Our next psychological tool, or trap relates to a concept called escalation. And the basic takeaway from this concept is that the most successful negotiators are able to look at the negotiations from the perspective of the other side. However there is also another very important lesson from escalation that I want to mention. Teaching escalation I use an exercise in class called, the dollar auction. Where, basically I hold up a $20 bill, the meaning of life and I explain to the class that I'm going to auction off the $20 bill to the highest bidder. They can bid in increments of $1, the highest bidder gets the 20. So if the highest bidder bids 12 that person pays me 12 and I give them the $20 bill. The only catch is that the second highest bidder also has to pay me. So, if the second highest bidder, bids ten that person pays me ten and receives nothing from me. So, when I do this in class, what I've discovered is that at the beginning of the dollar auction, a lot of people participate. And then gradually, as you approach $20, most of them drop out. And so you're left with two bidders. Let's say for instance, bidder A has bid 18, then bidder B comes in with 19. Now if it stops right there, bidder B pays me 19 and receives the 20. Bidder A pays me 18 and gets nothing. So bidder A quickly figures out, well if i jump to $20, then I'm going to pay 20, get 20 back and I'll break even. So they bid 20. And bidder B realizes well rather than paying 19 and get nothing back, I'll bid 21 and get 20 back so I'm only out a dollar. So often the bidding will continue beyond 20 and move up into 30 or even $40. Until finally the parties realize that this could go on indefinitely and it did. Not in my class, but in a class taught by a prominent professor at another university. And he explained that he did the dollar auction in his executive MBA class and he explained very clearly to the students in the class that this wasn't just a game they had to pay whatever they bid. So take the wildest guess possible as to what the winning bid was. The winning bid in his class, the person who won the $20 bid $15,000. The person who came in second bid $14,500. Now of course as the numbers got larger he wasn't limited to $1 increases, he allowed $500 increases. And these two people had to write him a check for the 15,000. Who got the $20, and the 14,500 person who didn't get anything. So he was very curious when this was over, what was going on? Why in the world would they bid so much money? Well, he asked the winning bidder and she explained that she was a doctor. She liked to make donations to charity. She sort of guessed he was not going to keep the money, he was going to give it to charity. And so she decided to have fun with it and also make a charitable contribution with the 15,000. Then he asked the $14,500 person why in the world would you bid that much? And this person explained that he just got caught up in the competition. He was a very competitive person. As I recall, he was an entrepreneur and he just hated to lose. And so as a result he was out $14,500 and did not even get the $20 back. Now, a lesson from this is something called competitive arousal, that was written up in the Harvard Business Review. Competitive arousal occurs in a scenario like this, where there's intense rivalry. In this case a one-on-one competition. There's a lot of time pressure and you're in the spotlight. In this case, they're bidding in front of the class. And so when you're in this situation, this article advises that you try to limit the role of someone who is especially intense. For involved in negotiations for instance. Try to manage time better and try to spread responsibilities so one person is not in the spotlight. If you're interested in this you can look at this Harvard Business Review article called When Winning is Everything. Here's an example written up in The Times of India. Sunil Mittal, very successful entrepreneur. He desperately wanted to acquire MTN and according to this article he was in a state of competitive arousal. When a CEO is in this state he is more prone to making the sort of rash decisions he would not make otherwise. And so this is one lesson from the concept of escalation, that you want to avoid becoming so competitive that your decisions do not make sense. But there's another very important lesson from this. And that is, always try to look at every deal, every negotiation, in this case the auction scenario, from the perspective of the other side. When you start participating in a dollar auction, it looks like a great deal from your own perspective. You think, well, gosh I could bid $12 and I might win $20. That looks like a good deal. But then think, you're in a class with 40 other people who are thinking the same way. And you realize how easily you can be trapped, and how this can easily escalate if everyone is thinking the same way, and not thinking about the perspective of the other side. So what the research shows is that what separates a good negotiator from a great negotiator is this ability to look at the deal from the other side. I had a dinner a couple of years ago with one of the most successful graduates of my business school. He was the Chief Finance Officer of IBM. He was on the Apple Board of Directors. He was involved in many complex financial deals. And over the course of the dinner, I asked him so Jerry, you've been involved in a number of very complex negotiations. You've probably seen some of the best negotiators in the world. What is it that separates these negotiators from others? And he didn't hesitate a second. He said it's the ability to look at the deal from the other side. Another friend who is on the Michigan Business School faculty was a senior advisor to President Clinton. He left our faculty for a while to serve in this position. And over lunch, he told me about President Clinton's negotiating style. He said that when President Clinton was visiting the prime minister of another country, my friend would have a half hour, very strict time limits, to brief the President on the issues relating to the other country. And so, he told me in that half hour he was told to give the President four main points, four main issues between the two countries. And then after that he was asked how do these issues relate to the concerns of the other country? And he said that it was amazing how quickly President Clinton grasped the initial four issues, and understood the issues from the perspective of the other side. And then was able to reframe the US issues, so that they met the concerns of the, let's say the Prime Minister of the other country. Let me test your ability to look at issues from the perspective of the other side with this story. We've got another President, running for office, by the name of Teddy Roosevelt, and it's in the final stages of a campaign. And Teddy Roosevelt has, let's say 3 million pamphlets printed with a picture of him looking very presidential on the pamphlet. And he intends to take a train tour across America, give speeches, and distribute these pamphlets. Just before the chore begins, after the pamphlets are printed, he learns that a photography studio holds the copyright to these pictures, to the picture on the pamphlets. And the problem is that he has no money left in his campaign to pay for copyright permission. Copyright permission could run, let's say, a dollar a pamphlet. That would be $3 million and he has no money left. He doesn't want to use the pamphlets illegally. That could kill his campaign but he needs these pamphlets to win the election. So he had a huge dilemma, didn't know what to do. So finally, he called a friend on Wall Street who is a famous negotiator. And he asked what should I do? Help me. Now, if he had called you under these circumstances, what would you do? Again, you need these 3 million pamphlets to win the election. You don't want to use the picture illegally in violation of copyright and you don't have any money to pay for copyright permission. And when I ask this question in class, students come up with some pretty good possibilities. Well why not make this person the official White House photographer if you win the election? Or why not give the photographer the chance for publicity? The publicity that you're using his picture on the pamphlets. And those are very good suggestions. And this is what the famous negotiator did. He sent a cable to the photography studio that said, we're planning to distribute millions of pamphlets with Roosevelt's picture on the cover. It will be great publicity for the studio whose photograph we use. How much will you pay us to use your photo? Respond immediately. And the photography studio responded, I forget the exact amount, I think it was around $250, they said we'll pay you $250 to use the photo. There's a great negotiator. Somebody who is able to look at the situation from the perspective of the other side. And instead of paying them, it ended up the studio paying Roosevelt. Let's try one other example and this is a bit of a mind bender, I'll warn you in advance. I hope you're awake wherever you are in the world, because this is a challenging scenario. So here's the deal. You work on an acquisitions team for a company, and you're considering making an offer to buy another company. The value of the target company is uncertain because they're involved in oil exploration, they're not sure the results. The value could be anywhere from $0-100 million. And all of those values are equally likely, in other words it's equally likely that the value is 47 million as it is 97 million. You do know that you have very good management in your company, and that under your management, the target company will be worth 50% higher than its current value, whatever that value is. Now the target company knows exactly what it's worth because it knows the results of the oil exploration. How much would you bid? You can only make one offer. Take it or leave it. So take as long as you want with this before I move on to the next slide. You might even hit pause. But think how much would you bid? And the correct answer is that you should bid nothing. Because all the offers that you might make have a negative value. Let's take an example. Let's say that you bid $60 million. Now the target company knows exactly what it's worth. So if it's worth more than 60, the target company is not going to accept your offer. It's only going to accept offers, the range from zero to 60. What's the average value of those offers? 30 million on average, because each value is equally likely. And you know that under your management the company's going to be worth 50% more than the bid, so on average your bid is worth 30 million. You add 50%, that brings it up to 45 million. Which means that you have lost 15 million on your $60 million bid. Now I promised that would be complicated, but there's a very simple underlying principle involved here and that is always look at the deal from the perspective of the other side. If you had looked at it from the perspective of the target company, then these results should be clear. And that concludes our look at escalation.
