the value of an offer is influenced by each relevant number that enters the negotiation process. Because they pull judgments toward themselves, these numerical values are known as anchors. In situations of ambiguity and uncertainty, first offers can have a strong “anchoring effect” and can exert a strong pull throughout the rest of the negotiations. Even when people know logically that a particular anchor should not influence their judgments, often they are incapable of avoiding its influence. But why?
The answer lies in the fact that every material item under negotiation in a business transaction has both positive and negative qualities — qualities that suggest a higher price and qualities that suggest a lower price. High anchors selectively direct our attention toward an item’s positive attributes while low anchors direct our attention to its flaws. Hence, a high market price directs a buyer’s attention to the company’s positive attributes (such as its strong earnings and profit) while pushing negative attributes (such as a high employee turnover) to the recesses of their minds.
Anchoring research suggests that making the first offer often results in a bargaining advantage. Specifically, when a seller makes the first offer, the final transaction price tends to be higher than when the buyer makes the first offer.
When not to make the first offer
There is one situation in which making the first offer may not be to your advantage: when the other side has much more information than you do about the transaction to be negotiated. For example, recruiters and employers typically have more compensation-related information than job candidates do. Likewise, buyers and sellers represented by investment bankers often are privy to more information than are unrepresented buyers and sellers.
This doesn’t mean that in all cases you should sit back and let the other side make the first offer. Rather, this is an opportunity to level the playing field by gathering more information about the business, the industry and your opponent’s alternatives. The well-prepared negotiator will feel confident about making the first offer, anchoring the negotiations in her favor.
Don’t be afraid to be aggressive
How extreme should your first offer be? Many negotiators fear that an aggressive first offer will scare or annoy the other side. However, research shows that this fear typically is exaggerated. An aggressive first offer allows you to offer concessions and still reach an agreement may be better than your alternatives.
In contrast, an unaggressive first offer leaves you with two unappealing options: make small concessions or stand by your demands. By making an aggressive first offer and giving your opponent the opportunity to negotiate some concessions, you may get a better overall outcome and increase the other side’s satisfaction.
Of course, it is important that your opening offer is not absurdly aggressive. An absurd offer can lead the person on the other side of the table to believe that there is no reasonable possibility , and as such, the appropriate response is to walk away.
Focus on your target price
When constructing a first offer, generally there are two considerations on which you should focus: your alternatives to agreement and a specific target price, above or below which you will walk away rather than reach a deal, and your ideal outcome, including your target price and the agreements, terms and conditions that would fulfill your principal hopes and desires.
I have found that negotiators who focus properly on their target prices make more aggressive first offers and ultimately reach more profitable agreements than those who do not.
Negotiators who focus too rigidly on their target prices or ideal outcomes sometimes curse if doing so results in rejecting profitable agreements. Remember that you want to reach an agreement that meets your objectives and that also satisfies the other side. A satisfied counterparty will be more likely to live up to the terms of the agreement and less likely to seek future concessions or revenge.
Gary Miller is founder and CEO, GEM Strategy Management, Inc. an M&A management consulting firm specializing in middle market privately-held companies. Gary’s team provides advisor services on M&A planning, exit planning, business transfers, preparing companies to raise capital, or owners to sell their companies, due diligence, valuations, and merger integrations. You can reach Gary at 970.390.4441 or email@example.com