by Andrew Syrios
It is almost taken as a fundamental truth of negotiating that he who speaks first loses. It is axiomatic among many in business that you should try to get the other party to state their price first, no matter how awkward it becomes. The reason for this is because it acts effectively as the first concession and perhaps tilts the deck in the other party’s favor.
For example, the first offer could be way lower than the other would pay and thereby provide a huge boon. One business professional gives the example of a garage sale to illustrate this kind of thinking in an article titled “Negotiating Tips: The person who makes the first offer always loses:”
“OK, now we’ve met the seller. There’s no pricetag on the table, so here’s how negotiations could go.
Scenario one:
You: I’ll offer you $20 for this table.
Them: I’d like to get $35 for it.
You: Would you take $25?
Them: $30 and you’ve got a deal.
You: OK, deal.
Scenario two:
You: How much are you asking for this table?
Them: I’d like to get $35 for it.
You: I can’t pay more than $20.
Them: Well, I could come down to $25.
You: Great, I’ll take it.”
Now, there’s certainly a time and place for this. Sometimes you don’t want to make the first offer, but it’s not true that you never want to make the first offer. In fact, I would argue that when the seller is motivated, you usually do.
The reason for this boils down to two things: 1) Many sellers, even those who are motivated, have a completely unrealistic view of what their house is worth. When they throw out a number, it almost kills the deal before it even starts, as you are so far below them that for them to come down to your price would not only be a huge financial hit, but it would also be a huge hit to the ego. And 2) The funny way the human brain works.
Anchoring
Nobel prize laureate Daniel Kahneman in his absolutely fascinating book Thinking Fast and Slow tells us about a very interesting test he conducted that provides great insights to negotiating:
“…we told participants in the Exploratorium study about environmental damage caused by oil tankers in the Pacific Ocean and asked about their willingness to make an annual contribution ‘to save 50,000 offshore Pacific Coast seabirds from small offshore oil spills, until ways are found to prevent spills or require tanker owners to pay for the operation.’ This question requires intensity matching: the respondents are asked, in effect, to find the dollar amount of a contribution that matches the intensity of their feelings about the plight of the seabirds. Some of the visitors were first asked an anchoring question, such as “Would you be willing to pay $5…” before the point-blank question of how much they would contribute.
“When no anchor was mentioned, the visitors at the Exploratorium—generally an environmentally sensitive crowd—said they were willing to pay $64, on average. When the anchoring amount was only $5, contributions averaged $20. When the anchor was a rather extravagant $400, the willingness to pay rose to an average of $143.” (Pg. 124-125)
This is the power of what psychologists call anchoring. Think about this example for a moment. The same types of people, randomly selected, reduced the amount they were willing to pay by 75 percent when given a low anchor and more than doubled it when given a high anchor.
Indeed, some examples of the power of anchoring are almost surreal and rather disturbing. Kahneman again:
“German judges with an average of more than fifteen years of experience on the bench first read a description of a woman who had been caught shoplifting, then rolled a pair of dice that were loaded so every roll resulted in either a 3 or a 9. As soon as the dice came to a stop, the judges were asked whether they would sentence the woman to a term in prison greater or lesser, in months, than the number showing on the dice. Finally the judges were instructed to specify the exact prison sentence they would give the shoplifter. On average those who had rolled a 9 said they would sentence her to 8 months; those who rolled a 3 said they would sentence her to 5 months.” (pg. 125-126)
Kahneman provides an in depth explanation for this psychological phenomenon, but in brief, anchors trigger our more automatic thinking processes (System 1), such as recognizing familiar symbols or faces. System 1 then sets the plate for the more deliberate thinking processes (System 2), which operates when trying to do more difficult tasks such as arithmetic or abstract thought.
As we all know, System 2 is lazy and likes its job made easy. So System 1 obliges. Anchoring feeds System 1 something to hang onto, which proliferates up to System 2 and influences the rational mind when it comes time to buckle down and do some serious thinking.
In other words, making the first offer sets the ballpark for the negotiation.
Real Estate Negotiations
An effective tool I’ve found when negotiating with sellers (particularly those who have an inflated view of their home’s worth) is to make my case first before either of us has had a chance to throw out an offer. So, let’s say I just recently bought a similar house nearby, or better yet, more than one. Then I describe those purchases to the seller to explain where I’m deriving my valuation from. I could also discuss the defects of the house that will require rehab and an estimate for that. Or if I know of nearby comps or anything else that supports my offer, I can bring that forth as well.
I’m not a flipper, but I do explain that we only buy deals we could flip. Therefore, you can just lay out the whole process. If it needs repair, explain that it’s most likely investors will be the only ones interested. Describe to them the 70 percent Rule, or better yet, break out the expenses individually and show them what it will take to make the deal work for you. Then make the offer.
All of this will dissolve the delusions of grandeur many sellers are afflicted with, while simultaneously anchoring a realistic and profitable price for yourself in their mind.
But please note, while negotiating is an important skill to learn, it’s important to not use these tactics unethically or to become some sort of used car salesman-type. The goal is to dissuade overly optimistic sellers and provide a service by being able to purchase a motivated seller’s house quickly and easily at a price that will be profitable. It shouldn’t be to try and trick someone. If that’s the goal, you will gain a bad reputation, and deals may very well blow up in escrow as the seller starts to believe they are getting screwed and desperately tries to get out of it.
If You Are on the Receiving End
So let’s say you get beaten to the punch, and the other party makes the first offer. Kanheman describes the approach of psychologists Adam Galinsky and Thomas Mussweiler when someone makes an opening offer that is too high: “They instructed negotiators to focus their attention and search their memory for arguments against the anchor” (Pg. 126-127). If you are conscious of the anchoring effect, you can counteract its influence and bring yourself back to a neutral state. System 2 needs to actively fight off the unsolicited influence of System 1. The worst thing to do is get so caught up in the negotiation (and the anchor) that you buy or sell something at a price you shouldn’t have.
As for Kanheman… well, I will end with his rather colorful advice:
“My advice to students when I taught negotiations was that if you think the other side has made an outrageous proposal, you should not come back with an equally outrageous counteroffer, creating a gap that will be difficult to bridge in further negotiations. Instead you should make a scene, storm out or threaten to do so, and make it clear—to yourself as well as the other side—that you will not continue the negotiation with that number on the table.” (Pg, 126)
In other words, use the patented “Toddler Tantrum” method of negotiating.
Weigh in: In your experience, do you like making the first offer, or would you rather counter? What’s your best advice when it comes to negotiating?
Leave a comment below!
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