Leadership Mar 2, 2011
When to Come Out Swinging
Devise the right strategy for negotiations or online auctions
Negotiations and auctions are both structured economic exchanges, but the strategies used in the two are radically different.
Indeed, the two are entirely different games with different sets of rules and psychological variables. Should you wait for your negotiating opponent to make the first offer? Should you set a high opening price on your eBay listing? The key to success in both negotiations and auctions is understanding the psychological processes involved, says Adam Galinsky, a professor of management and organizations at the Kellogg School of Management. That knowledge can suggest strategies that could help you gain the upper hand in these forms of economic exchange.
Negotiations: The Best Defense Is a Good Offense
The conventional wisdom about negotiating is that it is best to wait for the other side to make the first offer. By receiving the opening offer, the argument goes, you will gain valuable information about the other side’s bargaining position and insights into possible agreements. However, Galinsky, along with Gillian Ku, an assistant professor at the London Business School, and Thomas Mussweiler, a professor at the University of Cologne, report that many studies have shown that the final selling price tends to be higher when the seller makes the first offer and lower when the buyer moves first. This phenomenon is known as anchoring.
In their research paper, Galinsky and his colleagues explain that two attributes of human thinking account for anchoring. The first is the tendency for people to use the value of the first offer in estimating the true value of an item or service up for negotiation and to adjust insufficiently from this anchor. For example, when the seller makes the first offer, the buyer knows the number is likely too high and adjusts down from it when making the counteroffer, but the buyer’s counteroffer is still anchored by the value suggested by the seller’s first offer.
This is known as “insufficient adjustment.” The second factor, “selective accessibility,” is that people tend to focus on information that is consistent with the value of the anchor, ignoring attributes that are inconsistent. For example, when car dealers give a high opening offer when selling a car, the buyer takes note of features, such as luxury extras, that are consistent with the high price, Galinsky explains.
The combination of these two thinking processes can explain the influence of starting prices on final prices in negotiations. “The buyer knows she should adjust from the seller’s high opening offer, but does so insufficiently. Similarly, her opponent’s high opening offer selectively directs negotiators’ attention toward an item’s positive attributes; in contrast, a lower opening offer would direct attention to its flaws,” the authors write. “These processes are hard to overcome, so you need to have psychological protections in place,” Galinsky says.
One way to protect yourself from these phenomena during negotiations is to focus on facts that are inconsistent with your opponent’s first offer, such as the amount you would like to receive or weaknesses in your opponent’s position. Another way is to counteroffer at the opposite extreme.
“These processes are hard to overcome, so you need to have psychological protections in place,” Galinsky says.
As an example of protecting against an extreme opening offer, Galinsky described an experience he had negotiating with a Moroccan rug vendor. Galinsky was considering making an offer for two rugs, but before he made an offer, the vendor said the price would be $10,000. “In that context, you have to go as far as possible to the other extreme sometimes, so I started off at $100,” Galinsky explains. The vendor’s next offer was $5,000 and Galinsky countered with $200. They settled at $1,500, much closer to the smaller concessions that Galinsky had made.
In a negotiation about the price of suits in Thailand, Galinsky wrote down his opening offer at the same time the salesperson wrote down his offer. In the end, they made a deal near the midpoint of the two initial offers. “What determined the midpoint was not his offer or my offer, but the combination of the two offers,” Galinsky says. “If I make an extreme first offer as a seller, then I’m going to anchor the counteroffer and the midpoint is going to be much closer to what I want it to be. But if I go second, then I have to make a pretty aggressive counteroffer or the midpoint is going to be biased against me.”
Although research indicates that starting high in negotiations leads to high ending prices, there are limits. When studying factors that make for a successful negotiation, Galinsky and his colleagues found that the final price is only part of the picture—it is important to consider whether a deal will get made. For example, an unreasonably high starting offer might anger or discourage the negotiating opponent and decrease the chance of reaching a settlement.
Galinsky explains that the person who has more information in a negotiation has more power. This helps explain the one situation in which making the first offer may not be to your advantage: when the other side has much more information about the item to be negotiated or about the relevant market than you do. In these situations, your opponent’s opening offer could provide you with additional information.
But, Galinsky warns, it is important to remember that information provided by that offer will be biased. However, if you lack information, your first offer could be extremely low or unacceptably high and it could be to your benefit to wait. This does not mean that you should simply let the other side make the first offer. Rather, you should level the playing field by gathering more information about the item, the industry, or your opponent’s alternatives to the negotiation. A well-prepared negotiator can make the first offer with confidence and therefore anchor the negotiation in their favor, Galinsky says.
Auctions: Open Low
In contrast to negotiations, where starting high usually leads to a higher final price, in auctions starting low can often produce a higher selling price.
One major factor that differentiates auctions from negotiations is the number of participants. In negotiations the number of actors is often predetermined as two people negotiate one on one. However, in auctions the number of bidders is determined by the features of the auction. Maximizing the number of participants in an auction benefits the seller—a greater number of participants will usually result in a higher ending price, so from the perspective of the seller, it makes sense to focus on factors that will increase participation.
Galinsky illustrated this point by describing the experience of a colleague who wanted to sell a sink on eBay. He listed it at a price of about $200 and no one bid on it. “You’ve have to start low in this case or you’re creating barriers to entry,” Galinsky advised his colleague, who relisted the sink for $75. It eventually sold for $275.
Low prices decrease psychological barriers to making a first bid. Once someone makes a bid, they become invested in the process—that is, they spend time and energy on bids that can lead to a sense of competitiveness with the other bidders and a desire to “win” the auction. This phenomenon is known as “escalation of commitment to sunk costs.” As the bidding activity increases, both current bidders and potential new bidders may see the item as being exceptionally valuable. Because bidders use traffic as an indicator of value, early bidding begets later bidding, creating a herding effect.
As an example of how competitive bidding can result in higher prices, Galinsky told of a colleague in Germany who bought a BabyBjörn baby carrier for 75 euros. He used it for a year for his baby, then sold it on eBay. He started the auction at 1 euro and it eventually sold for about 85 euros, more than the cost of a new one. “You can see how these auctions can cause you to make irrational responses,” Galinsky said. “You can overpay because of the psychological properties of auctions.”
But Galinsky warns, “If you are going to start low in an auction, you have to be careful that you know what the market looks like.” He related the experience of a friend who was trying to sell old indie rock phonograph records. He set the opening price quite low on the theory that it would generate competitive bidding, but only one bidder was interested, so that person got all of the records very cheaply.
The ability to adjust your strategy is the key to success in both negotiations and auctions, according to Galinsky. Just as the play callers in a football game might take one approach in fair weather and another in a pouring rain, parties to a negotiation and sellers and buyers at auctions must adjust their strategies based on an assessment of their current situation.
“One strategy is to go first in a negotiation and go high; another strategy is go low in auction when there is a lot of traffic,” Galinsky concluded. “But even if you can’t do those things, you can think about ways to protect yourself, based on these processes. That’s what expertise is—understanding the subtle distinctions that don’t give you just one strategy, but knowledge that enables you to perfectly calibrate your strategy to the current situation.”
Related reading on Kellogg Insight
Galinsky, Adam D., Gillian Ku, and Thomas Mussweiler. 2009. “To start low or to start high? The case of auctions versus negotiations.”Current Directions in Psychological Science18: 357–361.