CHAPTER 1

The Settlement Range

The first Core Concept is the Settlement Range. The Settlement Range provides us with a critical visual picture of what is going on behind the scenes in a negotiation. Here is how it works.

Imagine a negotiation between a salesperson for a software company and a buyer. The buyer needs to purchase 11 licenses for this type of software. The salesperson has told him that the price for 11 licenses will be $500 each. Unbeknownst to the buyer, however, the salesperson is actually authorized to go as low as $400 per license in order to make this sale.

Let’s paint a picture of what we know about the salesperson’s negotiating position. We can do this by creating a range of all the possible agreements that the salesperson could make. Her opening offer is $500 per license and her absolute bottom line is $400 per license. If she can’t get the buyer to agree to at least $400, then she will walk away from this sale. Thus, she can make the sale at any price from $500 to $400. This is her Settlement Range. We call the opening offer the Maximum Supportable Position or MSP and the absolute bottom line the Least Acceptable Settlement or LAS.

Now let’s look at the buyer’s Settlement Range. He has been around the block a few times and he knows that there are often substantial discounts available for software. So he tells the salesperson that although his company really likes her software, the home-grown workarounds that they are using right now are adequate to do the job, although not as convenient. Therefore, although he would really like to purchase the software from her, he needs her to reduce her price to at least $350 per license. That is his Maximum Supportable Position (MSP). (Notice that for the buyer the MSP is the low dollar amount offered whereas for the seller the MSP is the high dollar amount offered.)

However, unbeknownst to the seller, the buyer has a budget of $5,000 for this software. The department that will be using the software has told him that under no circumstances can they go above $5,000 and that if the software costs more than that, they will continue to make do with what they have. The amount of $5,000 divided by 11 licenses is just over $450 per license. Therefore the buyer’s LAS, that is the absolute most that the buyer would be willing to spend, is $450 per license.

Figure 1.1 The settlement range

NOTE: Often people will use the term “bottom line” to indicate the point that is the last stop on their Settlement Range. That works okay for the seller since the seller’s bottom line is the lowest dollar amount they would accept in a price negotiation. However, when we are talking about the buyer we run into a tongue twister. Thus, the buyer’s bottom line is the most they would be willing to pay. Using the term LAS gets us out of the semantic problem. Furthermore, using the term LAS lets us use a single, universal term to apply to any negotiator’s worst case position for any issue that might be negotiated such as delivery, lead times, length of warranty, payment terms, royalty rates, and so on.

These two settlement ranges are shown in Figure 1.1 on page 4. It provides us with a visual image of what is actually going on in the minds of the two negotiators.

Now let’s take a look at the two ends of the range, the MSP and the LAS.

The Least Acceptable Settlement

The Least Acceptable Settlement, and more specifically the other party’s Least Acceptable Settlement, is the central focus of any negotiation.

Why? Because the other party’s LAS is the absolute best deal you can achieve. For that reason, we need to spend a few minutes examining where the LAS comes from, so that later on we will be able to develop a road map that will allow us uncover the other person’s LAS.

The first step is to start looking at how the other party builds their LAS. If we can determine how the LAS is built, then by looking for and finding those building blocks, we can work backward and make an educated guess as to where their LAS is located.

Let’s use an example of a situation that you may have experienced. Let’s say that you are looking for a new house. You currently live in East Podunk. Your house has become too small and you’re looking for a bigger house in the more upscale neighboring town of West Podunk.

You have found a house that is listed at $450,000, which you could actually afford to pay if necessary. So let’s look at several possible scenarios:

In Scenario 1, you have just started looking for a new house. You are in no great hurry. While you like that $450,000 house, it is not perfect. Houses come on the market fairly regularly in West Podunk. Therefore, you have decided that if you could get the house at a real bargain, you would buy it. Otherwise you will wait and see what else you can find. You set your LAS at $400,000.

In Scenario 2, you’ve been looking for over a year in order to find a new house. This house isn’t perfect, but neither are most of the other houses in West Podunk that have come on the market recently. You really would like to move and get this house-hunting business over with. You decide that your LAS is $425,000.

In Scenario 3 you been looking for six months and this house is perfect. You really want this house badly. You have fallen in love with it. You will try to get it for less, but if you can’t, your LAS is their asking price of $450,000.

In Scenario 4, it is mid-July. One of the primary reasons for moving from East Podunk to West Podunk is so your children can be in West Podunk’s superior school system. Even with a 45-day closing, this is tight timing if they are to start in September. The house is good enough, although not perfect, but you still decide that your LAS is $450,000, provided you can get the seller to move quickly on the closing.

In each of these scenarios, we’re talking about the same house. But in each of the four scenarios, there is a different set of circumstances, with each producing a different LAS for the exact same property.

In each case, you looked at the facts, that is the house, its condition, whether it is fairly priced for the market, all the features that it has, and so on. You also had to factor in your needs such as your need to stop house hunting or to get out of your current house. You factored in pressures such as time pressure—the need to move before the beginning of the school year.

Then, you looked at your alternatives, which would be to stay in your existing house, and you looked at the competition, namely the other houses for sale in West Podunk. Finally, you ran all that through your own subjective view. For example, the facts of the house don’t change, but how you look at them can to be very different from one person to another. One person thinks the house is adequate while another thinks that it’s absolutely perfect. You put all of these factors together, often subconsciously, and come up with a figure. That figure is your LAS.

How does the other party develop their LAS? The same way you did in developing your LAS for buying the house. They look at the facts, their own needs, the pressures that they face, what alternatives they have, what the competition is and any other relevant factors, and then they apply their own subjective evaluation to the mix. These are the building blocks of their LAS.

The LAS in a Competitive Environment

Many, many business negotiations involve sales and purchasing. And frequently, there is a high level of competition. If you buy or sell in a competitive environment, then this section is essential. If your negotiations are seldom, if ever, about buying and selling, or if you buy or sell in a noncompetitive environment, then go ahead and skip into the next section.

In most selling situations, there will be competition, and so in addition to looking at the facts, needs, pressures, and alternatives, it is important to pay particular attention to how the buyer uses available competition to develop their LAS. So let’s spend a few minutes looking at how the buyer builds their LAS where they have the luxury of being able to buy from more than one supplier.

If what is being purchased is a true commodity, it is easy for the customer to set their LAS. The lowest price that any one competitor is offering becomes the customer’s LAS. What is a true commodity? When one product can’t be differentiated from another, it becomes a commodity, much like wheat for example. From one farm to another, it is the same, so its price is based on supply and demand, not on negotiation. If a supplier can’t differentiate their product or services from their competitor’s product or services, the buyer will simply treat it like a commodity and set their LAS at the lowest price available from any one supplier.

If on the other hand, levels of quality, service, and so on are different, then the buyer will have to build their LAS based on those differences. To illustrate, let’s make up a simple example.

Let’s imagine that you are a buyer for Alfa Manufacturing, in charge of purchasing widgets. In the past, you have purchased widgets from both Bravo Industries and Delta Electronics. Although these widgets are produced by different manufacturers, they are pretty much the same from a functional point of view.

Because of your increased sales, the volume of Alfa’s widget purchases has skyrocketed, so this would be a good time to negotiate an annual widget contract instead of continuing to make spot purchases.

Your manufacturing people have been lobbying intensively for Bravo because they believe that Bravo’s service is better than that of Delta’s. Unfortunately, Bravo’s prices tend to be higher. For the annual contract, Bravo has quoted $212 per case and Delta has quoted $200 per case.

In planning your negotiation with these suppliers, you need to figure out your LAS for each of them. You have to decide who is better in the areas that matter to you, and you have to place a value on those differences. In discussions with the plant, it appears there are four primary areas that differentiate the two suppliers: reputation, service and responsiveness, problem-solving capabilities, and delivery.

On the issue of reputation, you’ve convinced the plant that reputation is really a function of the other quality areas, and therefore you should never pay a premium for reputation in and of itself. With regard to service and responsiveness, Bravo is better and you decide you would be willing to pay a premium up to $4 per case. You also believe their problem-solving ability has really helped your company, and that is worth a premium of up to $8 more per case.

However, you have had some delivery problems with Bravo, and it is clear that Delta does a better job in that area. Therefore, you would be willing to pay Delta up to $4 per case more for their better delivery.

To keep track of all this, you need to create a Buyer’s Added Value Matrix, as seen in Figure 1.2, page 9. Adding up the added values, you can see that Bravo comes in with a plus $12 and Delta a plus $4. So the net difference between them is a $8 advantage for Bravo. Given that, it is now relatively easy to construct your Settlement Ranges for each of the suppliers.

You expect that you can probably get them to reduce their prices some, so you are going to offer to pay $180 per case. This is your MSP and you have decided to use it for both Bravo and Delta. However, because each supplier has a different mix of added values, you have different LAS’s for Bravo and for Delta.

Your LAS for Delta is simple. They have offered the low price so your LAS for them is $200 (You have to buy it from somebody unless you are able to make it yourself.). To figure out your LAS for Bravo, you just look at what Bravo’s extra added value is worth to you and then add that to Delta’s low price of $200. Since Bravo’s added value nets out to $8, your LAS for Bravo is $208. All of this is shown in Tables 1.1 and Figure 1.2.

Table 1.1 Buyer’s added value matrix

Figure 1.2 Customer’s settlement range for each supplier

Of course, the situation may not remain static. It can change. For example, Delta might decide that they wanted the business so much they would drop their price to $192. If that were to happen, what would your LAS be for Bravo? Since Bravo is still worth $8 more than Delta and your LAS for Delta is now down to $192, your LAS for Bravo is at $200. Thus, the difference in added value creates a fixed differential in your LAS, in this case, $8.

Now, if you are the salesperson for Bravo, you have your work cut out for you. Even if Delta does not cut its price, the most Alfa will pay you is $208, and if Delta does drop to $192, the most you can get will be $200. Thus, if you want to sell those widgets, you either have to cut your prices or you have to raise the customer’s LAS. Cutting your price is the last thing you want to do, so you want to raise their LAS, something that we will discuss in detail later.

The Maximum Supportable Position

Now let’s talk about your opening offer, the MSP. We could actually just use the term “opening offer.” However, the words “Maximum Supportable Position” more accurately describe the process of establishing that opening offer, as you will see in the following example.

Let’s go back to our software example. The seller has offered a price of $500 per license. How should the buyer go about deciding what his counteroffer should be? Well, that opening offer should in fact be based on the buyer’s guess as to the location of the seller’s LAS. Let’s say that the buyer has made a guess that the seller could go as low as $410 per license.

Okay, now what? Well conceptually, there are three possible areas to locate his MSP. One would be to place his offer above his guess as to the location of the seller’s LAS, say at $425 per license. Obviously, this would not be a very good idea because if he is right in guessing that the seller could go as low as $410, he is leaving money on the table before he even begins the negotiation.

Alternatively he could place his MSP at $410, right at his guess as to the seller’s LAS. Technically this is okay, but from a psychological point of view it is not that good an idea. The reason is that if he does that and just sits at $410 while trying to force the salesperson to make all the concessions from her opening offer of $500, it will definitely feel unfair and not like a win-win to the salesperson.

Finally, he could put his MSP below his guess as to her LAS. An opening offer of $380 would accomplish that. This leaves him some room to make concessions upward and still have a chance to settle at her LAS. That is why we use the term maximum in MSP. It is a reminder that before we put an MSP on the table, we need first to make a guess as to the other party’s LAS and then make sure our offer is below their LAS.

Of course, it’s possible to take that idea too far. Let’s say we offered to pay $25 per license. Did we get beyond her LAS? We sure did. But the problem is that an offer of $25 is in no way supportable. In fact it’s downright foolish and it would make us lose credibility. That’s why we use the term supportable in MSP. A good opening offer is maximum in that it is based on going beyond your guess as to the other party’s LAS, but it is also in some way supportable so that it is taken seriously.