The Program on Negotiation at Harvard Law School has been a leader in the research and analysis of negotiation for many years. A question examined and re-examined over the years is, “Who should make the first offer?” Research shows, unequivocally, that in a distributive negotiation, (where one party pays and the other receives) the first offer has an anchoring effect and leads to the offering party obtaining a better outcome. But there are important exceptions as a recent mediation demonstrates.
James and Ezra were locked in a personal and economic battle over the break up of their business partnership. It had been expensive for both sides. Ezra, the departing partner, felt he was nearing bankruptcy, although business was looking better than it had in the years since the Great Recession. Even James, who was represented by a very experienced personal injury lawyer who had agreed to a contingent fee, was feeling the pinch of court costs and time invested in the litigation.
Prior to the mediation, both parties had carefully evaluated the case and considered possible outcomes. Although they did not share their analysis with each other, both had decided that the likely outcome would result in James recovering between $100,000 and $250,000. Both parties knew that litigation would have substantial costs, and that recovery of any judgment could be difficult.
With this information, what was the best approach to settlement at mediation?
James’ attorney took the approach that he takes in all of his cases. He laid out his best-case scenario, putting up the maximum numbers that he could possibly hope to get from a jury (adding some hyperbole), and demanded $1.5 million.
Ezra’s reaction was predictable. He responded that the demand was outrageous, that he couldn’t pay that amount even if he wanted to and that he was ready to go home. Instead, the mediator talked him into waiting until he found out if James would come down. So Ezra offered an equally outrageous $5,000.
After a long afternoon of going back and forth and never getting into the same ballpark, Ezra finally decided to make a “final offer” of $50,000. James considered the offer for a long time and said to his attorney, “I just can’t do this any longer. I know this guy. He’s not going to offer any more and I have to take this.”
So the case with a $1.5 million demand settled for $50,000.
What happened, and could anything have been done differently to obtain a different outcome?
In their classic book, Getting to Yes, Roger Fisher and William Ury wrote that understanding the interests of the parties in a negotiation was more important than knowing their positions. Had the interests of the parties been better understood by James’ lawyer, perhaps he would have taken a different approach. James was trying to make his business grow after the departure of his partner and was doing pretty well. The litigation was draining his capital and, more importantly, his time. He felt that he needed to end the litigation to make his business successful. Ezra was struggling, too, and knew that an adverse judgment could put him into bankruptcy. But he had some cash and was willing to spend it to avoid visiting with a Bankruptcy Judge.
When James’ attorney demanded $1.5 million, did he consider the interests of either party?
Rather than anchor the negotiation, the offer was so much greater than Ezra could pay, and any further negotiation seemed fruitless. His attitude was that it was better to go ahead and pay for the bankruptcy. And, since it was not in the realm of possibility, it didn’t do anything to advance James’ desire to get out of the litigation.
What could have been done differently?
A demand closer to the realistic assessment of a likely outcome of the case might have convinced Ezra, early on, that he had a chance of negotiating a settlement that would keep him out of bankruptcy. And, it would not have taken James anywhere that was below what he could expect to receive in a realistic assessment of the case.
Weeks after the mediation, the mediator had a chance to ask Ezra’s attorney and asked, “If the initial offer had been lower, would your client have reacted differently?”
“Yes,” Ezra’s attorney said. “If we had started closer to a realistic jury verdict, say $250,000, I think my client might have gone up as high as $100,000 to settle. He had money set aside, but as it was, he was so ticked off that it was a struggle to get him to offer anything. And once he dug his heels in, he was willing to walk away, even when the offers got into a reasonable range.”
Using the anchoring effect of the opening offer makes sense, but the offer needs to take into consideration the interests of the parties.
Tailor the initial offer to make it appeal to the interests. And, if you don’t know the interests of the parties, work with your client to disclose what is important and withhold any offer until you have a chance to learn more about your adversary.
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