Silicon Valley Globe
By Gary Miller – Managing Director, Consulting Division, SDR Ventures
I often receive inquiries from business owners who are negotiating to buy or sell a business. They often ask: “Should I make the first offer or wait until I receive an offer?” Commonly accepted negotiating “wisdom” says that it’s better to wait for the other party to make the first offer. But in fact, you may be better off by making the first offer yourself.
In this article, I explain when and how the first offer may very well materially: affect final outcomes, and influence the negotiation process of any final agreement. Whether you are negotiating to acquire or sell a business, someone has to make the first offer. The question of whether to make the opening move plagues negotiators. Uncertainty compounds this issue. If you lack reliable information about your opponent’s true bargaining position, you’ll be unsure about what offer he/she may find acceptable or whether he/she may walk away from the bargaining table.
By sitting back and receiving the opening offer, the argument goes, you’ll gain valuable information about your opponent’s bargaining position and clues about acceptable terms. This advice makes intuitive sense, but it fails to account for the powerful effect that first offers often have on the way people think about the negotiation process. Substantial psychological research suggests that, more often than not, negotiators who make first offers come out ahead.
THE DRAMATIC EFFECT OF ANCHORS
Research into human judgment has shown that how we perceive a particular offer’s value is highly influenced by each relevant number that enters the negotiation process. Because they pull judgments toward themselves, these numerical values are known as anchors. In situations of ambiguity and uncertainty, first offers can have a strong “anchoring effect” and can exert a strong pull throughout the rest of the negotiations. Even when people know logically that a particular anchor should not influence their judgments, often they are incapable of avoiding its influence. But why?
The answer lies in the fact that every material item under negotiation in a business transaction has both positive and negative qualities—qualities that suggest a higher price and qualities that suggest a lower price. High anchors selectively direct our attention toward an item’s positive attributes while low anchors direct our attention to its flaws. Hence, a high market price directs buyers’ attention to the company’s positive attributes (such as its strong earnings and profit) while pushing negative attributes (such as a high employee turnover or a high customer concentration) to the back recesses of their minds.
Anchoring research has shown that making the first offer often results in a bargaining advantage and that the final outcome of a negotiation is affected by whether the buyer or the seller makes the first offer. Specifically, when a seller makes the first offer, the final transaction price tends to be higher than when the buyer makes the first offer.
WHEN NOT TO MAKE THE FIRST OFFER
There is one situation in which making the first offer may not be to your advantage: when the other side has much more information than you do about the business transaction to be negotiated or about the relevant market or industry. For example, recruiters and employers typically have more compensation-related information than job candidates do. Likewise, buyers and sellers represented by investment bankers often are privy to more valuable information than are unrepresented buyers and sellers.
This doesn’t mean that in all cases you should sit back and let the other side make the first offer. Rather, this is an opportunity to level the playing field by gathering more information about the business, the industry and/or your opponent’s alternatives. The well-prepared negotiator will feel confident about making the first offer and anchoring the negotiations in his or her favor.
DON’T BE AFRAID TO BE AGGRESSIVE
How “extreme” should your first offer be? Research suggests that first offers should be aggressive but not absurdly so. Many negotiators fear that an aggressive first offer will scare or annoy the other side, and perhaps even cause him/her to walk away in disgust. However, research shows that this fear typically is exaggerated. In fact, many negotiators make first offers that are not aggressive enough. In addition, an aggressive first offer allows you to offer concessions and still reach an agreement may be better than your alternatives.
In contrast, a nonaggressive first offer leaves you with two unappealing options: make small concessions; or stand by your demands. By making an aggressive first offer and giving your opponent the opportunity to “extract” concessions from you, you may get a better overall outcome AND increase the other side’s satisfaction.
Of course, it is important that your opening offer is not absurdly aggressive. An absurd offer can lead the receiver to believe that there is no reasonable possibility of mutual agreement, and as such the appropriate response is to walk away.
FOCUS ON YOUR TARGET PRICE
When constructing an aggressive (but not absurdly aggressive) first offer, generally there are two considerations on which you should focus upon.
First, your alternatives to agreement and a specific target price above or below which you will walk away rather than reach a deal
Second, your “ideal” outcome, including your target price and the agreements, terms and conditions that would fulfill your principal hopes and desires.
I have found that negotiators who focus properly on their target prices make more aggressive first offers and ultimately reach more profitable agreements than those who do not.
Negotiators who focus too rigidly on their target prices or ideal outcomes sometimes curse if doing so results in rejecting profitable agreements that surpass their alternatives. Remember that you want to reach an agreement that meets your objectives and that also satisfies the other side. A satisfied counterparty will be more likely to live up to the terms of the agreement and less likely to seek future concessions or revenge.
About the Author
Gary Miller is the Managing Director of SDR Ventures Inc.’s Consulting Division, where he assists middle-market private business owners prepare to raise capital, negotiate to sell their businesses or buy companies, and helps them develop strategic business plans. He is a sought-after business consultant and speaker on M&A and capital market trends, what buyers are looking for in acquisitions. He can be reached at 970-390-4441 or firstname.lastname@example.org.
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