There are situations in life when you learn some fundamental truth or skill with shocking speed and clarity. These situations - and their lessons - are burned into your memory, and are triggered whenever you encounter similar moments later in life. Ideally, these moments don’t cost you anything.
Walking into my first COMM 412 class on Friday, I didn’t expect to encounter one of these moments - I honestly haven’t had one of these at school in a long time. So, when I found myself sitting across from my scene partner in my first ever negotiation and failing really, really hard, I shook my head in wonder and grinned big. This was a lesson I’d never forget.
Setup
Credit to Creative Consensus, Inc. for creating the exercise
As the CFO of a mid-sized pharma company, Seltek, I needed to sell off a US plant originally set up to produce a line of genetically engineered compounds, but was only able to successfully produce one - Petrochek (used to clean up oil spills). We need to sell the plant since it barely breaks even - we used to want to manufacture several compounds on the line, but Petrochek was our only success (we’re getting out of biotech manufacturing all together).
There’s enough demand that we could keep the plant operating at break-even for a year if BioPharm can’t do the deal right away. However, we’re desperately short of funds to invest in projects with greater strategic importance, so selling the plant and the patent is an immediate priority.
The plant is configured to manufacture genetically engineered compounds only - it would take 6 months and $3M to rebuild the plant, resulting in it’s appraised value being $10M. Additionally, if BioPharm were to purchase the plant, we’d want them to keep the existing (specialized) workers, otherwise we’d have to pay $1M severance.
- BioPharm engineers inspected the plant and deemed it suitable for their purposes, but we don’t know what they want the plant for (they have no genetically engineered compounds in their current product line).
As a final piece of info, Petrochek has a business potential for the oil industry of $5-7M, with potentially large value for the sewage treatment industry, depending on worldwide environmental regulation trends. We still need to sell the Petrochek patent, which a European company has offered $4M for - if we waited a year, there’s a 50% chance we could sell the patent to Exxon.
Publicly-available info is as follows:
- The plant (building + land) was appraised by a real estate agent 2 years ago at $20M. The local real estate market has declined 20% in last 2 years due to economy.
- Public accounting shows the plant is valued at $12M on Seltek’s accounting statements - land is $1M and the building has been depreciated from an original $20M down to $11M for tax advantages.
- Building insured against total loss for $8M.
- An identical plot of land across the street sold for $500k after being on market for three years.
There were some smaller additional points that I left out of the main description, since these are the items I deemed relevant for the main negotiation.
Negotiation
Right away, my partner, Angus, slid into the role well. He was professional, but friendly - asking about my holiday break to put us both at ease. I started by asking Angus what he was going to do with the plant (a good question), and he answered by saying he honestly wanted to purchase the plant as-is, no modifications required.
- Angus verbally saying he was going to be honest with me, and explaining a bit of his company’s side of thing, immediately had me trusting him. Coming into the negotiation, I felt I needed to hide everything, leading me to take on a closed-off and guarded manner that likely wasn’t conducive to getting him “on my side”.
- This was because I didn’t understand what company-confidential information could actually be used to weaken my position and future valuation arguments vs. what I could - and should - have strategically been open about, in order to gain his trust and make the counter/offers I’d make later seem fairer.
As soon as Angus said BioPharm wanted the plant as-is, I should’ve understood that this suddenly placed value on not just the building and land, but on the manufacturing line itself, including the workers.
- After the exercise, Angus told me that BioPharm would have to spend $25M to build a new plant, which would take 12 months, and they’d lose $1M each month. Therefore, anything deal below $37M for BioPharm would be favourable over their BATNA.
I asked if he would take the workers, and he agreed. However, when asking this question, I a) didn’t push further on the terms of keeping those workers (same salary? how long would he be required to keep them?), and b) didn’t consider the fact that the knowledge of the workers was also a monetizable asset.
Finally, I asked him about the patent, which he didn’t want to purchase, and to his credit explained why it wouldn’t work for their market strategy. I knew this detail wasn’t worth pressing, as we had alternative sales pathways available for it. Then, all that was left was the offer.
The Offer
I didn’t know who was typically “meant” to make the first offer in that scenario, so I asked him to do it. He offered $8.5M. As soon as Angus made this offer, I knew I was in trouble. I hadn’t come into the negotiation with any ideal number in my head, and as such, was set scrambling in the moment to figure out whether that was “fair to me” or not.
I should’ve come into the negotiation with my ideal number in my head! This was such an obvious blunder that I actually laughed out loud, but wasn’t able to recover in the moment. I’ll go into more detail about choosing the number in a moment.
- After the exercise, Angus told me that by making the first offer, he was “anchoring” his number in my head. During the following lecture, our professor emphasized the importance of making the first offer, since the vast majority of deals end up around the median of the first offer and counteroffer.
- So, when Angus offered $8.5M, I should’ve countered with my ideal high offer, so we could end in the middle. There was no sense playing around Angus’ low number, just because he’d thrown it out first.
Angus explained after that his offer was strategically based on the publicly-available info - the building was insured for $8M, and the plot across the street had sold for $500k - $8.5M total, a fair offer that he’d be able to explain if asked. I should’ve picked up on this given the publicly available info, so that I understood his reasoning for the number - or, I could’ve just asked him, which I didn’t. Instead, since I had no idea of what I wanted from the sale, I struggled for literally minutes, and finally accepted his offer, entirely unsure of what I’d even base a counteroffer on.
I knew I’d gone wrong, but for the life of me I didn’t know where - a helplessness I was surprised by. I knew I wouldn’t be great at this, but I didn’t think I’d be this bad.
Setting My Number
To set my ideal number, I should’ve aimed high: the plant was appraised by the agent at $20M, and since I knew the line (and workers) had value, I should’ve calculated a reasonable sum for this - in real life, I’d get a rough estimate on how much it’d cost to build and recruit new workers, and add this to the $20M - for example, $10M, bringing the total I’d ideally want to $30M. Crucially, this number is evidence-based - if Angus had asked, I could’ve explained it’s origin (and thus, it’s fairness).
- The two-year decline in real estate prices, the tax appraisal, and the insurance were all things I should’ve anticipated Angus would know, but not things that I should’ve latched on to when coming up with my number.
- Angus would’ve likely countered that our tax documents showed $12M, to which I could have assented (or known more about tax law to argue that didn’t matter), and if so, I should still have added the manufacturing line value (ex. $10M) to my counteroffer.
There was a lingering $200k tax lien on the building from disputed taxes (for which the court filed in our favour). Angus initially didn’t bring up whether this was included in his offer or not, and by doing so, left the burden on me to raise or pay. When I did raise the question, Angus leaned on my emotion by constructing a statement which we would both agree was fair: “Your debt is yours to settle”.
- What I would’ve done differently: if the amount was larger, I would’ve expressed that since the court ruled in our favour, we believed the debt was settled. However, since it was such a small amount, I wouldn’t have even mentioned it, especially considering we already had this amount earmarked.
All in all, it’s hard to think of another time when I learnt so much in 15 minutes. Thank you, Angus, for being an excellent partner and explaining the reasoning behind your decisions after the exercise. I’m excited to see where the class goes from here.