Chapter 014 Student

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Purchasing and Supply Chain Managementby W.C. Benton

Chapter FourteenBargaining and Negotiations

McGraw-Hill/Irwin Copyright 2010 The McGraw-Hill Companies. All Rights Reserved.


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Learning Objectives

1. To understand the difference between bargaining andnegotiations.

2. To identify the differences between distributive andintegrative bargaining.

3. To identify the differences between the psychologicaland economic aspects of bargaining.

4. To learn the six psychological factors that affectbargaining.

5. To learn the factors related to the payoff system.

6. To implement bargaining strategies.

7. To identify the elements of negotiation.

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Bargaining and Negotiations

Economics and psychology __________________________________________________________________________________________________________________________________________

Whenever the terms of a sales transaction aredetermined, or a business deal is settled,

bargaining is likely. In a sense, everyone becomesa bargainer at one time or another.

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Bargaining

Bargaining occurs between all forms of humangroupings including individuals, groups,organizations, and countries.

The condition under which bargaining takesplace is ________________________________

_______________________________________

_________________________________________________________________________________________________________________________________________________.

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Three Necessary Conditions

Three additional conditions also mustexist in order for bargaining to occur:

1) Mutual compromise must be possible._________________________________________________________________________________________________________________________________.

1) The possibility must exist for provisional offers to be made by

those involved in the situation.

1)______________________________________________________________________________________.

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What is Bargaining?

A bargaining situation can then be defined as________________________________________________________________________________________________________________________________________________________________.

This is referred to as explicit bargaining.

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Distributive and Integrative Bargaining

Two-party bargaining can be divided into twotypes: distributive and integrative.

The parties in distributive bargaining are in basicconflict and competition because of a clash ofgoals: __________________________________

______________________________________________________________________________.

That is, the total gains from the situationmust be distributed between the twoparties involved and each party usuallywants as much as it can get.

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Distributive and Integrative Bargaining

Discussion, understanding, and agreements arevital to distributivebargaining.

By the very nature of the situation, _________________________________________________.

Without some degree of cooperation, eitherparty can block trading and reduce individualgain to zero.

__________________ can therefore be modeledand examined by using_______________.

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Distributive Bargaining

A two-party, varying-sum, or zero-sum scheduleis suitable depending upon the payoff scheduleinvolved.

In a varying-sum schedule bargaining situation,______________________________________________________________________________

_____________________________________________________________________________________________________________________.

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While the payoff schedules are usually inverselyrelatedif one gains, the other must losethere can besome situations where both parties realize a gain (orloss) not in direct proportion to what happens to the

other bargainer.

In the zero-sum bargaining situation,___________________________________________________

_______________________________________.

The term zero-sumstands for the fact that what one

bargainer gains,___________________________

______________________________________.14-10


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______________________________________________________________________________.

To go from the 90 percent level to the 95 percent level,

a gain of only 5 percent improvement for the customeroften can mean a doubling of the costs to the supplier toattain that increased level.

The zero-sum schedule is___________________________________________________________________________________________________.

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Integrative Bargaining

Integrative bargaining exists where there are areasof mutual concern and complementary interests.

_____________________________________________________________________________________________________________________.

_____________________________________________________________________________________________________________________.

At this point, we are tempted to generalize thatintegrative bargaining is more common to industrialmarkets and interactions while distributive bargaining ismore common to consumer markets and interactions

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Negotiations and Bargaining

In most bargaining situations, there is usually apreliminary discussion, called negotiation.

The word negotiationis derived _____________

______________________________________________________________________________.

The modeling approach to bargaining is_______________________________________

_____________________________________________________________________________________________________________________.

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The bargaining model offers an agreement(solution).

Others, however, have felt the similarities of definition are

so strong that the terms bargainingand negotiation________________________________________________________________________________.

A model of a bargaining problem calls for an asymmetricform of analysis and both a normative focus on_______________________________________________________________________________________.

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The bargainer needs to determine _________________________________________________________________________________________.

The minimum necessary variables for a model ofthe overall bargaining process include both thedecision makers and the opponents initial

offers, desired outcomes, maximum level_____________________________________________________________________________________________________________________

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Two parties can bargain over price; the seller usuallywants the price to be high, _______________________.

The seller is often working under a profit-maximization

strategy and the buyer is more interested in minimizingcost.

_______________________________________

_______________________________________.

The building contractor wants more time; the futureowner wants __________________________________.

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The distributive bargaining situation hasbeen most fully explored by psychologists.

The results of the distributive bargainingresearch are a myriad of small laboratorystudies that have not generated a generaltheory of bargainingor a comprehensive

model to incorporate the many isolatedfindings.

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Economists, on the other hand, have seendistributive bargaining as a problem that onlyinvolves two parties dividing fixed resources with noopportunity for any outside influence of thirdparties.

Economists,____________________________________________________________________________________________________________.

Economists have spent most of their efforts inexamining bargaining_______________________

_______________________________________.

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Psychological BargainingFramework

The findings by psychologists can be categorizedunder six areas, each representing a major factorassumed to affect bargaining.

1. General bargaining predispositions.

_______________________________________________________________________________.

For example, bargainers may have a cooperative orcompetitive general orientation.

2. Payoff system.___________________________________________________________________.

For example, certain terms may yield a specific amount ofprofit, or there may be a bonus for attaining a specifiedagreement, or the time spent in bargaining may involve

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Psychological BargainingFramework

3. Social relationshipwiththe opponent. This factorrefers to the socialrelationship existing betweenthe bargainers.

______________________________________.

4. Social relationshipwithsignificant others.

_______________________________________________________________________________________________.

5. Situational factors. Thephysical and social setting ofthe bargaining may have aneffect. ___________________

____________________

________________________________________________________________________?

6. Bargaining strategy. Thisfactor includes the specificactions of the bargainer during

bargaining.________________________________

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The Payoff System

The actual payoff system that bargainersface in an interaction must certainly be amajor determinant of bargaining behavior.

Several different factors related to the

payoff system have been studied.

1. _________________________________________.

2. _________________________________________.

3. _________________________________________.4. _________________________________________.

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The Payoff System

5. ___________________________________________________________________________________.

6. Whether payoffs are based solely on ones own profitschedule or are based, in whole or in part, on the degreeto which ones profits exceed those of others.

7. ___________________________________________________________________________________.

8. Penalties the bargaining______________________________________________________________.

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Breakeven Point

Various names have been used to describe theamount that must be exceeded in the bargaininginteraction in order to obtain a profit:

_____________________________________________________________________________________________________________________.

A bargainers resistance to making concessionsis positively ___________________________________________________________________________________________________________.

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Breakeven Point

The level of resistance also is assumed to berelated to the minimum necessary share.

As a bargainer________________________________________________________________________________________________________.

It also can be predicted that for a given offer,the higher the minimum necessary share,

_____________________________________

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Time Pressure

_______________________________________________________________________________.

Consider the situation in many labormanagement

negotiations.

_______________________________________________________________________________.

In cases of buyerseller negotiating, time pressure maybe created by the buyers imminent need for the productor service,________________________________

_______________________________________________________________________________.

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Time Pressure

Time pressure in psychological experimentshas been exerted in various ways:

1. High or low probability that the present roundof offers would be the last.

2. _____________________________________.

3. _____________________________________.4. _____________________________________.

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Cost of No Agreement

In most of the psychological research, the majority ofexperiments have been structured so that thealternatives of reaching an agreement and its possibleterms are usually preferable to no agreement.

Warning the subjects that the end of negotiations isimminent often produces extremely rapid concessionmaking, so uniformly rapid, in fact,_____________

________________________________________

________________________________________.

This is not necessarily true in buyersellernegotiations as____________________________

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Multiple Bargaining Interactions

In most psychological research, participants aregiven the goal of maximizing their own gain;however, they also may be interested in

outperforming the other bargainers.

In personal selling situations where the samesalesperson often negotiates with the samebuyer, this may be an important issue.

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Multiple Bargaining Interactions

The question is, What is the effect of beingbested on a previous bargainingencounter?

How will this translate into bargainingstrategy on subsequent interactions withthe same opponent?

It appears that in the second encounter, thosewho had failed on the first encounter bargain ina tougher manner than those who hadsucceeded.

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Bargaining Strategy

Usually a tougher bargainingone using a more extremeopening position, fewer concessions, and/or smallerconcessionscan obtain a more favorable fail agreement.

There appear to be exceptions to such a conclusion,

however.

Never making a concession may be responded toby the other side in a similar fashion, leading tolittle or no convergence in the bargaining

interaction.

When time allotted to bargaining (or that which is left) isvery short and when not reaching an agreement is clearlydisadvantageous, toughness may be a poor strategy

because it could result in no agreement. 14-30


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Bargaining Strategy

Also, when bargaining is deadlocked, toughness iscounterproductive.

Excessive toughness in bargaining could be a particularlybad strategy in buyerseller interactions where futureinteractions were expected.

If one party always chose a very tough stance, the otherparty will develop a similar approach to the bargaininginteraction.

This could result in high transaction costs, lack of futureagreements, and, where possible, replacement of thebargaining opponent.

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Bargaining Strategy

The best strategy is to give the other side theimpression that one is tough but fair.

A strategy of always reciprocating both thefrequency and magnitude of the otherbargainers concessions was found to bemore effective in obtaining concessions from

the other bargainer than strategies involvingless reciprocation.

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Bargaining Strategy

Conceding only in response to a concession by the otherside gives the impression that one is strong, while alwaysreciprocating a concession gives the impression that oneis fair.

This leads to the general conclusion that everyagreement ought to lie somewhere between the twostarting points of the bargainers.

Some agreements are closer to one bargainers startingposition than others because of tough or skillfulbargaining tactics.

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Bargaining Strategy

In conclusion, giving a bargaining opponent theimpression that tough bargaining is because of onespayoff system and that one is firm but fair is thebest strategy.

An example of this in an industrial setting is when asalesperson must contact other members of thebuying center before continuing negotiations with

a purchasing manager who is under pressure fromhis/her constituency to obtain a very low price.

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ECONOMIC BARGAINING FRAMEWORK

While most of the empirical research

to date has been in distributivebargaining and done by psychologists,most of the work done on integrativebargaining has been of the theoreticalnature and accomplished byeconomists.

In the Nash solution, the bargainingproblem is conceived in the usualgame theoretic terms. He considers asrelevant data only the utilities thateach alternative point of agreementprovides to the players.

Nash originally took the position that

his model constituted a positivetheory and that it would describeactual bargaining outcomes, but it isnow much more common to give anormative interpretation to theanalysis and to treat the Nash solutionas a desirable outcome of the

bargaining process.14-35


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The Nash solution assumes individual utilities are notcomparable. It is of a normative nature and assumesaway such features as bargaining ability.

The Nash solution to the bargaining problem suggests a

method offair division. It suggests a way of dividing joint profits that is fair in thesense that a referee or judge should follow if called upon tosettle a division between two corporations.

The contract should be Pareto optimal. However, some

points on the Pareto optimal joint strategy curve leave aplayer worse off than if he/she had not made anagreement.

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The subset of Pareto optimal joint strategies offeringeach player at least his/her security level is called thenegotiation set(contract curve).

The unit price in a Pareto optimal contract can vary

anywhere between the two limiting prices, the higher ofwhich would give all the joint profit to the manufacturerand the lower of which would give all the joint profit tothe distributor.

The tendency in this situation is to split the joint profitevenly between the buyer and the seller.

This seems to agree with all proposed theoriesyielding a specific Pareto optimal strategy (whenutility is linear with money).

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For example, the only reasonable status quo pointseems to be no-deal, in which case the Nashsolution requires a 50-50 split of the profits.

Neither player can enforce a relative advantageover the other; this also leads to an even split.

One problem here is that the subjects are not in

direct contact with each other and thereforepsychological aspects are not a part of the process.

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Economic Theory

In general, economic theory can help predictthe approximate outcome of bargainingsituations, but psychological conditions willcause the true solution to vary around the

predicted outcome point.

A combined economic/psychologyapproach will help provide the truestsolution and best approach tounderstanding bargaining and negotiationsituations and their outcomes.

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An Experiment in Distributive Bargaining

To better illustrate the effects of both economicand psychological aspects on the outcome ofbargaining situations, it is necessary to turn to afield experiment in distributive bargaining.

The experiment examines the effect ofcontingency compensation on both buyers andsellers. It also allows speculation about thedifference in the power systems of buyers andsellers and how they affect the outcome ofbargaining situations.

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Consider the following sales situation where anagreement has to be reached in the specifications ofthe product to be bought and the money to be paid.Both the seller and buyer can make concessions. Tosimplify matters, also assume the following bargainingconditions:

1. Only one deal is being negotiated.

2. The bargainers are honorable people.

3. The decisions made are binding.

4. No arbitration or third party is available toassist bargainers.

5. Any party can break off the negotiation andcontinue as before.

6. The setting and language are not important.14-41


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An Experiment In Distributive Bargaining

Sellers and buyers tend to have conflictingbargaining goals.

The aim of a selling organization is to instill in itssalespeople the objective of influencing the buyers

actions to the advantage of the seller. This goal iseffectively communicated and reinforced by the sellerscompensation system.

Salespeople are often compensated on the basis of

salary plus commission, making their earnings directlycontingent upon some measure of selling effectiveness.

Logic dictates a similar objective for the buyingorganization. See the next slide

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This price includes thetotal costs plus an

expected profit margin.The buyers reservationprice (Rb) representsthe maximum amountthat he or she is willing

to pay for any finaldeal, *.

To pay more than thereservation price, Rb,

the buyer would bebetter off with noagreement (see theFigure to the right)

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An Experiment in Distributive Bargaining(Results)

The results yielded a number of interestingfindings.

First, the initial offer from the buyer was always

consistently above the sellers reservation price. This casewill result in an agreement favorable to the seller in eachsituation.

Second, the results suggest that the way a negotiator is

paid will affect significantly the process and outcome ofthe negotiations. As shown in the next slide Figure (d),the effects of contingent rewards are to shift the sellersmarginal surplus upward and the buyers marginal valuedownward. See the next slide

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When only one party is contingently rewarded,the effect is to shift the settlement in thatpartys favor. When both parties arecontingently rewarded, the result is a much

longer and more difficult negotiation process.

This study, like much of the bargaining research,focused exclusively on price as the relevantcriterion.

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While this is not always true of bargaining situations, theresults of this study have three specific implications forunderstanding bargaining and negotiations and help tomerge economic considerations with psychologicalvariables.

First, contingent rewards make a difference innegotiation outcomes. The reward practices that exist today in purchasing put the

buying organization at a distinct disadvantage.

Although the sales activity is essentially a mirror image ofthe buying activity, sales organizations have developedreward systems that motivate their personnel throughcompensation; purchasing organizations, for the most

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Second purchasing organizations need tobe aware of the salespersons rewardsystem. By knowing about the contingencies created for

sellers, the buying organization can developcompeting contingencies for its personnel where theefforts would have the greatest benefit.

A purchasing representative also can takeadvantage of the sellers own motivation tomaximize some element of the negotiation byseeking important concessions on other elements

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The third implication is that managementmust develop stronger contingencies to

encourage purchasing effectiveness.

This can be done by concentrating on the areasof purchasing that are most critical, recognizingthe most important variables involved in thenegotiations for any given purchase, and

improving performance appraisal processes toreflect purchasing effectiveness in relation to thereward.

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PLANNING FOR A FORMAL

NEGOTIATION

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Planning (Sellers Perspective)

The most important planning activity for a seller is tosubmit the most responsive Request for proposal (RFP)or Request for Quote (RFQ).

The sellers proposal should be based on a

thorough conceptual and economic analysis. If this phase in the planning process is non responsive, the

negotiations will not be conducted... The seller cannot alter theproposal after it is submitted.

On the other hand until an agreement is signedthe buyers can his/her mind. There is always a chance of rejection no matter how strong the

sellers initial RFP. At the same time no matter how weak acompeting proposal, it still has a probability of acceptance nomatter how remote.

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As an example, Custer-Battle, a security firmcontracted by the US government to providesecurity for commercial aviation at the Baghdad

Airport arrived in Iraq immediately after theground war looking for work.

According to published reports they scribbled a

contract on a sheet of notebook paper and weregiven 15 million dollars as a down payment on

the same day.

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There are standard procedures for processingRFPs. After receipt of the initial proposals, the proposals should be

screened for responsiveness in terms of technical quality, ifrequested, managerial capability, financial stability, experience on

similar projects and other relevant criteria.

The buyer should maintain strict confidentialityafter the proposals are received. No information regarding the identification of the participating

bidders or the number of proposals should be disseminated toanyone not officially involved in the selection process.

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In most significant governmental RFPs a mandatory pre-bid meeting is required. The manner in which the buyer acknowledges the seller is a

strong indication of the sellers chances for success.

If the seller does believes that the proposal is not beingconsidered, immediate trouble shooting steps shouldbegin... If the problem is the technical approach, thereis very little he/she can do to reverse the situation. But if the proposal is technically sound, the differences may be

the cost proposal. Whether or not the seller should reduce thecost should be based solely on the selling firms cost structure.

Finally, if both the technical and cost proposal isacceptable, the problem is probably political.

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The sellers bargaining strengths dependon the following:

1. The sellers current capacity2. The probability of being the successful bidder

3. The sellers deadline4. The status of the seller

The sellers bargaining strengths are:

1. The number of bidders2. The urgency of the buyer needs.3. The length of time before agreement4. The status of the buyer

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The Pricing Criterion

Price is not always the major selection criterion.The quality of the technical proposal and thesellers managerial team can easily become thecontrolling criterion.

The seller should also determine the buyerspricing behavior in terms of fixed price versus,cost plus contracts.

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Planning (Buyers Perspective)

The planning process for the buyer is consistentwith the sellers planning process.

The buyers strengths are driven by the number of

sellers in the market, the number of buyers in themarket, knowledge of the item or service, the costbreakdown (if applicable), and the level ofpreparation.

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The buyer must carefully analyze all of the informationsubmitted by the seller.

The buyer can also select specific items from the sellersproposal to negotiate... The buyer must also evaluatethe sellers strengths and weaknesses.

The buyer must be thoroughly prepared for each andevery negotiation. Data collection is the first step in thepreparation process.

The next step involves sets setting the negotiationsobjectives, strategies and tactics.

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Once the buyer has a complete understanding of whathe/she is buying, a thorough price/cost analysis shouldbe performed using the sellers cost data.

The buyer cannot be an effective negotiator without the

price analysis.

The only reasonable way to reduce the price proposal isconvincing the seller through data analysis. It is notreasonable to ask for price reductions without aprice/cost analysis.

Prior to the negotiations the negotiations objectivesshould be established. The buyer should establish

specific direct cost dollar amount and profit limits. 14-59


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It is not enough to set as an objective to negotiate apercentage improvement from the sellers original priceproposal.

The buyer should never reveal its objectives to the seller.

The negotiations objectives should also use a data drivenapproach to determine minimum and maximum pricingstrategies.

Of course, the buyers minimum and maximum strategiesshould be listed as shown in Tables XX below:

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Buyers Negotiating Objectives


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Negotiating Procedures

Price is usually the major negotiating factor simplybecause delivery, quality, and adequate quantitiesshould be the minimum expectation from thesupply source.

Procedure

1. Team. Select team, if needed. You mayneed the cost accountant and certainengineers. Select the chief negotiator.

2. Objectives. Determine objectives, such asa win-win outcome for both.

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3. Preparation. Prepare a pricecost analysislook at comparative bids; perform a vendorvisit; look at vendor rating-evaluation records;perform a value analysis-engineering; look at

contract terms and legal, industry price trends,new product ideas, survey data, and testreports; prepare a proposal analysis:determine questions, get input from ultimateusers, establish criteria, and get past purchasevolume from the vendor.

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4. Bargaining strength. Determinebargaining strengthbe honest.

5. Plan. Develop the plan: the agenda,place, time, min-max positions. Is this areorder? Establish your authority.

6. Strategy. Set your strategy based onobjectivesgoals.

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7. Tactics on how to achieve the strategy. Start withthe easy issues. Set the tone; establish rapport; preparequestions and who asks; determine when to recess orask for new proposal; have several responses.

Establish rules such as never reveal your maximum onitems such as price, no games, no dishonesty, no

psychological tricks (this is business, not a card game).

Give when it is proper, reasonable, and so forth.Determine roles for each team member. Compromisesituation buyer policy, establish vendor weak point. Useyour cost analysis to check labor rate and time; have the

facts at hand.

8. Follow-up. Conduct a post-negotiation review andfollow-up. Develop the action plan based on youragreement. Critique team member performance.

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Hints


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Hints1. Read, study, tear apart the

vendorproposal.

2. Be persuasive, not cocky.

3. Stress tact for all teammembers.

4. Stress listening.

5. Prepare questions in writing on35 cards, and so on.

6. Recordtake notes.

7. Assign roles and practice.8. Write down the plan.

9. Have reasonable objectives,positions.

10. Be firm but fair; give when youmake a mistake.

11. Have expert assistance on the

team.12. Admit when you make a

mistake or dont know.Recess and find out.

13. Be honest. Do notgivecompetitor prices. Do notguess about volume

requirements.

14. Developpatience.

15. Recess and review; change yourposition?

16. Dont play psychologist or bigman or big woman.

17. Background data are the key tocost and production methods.You must know how theproduct is made to be a goodnegotiator. You must know theterms. Visit the vendors plant,other users.

18. Learn from your mistakes

19. Learn the personalities of thevendor team. Use it to establishrapport. Capitalize on theirweakness such as lack of costdata.

20. Try to stay on the offensive yetget them to talkthen listen!

21. Remember we are notnegotiating with the cold-warRussians. We want the vendorto win also for a long-term,mutually rewarding

relationship. 14-66

A Richer Model of The BuyerSeller


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A Richer Model of The BuyerSellerInteraction

What should be clear by now in the chapter is that, whileboth economics and psychology offer useful insight intobargaining and negotiation, a richer conceptual model ofthe buyerseller interaction is necessary.

This model needs to capture both the economic andpsychological aspects of the bargaining situation. To thisend, we propose the exchange model of buyersellerinteractions.

The model is built on the relationships inherent in abargaining situation and illustrates at least five majortypes of relations that can be affected by any bargaininginteraction

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1 The buyerseller relationship


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1. The buyer sellerrelationshipmight be an exchange ofinformation and help in problemsolving on the part of the sellerfor credit for the specific sale

given by the buyer. Cooperation,trust, and mutual liking arevariables that can develop in apositive interaction betweenbuyer and seller.

The parties in the

sales/purchasingrelationship usually sharesome values and havemutual interests.

Each may want somethingthe other has and can giveor in some way be

dependent. This mutuality of interestscan take the form ofstrategic alliances,coalitions, contractpurchasing agreements,partnerships, or otherrelationships.

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A Richer Model Of The Buyer seller


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A Richer Model Of The BuyersellerInteraction

2. The seller exchangessalesefforts with the sellingorganizationfor money in theform of a commission orsalary.

Often there are sidepayments such as a trip to

the Bahamas for meeting aspecial sales quota.Recognition and praise arealso often exchanged forloyalty.

This dyadic relationship hasreceived a considerable

amount of research effort.Sales territory allocation,compensation systems, salesforce motivation, and salesforce selection andmanagement are all aspectsof this particular dyad in the

model.

3. The buyer exchangeshis/her talents and abilities ofbuyingand problem-solvingefforts with his/herorganization for money,usually a salary. However, buyers are

sometimes rewarded in theform of a percentage of thevolume of purchases, or froma cost-savings perspective.

The status that anorganization awards the buyerand that buyers efforts andfeelings of loyalty toward theorganization are furtherexamples of exchanges thattake place between thebuyer/buying organizationdyad.

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A Richer Model Of The Buyer seller


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A Richer Model Of The BuyersellerInteraction

4. Images of the buyingorganization are held by theseller while the buyer harborsfeelings and images about theselling organization. The images held by the buyer and

other members of the buying

organization have been examinedfrequently in the literature.However, the images held by theseller have received little attention.

It would make sense to examinethese perceptions because theydetermine what type of marketingapproach or product characteristics

the seller will emphasize to thebuyer. Dyadic relations depend upon the

individual actions and purposivebehavior of the parties involved.The seller and the buyer both haveplans, goals, set ways of behaving,and intentions they hope to satisfy

5. The primary economicexchange occurs between thebuying and sellingorganizationswhere theproduct/service is exchangedfor money or credit. Reciprocal trade relations or some

form of agreement may developbetween the two organizations.The supply and demandparameters of each individualbargaining situation dictate whattype of interaction developsbetween buying and sellingorganizations.

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