The Naked Negotiator

Skilled blackjack players think like investors.

In his book Beat the Deal, author Ed Thorp says the main job is to assess the probability of drawing a favourable hand.

Thorp shows you how to count cards so you can work out when the probability of holding a winning hand moves in your favour.

When the odds favour the player, the best strategy is to increase the bet so you can increase your payout.

Thorp calculates that a favourable opportunity comes up just 9.8% of the time. The odds favour the house the other 90.2% of the time.

The lesson for deal makers is that long term success depends on discipline and expertise. Professional gamblers have played lots of games, they stick to a specific game such as blackjack that increases their zone of competence - then they play the odds.

Professional gamblers only bet big when the odds favour them. In the Casino you have to bet every time you play. In deal making you don’t have to play, until the odds favour you.

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In my book, The StreetSmart Negotiator (Amazom, 2005) I list a number of psychological persuasion traps deal makers fall into. Like it or not, negotiators are not always rational, Dr. Spok like characters.

Minds play tricks on the very best of negotiators. In mergers and acquisitions, the time when negotiators are most vulnerable to mind traps is during the price setting stage - when we are conducting the preliminary due diligence.

Overconfident negotiators often overlook evidence that points to deal problems. They fall victim to what behavioural psychologists call confirmation bias.The very time you need to guard against overconfidence and confirmation bias is during the preliminary due diligence. It is here that you formulate your letter of intent which includes your price range, which you hope will propel the deal forward.

Since deal makers rarely recover from an initial offer that’s too high its a mistake you have to guard against or you’ll make the same fatal mistake as Career Education Corporation (CEC).

In Deal without Delusions (HBR Dec 2007) McKinsey authors Dan Lovallo, Patrick Viguerie, Robert Uhlaner and John Horn highlight the case of CEC paying $245 million - 14 times its annual operating earning for Whitman Education Group in 2003 (the historical multiple in this industry is six to eight times earnings).

CEC executives rationalized the sector was in a phase where high prices were the norm. They weren’t. Prices have fallen back to their historical levels.

Overconfidence coupled with confirmation bias is a fatal mix when acquiring companies. So beware!

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“Sequencing in negotiation involves lining up deals so that each deal raises the odds of knocking over the next one.”

When President Nixon and Henry Kissinger were planning their historic visit to restore diplomatic relations with Communist China in the early 1970’s, they were mindful of an even bigger need to get the Russians to agree to a summit, to discuss placing limits on nuclear weapons production.

For 14 months, the Americans had talked to the Russians about holding a summit - with little concrete progress. The Russians kept stalling and stalling.

However, the announcement from Washington that Nixon was planning a visit to China, put increased pressure on the Russians. The Russians were worried the Americans would ally with China into an anti-Russian Sino-America alliance. The Russians quickly shifted ground.

At a meeting with Henry Kissinger on June 8, the Soviet Ambassador Anatoly Dobrynin, became in Kissinger’s words, “…totally insecure.” The Soviet Ambassador stopped being “grudgingly” and “petty” and spoke in a spirit of “goodwill”. Moscow was now very keen for a summit, but asked the Americans to “come to Moscow before going to Beijing.”

Kissinger said no. Meeting with the Chinese would create further leverage for the U.S. when they had talks in Moscow.

Whenever you’re planning to negotiate with a critical but difficult party, ask yourself which prior deals or agreements with another party will tip the balance towards agreement with the most important player you ultimately need to do business with.

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In November 2007, The New York Times wrote an expose on the fiasco surrounding the federal government’s purchase of spy satellites.

In 1998, the U.S. spy satellite agency sought bids to build a fleet of inexpensive spy satellites. The two bidders, Lockheed Martin and Boeing were told the project would operate under a tight price-cap. The government procurement agency made price 50% of the rating score when scoring contract bids. Previously, price had rarely accounted for more than 25 percent of the company’s score.

The front runner based on experience had to be Lockheed Martin. They had years of experience building similar complex projects. By contrast, Lockheed Martin had no track record of building spy satellites.

To win the deal, Boeing came up with a revolutionary play which they claimed could be built for a bargain price.

The Satellite Agency accepted Boeing’s bid. Even so, creating high-concept technology on a fast schedule inside a tightly managed budget - was high risk.

Boeing’s formula to win the bid only on cost and correct the government’s sins with price changes was a train wreck waiting to happen. The project cost $2billion to $3 billion more than planned. The project ran years behind schedule until the government finally killed the project. (The government’s write-off costs have been estimated at $4 billion).

The New York Times investigation reveals that the “multiple failures that led to the program’s demise reveal weaknesses in the government’s ability to manage complex projects.”

Here are some lessons for would-be procurement negotiators.

1. If a price for a complex project looks too good to be true, it probably is.
2. Carefully manage your contractor’s incentives. Incentives for Boeing encouraged them to hide setbacks and dilly dally.
3. Tightly manage big projects. If necessary break them into smaller chunks. Use a traffic light audit system to alert you to problems.
4. Remember if the contractor has a problem, you have a problem. You need to build in contingencies for failure or an early exit.

I help a number of clients negotiate with governments at both the local and central level. It’s remarkable how often you hear suppliers, when formulating a bid comment, lets give them a low price and claw back our margin in “spec charges.”

Is there a flaw in the way many government agencies and big companies manage their big procurements? There is a lot of anecdotal evidence to suggest there is. For a sobering read on the perils of poor contract management, read the full NY Times article.

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