We have seen that behavioral economics holds valuable insights into the way that people make decisions. Specifically, behavioral economics teaches that behavioral patterns and cognitive errors play a tremendously important, if seldom recognized, role in decision-making.
Now we get to the fun part: learning to use behavioral economics to help our clients and ourselves make better decisions, not just in mediation, but in every negotiation.
Lesson One: Set Your Reference Points Before You Begin Negotiating.
Reference points are extremely important in every negotiation. They can be the key to an effective negotiation strategy, but they also can stand as an obstacle to a good settlement. Effective negotiators know how to use them to drive negotiations and to help close deals.
In Thinking, Fast and Slow, Nobel Prize winner Daniel Kahneman explains that people frequently adopt their goals as reference points. In golf, for example, par is a reference point. A birdie (one shot under par) represents a gain, and a bogey (one shot over par) represents a loss relative to the reference point, par.
We have seen that people dislike losing more than they like winning, and they work harder to avoid a loss than to make a gain. Economists who have studied golf (yes, there are such people) have found that professional golfers prove this point: they do far better when putting for par (avoiding a bogey, which is a loss relative to par) than when putting for birdie (making a gain over par). Whether the putt is easy or hard, at every distance from the hole, professional golfers are 3.6% more successful when putting for par than when putting for birdie. Over the course of a 72-hole tournament, this easily can be the difference between winning and losing.
Like golfers, parties frequently set reference points prior to a negotiation. Plaintiffs in mediation frequently know the “bottom line” number below which they will not move, and defendants frequently know their “top dollar.” These “walk-away” numbers become the parties’ reference points. A settlement that improves upon one’s reference point creates a gain; one that does not creates a loss. (It may seem strange to refer to a defendant who pays less than its top dollar as experiencing a gain, but remember that we are speaking of results relative to reference points, and even cold water can feel warm to a hand that has been sitting in a bowl of ice water.)
Because people work harder to avoid losses than to make gains relative to their reference points, all parties should establish their reference points before they start negotiating. Plaintiffs should know their bottom line, and defendants should know their top dollar before the mediation starts. Surprisingly, many parties walk into mediation with no reference points, thinking only that they want to do “the best they can.”
Experienced negotiators will set not only the walk-away numbers beyond which they will not move, but also goals that are better than those walk-away numbers. Parties who set “shoot-for” numbers as their reference points typically do better than those who only formulate walk-away numbers.
For example, a defendant who decides that it will not pay more than $100,000 but has the goal of settling for $80,000 will settle for closer to $80,000 than one who only sets its top dollar number. The same goes for plaintiffs: one who establishes a shoot-for that is higher than her bottom line will recover more than one who does not. The reason for this is simple: once the party sets a shoot-for number as her reference point, she will work very hard to defend it, as anything that falls short will be seen as a loss.
Setting one's reference points before the negotiations start is a simple strategy that will produce demonstrable results in your next mediation.
Next time: Think Like A Trader.
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