125. Steven Phelan on Innovation In Contracting

Entrepreneurs seek to provide markets with new value through innovation wherever they can identify an opportunity. Their vision is broad enough to include free market institutions such as contracting, where they identify new and better ways to expand the mutuality of value and better relationship models than those in the traditional legal approach.

Download The Episode Resource “Contracting In The New Economy” (PDF) – Download

Key Takeaways and Actionable Insights

Traditional contracting starts from an adversarial mindset.

Traditional contracts are written in anticipation of conflict. They aim to anticipate everything that can go wrong. Then they try to put every contingency in black-and-white. Clauses are inserted to give one party the upper hand over the other. This approach fosters negative behaviors that undermine the relationship and the contract itself. Often, little room is left for flexibility when conditions change in unexpected ways, leading to costly problems like litigation, mediation/arbitration, renegotiation, churn, and shading (withdrawal of effort by one party due to lack of trust).

A new form of contract called a relational contract aims to address the problem.

A relational contract approaches negotiation not from a transactional perspective but from a relational perspective: what are the best provisions to ensure a lasting and mutually beneficial relationship between the two contracting parties? Instead of focusing on how the value pie is divided between two parties, the shared goal is to maximize the total amount of value that can emerge from the partnership. There is a genuine good faith effort to align the two parties’ interests and to develop a fair and flexible framework to handle unexpected changes and events in the future.

The relational contract is designed to try to solve what economists call the hold-up problem.

Contracts refer to future events, and specifics (such as delivery times) can never be determined with certainty beforehand. The contract is said to be incomplete — not every contingency can be specified. The hold-up problem occurs when one party uses this situation to extract concessions from the other party, knowing that it would be costly for that party to change the arrangement.

Defense contractors, for example, are notorious for under-bidding costs and then adding to their revenue and profits via change orders. A contract may call for “best efforts” but this can never be defined specifically or completely.

The new approach is said to produce healthier and more sustainable partnerships.

In the article A New Approach To Contracts, the authors call for a “what’s in it for we” partnership mentality in contracting, where both parties have a vested interest in the other party’s success. Included relationship-building elements such as shared vision, guiding principles, and “robust governance structures” to keep the parties’ expectations and interests aligned.

Our guest, Steve Phelan, has written extensively about expectations management in negotiations, and concurs that contracts can perform as instruments of expectations management. However, they can’t be perfect, and the authors’ integration of trust-building mechanisms into contracts (e.g., regular scheduled trust-building meetings) seemed to him to be a bit artificial.

A better approach is to focus on identifying good-faith actors — those who work hard to follow both the letter and the spirit of the agreement. As is always underlined by the “Think Austrian” approach, subjectivism (in this case good-faith actors) brings better business solutions than hard and fast rules and mechanisms regarding how to build contractual trust.

It’s important to get there by the best route, since trust lowers transaction costs.

The new approach to contracting extends to psychological contracts.

Psychological contracts are unwritten relationships in which an individual holds a belief in mutual obligations between themselves and another party. An often-cited example is an employment relationship. There may be a written employment contract but, beyond that, an employee may have tacit expectations about job security, personal development, recognition, promotion, growth, personal well-being and respect. If these are not met, they may withdraw effort. Employers are well-advised to empathize with the unwritten expectations of the psychological contract in order to optimize employee motivation.

A brand promise can be a similar psychological contract. Brand make overt promises regarding the benefits they claim to bring to users. In turn, users create their own expectations — as we always emphasize, value is subjective and customers engage in a value learning process when they interact with brands. Their subjectively-defined expectations undergo continuous change, especially as they make comparisons with alternative offers and alternative sources of satisfaction. It’s imperative for brand owners to monitor the evolution of customer-perceived mutual obligations. Customers hold a strong perception of how much consumption work they have to do to receive the benefits that the brand promised, and if the equation gets out of balance, they’ll withdraw their effort.

Additional Resources

“Contracting In The New Economy” (PDF): Download PDF

“A New Approach To Contracts” (PDF): Download PDF

121. Bill Sanders: How Creative Conflict Expands the Value Pie

Value facilitation is a creative act of imagination, design, assembly, communication, and agile responsiveness. Our Economics For Business model applies these actions in the pursuit of new economic value. Bill Sanders, an expert in contract negotiation in business, applies them in dealmaking and business relationship management. His book, Creative Conflict: A Practical Guide For Business Negotiators, provides a highly actionable model for value facilitation in contract negotiations.

Download The Episode Resource The Negotiation Value Mapping Checklist (PDF) – Download

Key Takeaways and Actionable Insights

Business negotiations are searches for shared value.

Both parties in any negotiation are seeking value, and specifically subjective value. Each sees the eventual agreement on contract terms as a source of future value. Contract negotiation has often traditionally been viewed as a struggle for one side to capture the most value at the expense of the other.

But value facilitators view it differently. They first try to identify the total amount of value in a potential agreement, before thinking about the division of value.

Divergent thinking is a source of value.

In his book, Sanders refers to Creative Conflict as a positive, to be embraced. There’s no predetermined solution, and no absolutely perfect price. There are many possible solutions, and good negotiators are able and willing to continue exploring the ambiguity, and welcoming contending ideas. They are open to uncertainty. It may lead to a solution that neither party might have seen on its own.

Value potential can be mapped in preparation for negotiation.

Sanders introduces the concept of value mapping. Economists are somewhat familiar with this approach at the market level, but perhaps not at the level of individual exchange. Value mapping in contract negotiation is the mental connection of one side’s assets to the other side’s needs. The value map would include a list of concessions desired from the other side (with a subjective estimate of their importance) and a list of what can be given up by your side to generate more value for the other party. In some cases, the values can be quantified.

When presented, these lists become a value proposition for the shared outcome of the negotiation. Sanders provides a value mapping checklist as a tool to help negotiators think about all the assets they might have to bring to the negotiation, and all the areas where concessions might be sought in return.

Value mapping points to the productive end of the negotiation continuum.

Bill Sanders presents types of negotiations on a continuum. On the left-hand end is bargaining, the traditional zero-sum exercise to capture value, a purely distributive process. At the midpoint is creative dealmaking, where value mapping is applied to surface extra value so that both sides feel they gain more than they relinquish. On the right-hand end is relationship building, where the two parties enter into a partnership in which each works hard for the other party to succeed. The spectrum is one of ascending creativity from left to right.

Austrian economics has a big role to play.

Many of the techniques Sanders proffers in Creative Conflict are firmly based in Austrian economics, as he himself emphasizes. Some of the relevant concepts are:

Subjective Value: Each party experiences value in their own mind, and anticipates future value in the form of expectations, based on their own evaluative criteria. While subjective value can’t be quantified, the concept of an expanding pool of value can be considered by both sides, each from their own unique perspective.

Empathy: The tool for understanding the other party’s mental model for evaluation is empathy, the exercise of which we often stress as the entrepreneur’s primary value facilitation skill. This is as true in contract negotiation as in any other exchange.

Trust: Negotiation takes time and requires the declaration of parties’ wants and needs, preferences, capabilities and capacities, and the full functioning of the goods and services being traded. Trust is the required underpinning for these declarations.

Distributed knowledge: There are always things that the seller knows that the buyer doesn’t, and vice-versa. This is the normal (non-equilibrium) position, to be recognized and welcomed.

Uncertainty: Uncertainty is the quintessential condition of entrepreneurship. The future is unknowable. Sanders recommends the full recognition of uncertainty and indeterminism in contract negotiations. Explore possibilities rather than imposing mandatory conditions.

Heterogeneity: Negotiators are different, firms are different and have different priorities, every deal is different. There is no standard way of business negotiations. Sanders does not try to lay down “rules”.

Real time: Time is the context in which change takes place. Every advance in time brings new knowledge and more change. Since negotiation takes time, it must be flexible enough to accommodate change and avoid rigidity.

Processual perspective: The market is a process, value is a process and negotiation is a process. Austrian economics recognizes the role and influence of time — time as the context of change — at a high level of impact. Contract negotiators take the same perspective, using the time taken for the process to unfold as a means of facilitating greater value whenever possible.

Additional Resources

E4B Tool: The Negotiation Value Mapping Checklist (PDF): Download PDF

E4B Knowledge Map: The Negotiating Continuum (PDF): Download PDF

Bill’s Book Creative Conflict: A Practical Guide For Business NegotiatorsBuy on Amazon

The Austrian Business Model (video):

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71. Sanjay Yadav on the Process-Based Skills of Negotiation

Negotiation is an important economic process. The results of negotiation can significantly influence outcomes for all businesses. There are costs to asymmetry of negotiation skills between firms, customers, suppliers and partners.

Sanjay Yadav is an expert in negotiation. He learned his skills from both sides of the desk: in procurement and operations for large multinationals, and then in contract negotiation for creative services businesses of all sizes selling their services to similar multinationals.

From this unmatched combination of experiences, he has developed processes, tools and techniques and a comprehensive training program for executives.

Key Takeaways and Actionable Insights

Negotiation skills are vital to your business.

How well you negotiate will directly affect your cash flows, your costs, your margins, your scale, your financing and your resource allocation. It will indirectly affect your brand reputation, your organizational designs and your delegated management capabilities based on the employment contracts you negotiate.

Negotiation can be taught and learned.

As with everything in business, knowledge absence renders your outcome more uncertain. If your knowledge of the appropriate skills is lacking, you might experience disappointing results when negotiating with customers, suppliers, partners, employees and others in your ecosystem. If your role includes negotiating, allocate some time to skill development.

Negotiation is a process — the best results come from knowing how to do the right things in the right order.

For example, taking time to establish shared trust at the outset is better than having to recover lost trust later in the process. Think through the process from beginning to end — including what could go wrong or what unexpected difficulties might arise — so that you are never thrown off-track. When you know the correct next step to advance negotiations, you’ll be prepared in advance for that step and be ready with the appropriate action.

Negotiation is responsive to many Austrian principles.

Individualism: Austrian economics helps us think about the individual with whom we are negotiating, rather than the organization he or she represents. Every individual in every negotiation has unique identity, unique needs, a unique set of preferences and a unique context. Understanding individualism helps build trust and rapport.

Empathy: We are trained in Austrian economics to go inside the mind of the customer, in our imagination, in order to empathically understand their dissatisfactions and unmet needs. The same is true when working with a negotiator on the other side of the desk from us. Empathy helps us understand their goals and motivations, and to potentially create some subjective value from that knowledge. And it helps us think about the best tone and language.

Roundaboutness: Your actions early in the negotiation process will emerge as consequences later. If you pitch an absurdly high price at the beginning of a negotiation, thinking it will give you flexibility to lower it later, you’ll lose the trust of the other party and make negotiating harder. Small positive signals at the beginning can become major negotiating advantages later.

Entrepreneurial mindset: An entrepreneur thinks in terms of solving a problem — or relieving a dissatisfaction — for others. The market rewards creative solutions. Negotiation is an entrepreneurial undertaking — think about how to solve the other party’s problem.

Understanding value and communicating value are critical success factors.

Austrians have the best understanding of value. This is a huge advantage. At the outset, be sure to spend significant time communicating to the one with whom you’re negotiating the value of your offering. Value is not related to cost; it’s related to the experience your customer / partner / supplier is going to have as a result of collaborating or contracting with you. Be sure your counterparty can properly assess the subjective value you are going to create for them. If they anticipate the same value that you propose, then negotiation will not be a barrier to an exchange.

You can establish a negotiation culture.

Some companies — especially a small one negotiating with a large one (and especially with the procurement department!) — fall into the trap of feeling overwhelmed or under-qualified. Confidence in both content and process is important for success in negotiation. You can develop a negotiation culture of confidence via training, practice and preparation.

Negotiation is a universally applicable skill.

Mastery of the negotiation process is a life skill as well as a business skill. You’ll feel confident about establishing and managing relationships between your company and its customers, as well as with people you contract to provide services at your home, and in any kind of association or organization. You might find yourself negotiating with your spouse. Use your skills!

Negotiators are happy people.

Sanjay’s sign-off advice: negotiators are happy people. They know the value they are offering, they know how to get the appropriate rewards for their value, they are comfortable and confident with the process of negotiated value exchange, and they know how to resolve conflicts.

Free Downloads & Extras From The Episode

Negotiation: Our Free E4E Knowledge Graphic

Our latest free e-book, Austrian Economics in Contemporary Business Applications: (PDF): Our Free E-Book

Discover negotiation readiness at Sanjay’s website

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28. Steve Phelan on Negotiation As A Core Capability For Entrepreneurial Success

Negotiation is a capability that entrepreneurs use almost all the time. It’s an area of entrepreneurial performance where an understanding and application of Austrian Economics can be very helpful.

Key Takeaways and Actionable Insights

It’s all Austrian! Negotiation skills represent one of the resources entrepreneurs must assemble and maintain. The value of any resource is subjectively determined, and so the price is never fixed, it’s subject to negotiation. Two people can have different subjective opinions about the value of a resource – and those opinions can change, e.g. during the course of a negotiation, when one agent changes the opinion of another.

Negotiation starts on Day 1 and never stops. Founders deciding to set up a company negotiate over who plays what role, who gets what share of the equity, and so on. From Day 1, the entrepreneur bargains for advantage, putting the best case forward at all times, and always thinking ahead to the next negotiation.

In Bargaining For Advantage (Revised Edition, 2018), Richard Shell lays out 6 principles of negotiation that Professor Steven Phelan, himself a teacher of negotiation strategies to entrepreneurs in business school, reviewed and illustrated with examples.

Subjectivism: Know Your Own Bargaining Style. The entrepreneurial journey starts from self-assessment: Who Am I? Some people are uncomfortable with negotiation, and sellers might take advantage by making only fixed offers. There is a competitive negotiation style and a co-operative negotiation style, and some points on the spectrum between them. (Most professional negotiators think of themselves as co-operative.) Don’t feel bad if you hate the confrontation of traditional negotiation. You don’t have to drive the hardest bargain. You can control the timeline for greater reflection. You can prepare yourself well to reduce your anxiety. Know yourself, accept your self-knowledge, and learn how to apply it for advantage.

Know your ends and select the best means. Ends-means analysis is fundamental to entrepreneurship, as it is to negotiation. Identify your own expectations, set your goals high, and be ambitious. Remember that a goal is not a fixed point – like a price to settle on. It’s complex and layered and can have a lot of non-monetary components. These are the elements you can vary to adjust the bargaining advantage in your favor, by using them as concessions, or trading them for a better deal. For example, you may be able to reach the price you want by providing seller financing.

Use external – and authoritative – standards and norms to help you. Norms can narrow the uncertainty in negotiation for both sides. For example, real estate agents use “comps” (recent sales prices of comparable homes in the local area) to narrow the range of possible prices in a transaction. Of course, there are multiple norms and standards that could be used – like price per square foot, or lot size, or views – and you should know them all, select your preference, and then argue persuasively in favor. Pick a standard that shows your offer in the best light.

Time preference – thinking long term. A negotiation might seem like the very definition of short-term: you want a good outcome now! But is this the last time you’ll negotiate with this party? Does your agreement in this situation potentially affect future negotiations? If you bargain a new hire down to the lowest compensation level, do you risk them leaving in the future and jeopardizing a team project? Think of the second order consequences and the lifetime of your business. It’s a mark of the good economist – and the good negotiator – to always think in the long term.

Use empathy as the planning basis of all negotiations. We’ve emphasized many times that the core skill of the entrepreneur is empathy – understanding the feelings of the other party, whether that’s a customer or a party to a negotiation. Why is the other party negotiating with you at all? What do they want – or need? Get to know them as people. Take them to dinner. Meet their family. Can you ethically meet their personal needs as well as their corporate needs? You can never eliminate all uncertainty, but deeply understanding the other party can go a long way towards doing so.

Find your leverage: the situational advantage to reach agreement on your terms. Of course, leverage in a negotiation can be positive or negative at the outset, depending on the situation. You should always look for ways to reduce the value of the other party’s alternatives (that’s their leverage) and increase the value of their own. Put scarcity on your side by having more than one bidder for what you are offering. Use time – leverage can change over time, especially if you can wait and the other party can not. One useful tool is BATNA – best alternative to a negotiated agreement. If you have more alternatives than the party on the other side of the table, that gives you leverage.

Use the six principles to prepare a strategy. Shell recommends that you make your opening position as aggressive as you can, and support it with the best norms and standards you can compile. That will put the other party in the position of having to find contrary logic as a counter – it’s called anchoring: your opening bid becomes the anchor for locating the range of negotiation. Never meet in the middle. Let the other party concede first. Shell refers to if-then thinking. If you’re called upon to make a concession, then you know exactly what counter-concession you are going to call for from the other party. Never concede voluntarily, always ask for a responding concession.

Have a specific negotiation plan in mind. Use the accompanying planning tool, adapted from Richard Shell’s book. Physically fill it out, use empathy, acknowledge uncertainty, gather as much information as you can, find your own norms and predict which ones the other party will use, find a good agent if you need one. Planning in advance will give you confidence and help you succeed, even if you don’t relish negotiating.

Use this 10-step planning guide to plan your next negotiation.


PDF icon Download Our 10-Step Negotiation Planning PDF (124 KB)


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