“... it was far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price. ...”
These are wise words indeed. Given that today at noon Eastern Time in Washington DC, the self-styled master of the deal, Donald J. Trump becomes the 45th US President I am minded to consider what makes a good deal. I also wonder if a good deal in business can be scaled up to be a good deal between nations.
The structure of a deal
Most business deals are based around three basic components that carry a specific question:
1. Expected return. “...What do we expect to happen? ...”
2. Upside potential. “... What is the best possible scenario? ...”
3. Downside risk. “...What is the worst possible outcome? ...”
Where deals sometimes go wrong is that naïve parties will sense that to get a good deal, they must “win” and therefore other party must “lose.”
Now, if only money is up for negotiation then one can argue that the agreed deal is a zero-sum game. However, in the clear majority of deal arrangements and trade agreements, the issue of money is not usually the principal object of interest of either party.
In trade talks, it not just how much in dollars and cents or pounds and pence can be sold, rather, it is also about the depth and breadth of sales and purchases. Any nation that just sells vast amounts of one product will soon be left in the lay-by of technological change.
I ask the reader to reflect on the opening quote. It is clear that Charlie Munger has stressed that the quality of the business was a superior consideration to achieving the best possible price.
Anyone who has purchased a rug or a piece of jewellery in the Middle East will know that the enjoyment of the “haggle” is just as important to the process of exchange as is the final price.
To consider this point let me lean on the social science of economics. As the US gained its independence in 1776, so Adam Smith penned “The Wealth of Nations” in which he discusses the invisible hand.
It teaches that one may trade once with a counterparty and press them at every stage for such advantageous terms in price or quantity that all one will achieve is that one trade. Word will get around that one is not a good counterparty. Far better to achieve an agreement where all parties feel they are deriving an advantage from the deal. That way the counterparty to that deal and other interested parties will come back for more.
In short, the goal of creating a good deal for both parties is not simply possible; it is really the only sustainable way to do business. It produces the best long-term returns for everyone involved.
Let me borrow more from economics as I see this proving to be in effect what we may call a “Nash Equilibrium”.
This is a concept of game theory where the optimal outcome of a game is one where no player has an incentive to deviate from his chosen strategy after considering an opponent's choice.
Staying with that theme, a good deal is a “Pareto Efficiency” or “Pareto Optimality” i.e. a state of allocation of resources in which it is impossible to make any one individual better off without making at least one individual worse off.
President Trump would be better served by reading Adam Smith than his own (ghostwritten) autobiography. Images: Amazon
Theory to practice
The theory put forward by both Nash or Pareto sounds elegant and simple, however, as we know, humans and as a direct consequence, nations, have varied and complicated motivations. To be a successful deal the finalised agreement must satisfy the primary motivations for the parties involved.
This is tricky enough in a bilateral deal, however, increase the parties involved and one can see that a multilateral deal requires even more delicacy and consideration. Therefore, those that will seal the deal, so to say by adding their signature to the agreement, must ensure that they have made the most use of bright minds to accommodate as much as it possible of the real interests of all players. It is an exercise in creating the largest area of overlap in a multi-circle Venn Diagram.
Source: Spotlight Ideas
Typical high motive factors are prestige, enhanced consumer choice and welfare, risk mitigation, flexibility, the well-being of employees and of course monetary considerations such as a consistent cash flow, taxation benefits and profitability.
For these reasons deal negotiations have to focus on what is of principal importance and to ignore what is not.
No deal, best alternatives and creativity
There will be times when a deal cannot be agreed. As the UK prime minister said on Tuesday this week that when it comes to the UK negotiating its exit from the EU, “...no deal is better than a bad deal...”.
Therefore, the negotiating parties will consider what may be regarded as the “Best Alternatives” if a deal cannot be reached. This has been referred to as the best alternative to a negotiated agreement (BATNA) and will determine the incentive each party has to make a deal happen.
On the eve of the inauguration, the BBC (Radio Four PM programme) reported that in his corporate career, Trump had a reputation of starting most deal negotiations by seeking to intimidate his counterparts by taking an extreme, outrageous stance and making several provocative statements. As his would-be deal partners were left reeling or simply stunned, Trump would launch an all-out charm offensive by suggesting both parties seek common ground whereby a deal could be brokered.
As he starts shifting from “Brand Trump” to “Brand USA” I am sure the new president will tell his negotiators to always look out for what is the alternative for the US if a deal doesn’t get done?
He will be aware from his long business career that the better the alternative, the less the US will need the deal and the more risk he can allow his team to take in the negotiation process.
One just hopes that he will be open to impartial advice as deal making can become emotional, then in turn, irrational.
This is a trait that many commentators on economics and politics have raised about the next president. Certainly, the late night tweets against the press or intelligence agencies have not dispelled that opinion. One tried, tested and proven method of safeguarding against impulsive decisions is to seek counsel from someone trusted and not emotionally involved. Therefore, it will be wise to study the back record of the new cabinet members and closest presidential advisers.
A wise businessman will know that in the modern world, deals need to be creative. That will require a frequent reappraisal of one’s strengths, weakness, opportunities and threats (SWOT) so that Trump’s USA will be fully aware of all available national resources and will stand ready to deploy them in inspired ways.
This way one improves that chances of conceding on what is less important to you, but more important to them, and to get what is less important to them, but more important to you. This can widen the potential zone of possible agreement (ZOPA). This is the very heart of the Venn Diagram intersection.
As such the negotiated terms are simply servants of the underlying motivations. One must think creatively about how to satisfy the other party’s real interests. Pay attention to the other party. What do they like to do or eat? Book appropriate entertainment or restaurants. Do the homework on the other party and do not by making a foolish choice for socialising upset or insult one’s counterpart. It does not have to be a “zero sum” game.
Simple is superior
Complicated deals rarely work as complication, particularly across national boundaries and cultures creates confusion, uncertainty, misunderstandings. Inevitably that will lead to a bad taste and harbour resentment. So, keep the main thrust of negotiation focused around a few key points that serve the underlying interests, and any other issues should be as simple as possible.
After agreeing to something, immediately establish a definition. This creates a new baseline that the parties can return to if the negotiations become bogged down as against going back to the drawing board or scrapping the deal altogether. This is crucial if the BATNA is not attractive.
The definition itself can be simple but do it swiftly as an agreement that is undefined will create confusion later. That is the last thing wanted in long and complex deal negotiations, be it over permits, trade or certainly weapons.
As we set sail on the Trump era, the next few months and years will show if the new president really is the real deal or just a servant of self-interest.
– Edited by Clare MacCarthy
Stephen Pope is managing partner at Spotlight Ideas