We all negotiate every day. Whether you're discussing dinner options, seeking a pay rise or striking an international business deal, most of our daily interactions with each other involve joint decision-making.
Picture: Julia Taylor
A fundamental issue in any negotiation is who should make the first offer. What does the psychological research and negotiation theory say?
Opening offers matter
Let's say your next door neighbour, Kath, announces she is moving to New York. She has to get rid of her 1973 yellow Chrysler Valiant Charger, which you have secretly envied for years. You check carsales.com, where prices for similar era Chargers range between $17,000 and $100,000. Should you make Kim an offer or instead ask what she wants for it?
Professors Max Bazerman and Margaret Neale of Northwestern University, Illinois, say in their classic text Negotiating Rationally that "final agreements are more strongly influenced by the first offer than by any subsequent behaviour of the parties particularly when issues under consideration are of uncertain or ambiguous value".
High opening demands lead, on average, to more favourable outcomes than moderate opening demands. Why is this?
An initial offer is an anchor around which the subsequent negotiations pivot. The other party responds to the anchor by suggesting an adjustment to it, thereby giving the anchor credibility. The tendency is to insufficiently adjust away from the anchor set by the opening offer.
German social psychologist Thomas Mussweiler researches how people's comparisons of options influence decision making. He says that negotiations "typically involve a great deal of uncertainty on both sides". It is difficult to assess the intrinsic value of something and we instead use the most immediately available information — such as the other side's opening offer — to consider a response.
Behavioural economist Professor Dan Ariely of Duke University, author of Predictably Irrational, offered products such as computer accessories, wine and books to the subjects of a 2003 experiment. Each subject was first asked if they were willing to pay a price determined by the last two digits of their social security number. The subjects were then asked the maximum price they were prepared to pay. Subjects with above-median social security numbers were prepared to pay amounts over 57% more than subjects with below median numbers. The anchors (the subjects' social security numbers) were totally random but still affected the price the subjects were prepared to pay.
The anchoring process also applies in non-monetary assessments. In another study conducted by Mussweiler, participants were asked about Mahatma Gandhi's age at his death. One group was asked if Gandhi was 140 years at death and another group if he was nine. All members of both groups correctly indicated he was neither age. They were then asked how old he actually was when he died. The group who were initially asked if he was 140 gave estimates which, on average, were 17 years older the estimates of the second group. The subjects used the initial ludicrous suggested ages as anchors from which they adjusted (Gandhi was aged 78 when he was assassinated in 1948). Nobel Prize winning economist Daniel Kahneman describes this as a "priming" process by which the subjects search their minds for information as to Gandhi's real age which is consistent with the suggested ages.
How to handle the anchoring effect
First, consider if it is a single issue negotiation — like buying Kath's Charger — or a multi-issue negotiation.
In single issue negotiations, as a general rule, negotiators should utilise the anchoring effect by making the first offer. Care needs to be taken to not make the first offer so high or low as to be in the "insult zone". The tendency of the other person to walk away will partially depend on what alternatives they may have. The less acceptable their alternatives, the more aggressively you can pitch the first offer.
How to deal with Kath's news that she needs to sell the Charger? One option is to prime Kath by offering $5000. The anchoring effect suggests that Kath will calculate a counter-offer by adjusting away from $5000.
Knowledge is power
Making the first offer, however, can be a mistake when you lack information about the real value of the subject of the negotiation — both to yourself and to the other party. How would you feel if Kath immediately accepts your offer of $5000? Perhaps the car is a lemon, or Kath would have accepted a lower price just to offload the car before it is due for reregistration and reinsurance next week.
If you do not have any information as to the real value of the car to Kath, do not make the first offer. Instead, ask her what she wants for it. Perhaps she says $200,000. Remember the anchoring effect and consciously resist using $200,000 as an anchor from which you just adjust. You could try to set another anchor of $5000 but Kath may walk. Another option is to not make a counter offer but ask about Kath's reasoning in offering $200,000. You might be able to point out alternative information or factors to cause Kath to adjust her anchor before you even need to make a counter-offer. You might learn information about her real needs.
In multi-issue negotiations, it is harder to construct a single anchoring price. Consider beforehand what the relative value of each issue is to each party. You can trade off one issue (of lesser value to you but greater value to the other party) for an issue of greater value to you. Separate anchor points could be used for each of the separate issues. Consider making a number of alternative offers at the same time. Multiple offers utilise the anchoring effect whilst also appearing to be flexible. The different reaction of the other party to each alternative can be useful information in ascertaining how they prioritise the different issues.
Ask yourself: how much do I really need the deal? Where else can I satisfy my needs? And don't forget, there are plenty of other yellow Chrysler Valiant Chargers out there.
Matthew Shepherd is Lecturer Dispute Resolution Advocacy at University of Technology, Sydney.