Dr. Atul Gawande tells a story about negotiating his first job offer after completing his surgical training [1].  The chairman of the surgical department of Boston’s Brigham and Women’s Hospital offered Gawande a position, then the chairman asked him how much he wanted to be paid.  Gawande stalled the question by asking how much surgeons usually make.  But the chairman responded, “Look, you tell me what you think is an appropriate income to start with until you’re on your own, and if it’s reasonable that’s what we’ll pay you.”

To be fair, as Gawande tells the story, this was only his second interview, and presumably he did not realize that he was about to receive a job offer.  Gawande was unprepared and had to do several days of research to arrive at an appropriate figure.

Today’s post on Discussing Terms addresses preparing to negotiate.  We discuss some key points to think about while getting ready and provide a worksheet to aid in your preparations:

Know Yourself and Know the Other Party

The photo above shows the defenses of Port Arthur (present day Dalian, China) at the time of the Russo Japanese War.  By current day standards, it was a relatively short war.  Japan declared war in February 1904 and laid siege to the key Russian base at Port Arthur in August of that year.  By May of 1905, Russia had suffered three stunning defeats—Port Arthur had surrendered in January, the Japanese Army defeated the Russian Army at Mukden in March, and the Japanese Navy defeated the Russian Navy at Tsushima Straight in May.  It was an historic military victory—one that resulted in a favorable peace settlement for the Japanese side at the negotiation of the Treaty of Portsmouth in August 1905. 

The negotiation at Portsmouth did contain a small but important victory for the Russian side courtesy of the Russian lead negotiator Sergei Witte.  Witte knew that the Battle of Mukden had been shockingly costly to both the Russian and Japanese sides.  It was a massive clash involving more than 600,000 combatants and lasting more than two weeks.  The Japanese had eventually won, but at the cost of more than 15,000 Japanese dead and almost 60,000 wounded.  In the days leading up to the negotiation, the Russians moved four new divisions into Manchuria—the Russian clear threat was that if the negotiation was not satisfactory to the Russian side, the war might resume at who knows what cost.  Then, Witte made his move at the bargaining table.  He offered additional territorial concessions, but absolutely refused war reparations, and threatened to walk out of the talks.  His stratagem worked—the final treaty contained no requirement for the Russians to pay war reparations.  His ploy was successful for two reasons:  he knew what he wanted (no reparations), and he knew what the other party feared (a return to war)—he was in that sense prepared for the negotiation.

In the first section of the worksheet, there are a list of about 25 questions to be used in preparation for any bargaining session.  Of course, only a small number of these questions are pivotal.  For example, one common type of negotiation is contracting for manufacturing services between a pharmaceutical company and an active pharmaceutical ingredient manufacturer.  In this type of negotiation, the negotiation is simple:  1) the pharmaceutical company writes a request for proposal (RFP) that outlines every key requirement for manufacture of the drug; 2) the RFP is shared with multiple manufacturers and acceptable responses are compared; 3) a contract is negotiated which embodies the proposal, as well as.  In this case, the pivotal questions in preparation revolve around writing the RFP and selecting the candidate manufacturing firms.  As you prepare for your negotiation, decide which are the pivotal questions for your situation.

Your Negotiation Plays

In any negotiation, you will have a mix of complex emotions related to your desires, fears, and the stress of the moment.  To prepare for the negotiation session, it makes sense to have preset “plays,” just like in football.  These are questions and statements that you have planned out ahead of time to elicit helpful information from the other party and move the negotiation forward.

An example of the use of “plays” comes from the Watergate Scandal.  Watergate was set off by a burglary of the Watergate complex in Washington, DC (seen in the aerial photo above) and ultimately led to the resignation of American president Richard Nixon.  During the Watergate investigation, a critical revelation was the existence of a taping system in the White House documenting ostensibly private conversations in held in the Oval Office.

The existence of the taping system became public during questioning of former Whitehouse assistant Alexander Butterfield by a lawyer for the Senate committee investigating Watergate.  Any discussion which involves the authority of the legal system is a kind of negotiation. When Deputy Minority Counsel Donald Sanders began to question Butterfield, they were exchanging Butterfield’s honesty for the Senate’s promise of non-prosecution.  As one question followed another, Sanders realized that there must be some kind of recording system in the White House.  Eventually, Sanders asked Butterfield if such a system existed, and Butterfield replied, “I wish you hadn’t asked that question, but, yes, there is [2].”

In that sense, both Sanders and Butterfield were running “plays.”  Sanders had prepared a list of questions in advance which led him to the revelation of the taping system.  Butterfield had likely prepared in advance that he would not volunteer information about the taping system, but he was prepared to give the information up if asked.  Such in-depth preparation is common prior to giving a deposition—PharmaTopo.com has previously posted on deposition preparation [3].

Run Things by Counsel

So far, we have discussed things you can do yourself, but you may need to consider bringing in outside counsel, either in the form of an actual attorney or perhaps in the form of a subject matter expert, or just a friend.  Running your thoughts on the negotiation by a disinterested third party has two benefits.  First, they may see facets of the negotiation that you missed or got wrong.  Second, by stating openly and in confidence, your negotiation position, you commit yourself to the position emotionally—this means that you will be more likely to stick to your guns when the negotiation gets difficult.  DiscussingTerms has previously posted on the use of counsel in negotiation [4].

Conclusions

In the 2006 hostage negotiation drama Inside Man, the criminals play recordings of former Albanian dictator Enver Hoxha’s political speeches to confuse police officers listening in via hidden microphones.  When the police figure out the scheme, the following conversation ensues:

Detective Frazier:  They’re playing tapes for us now?

Detective Mitchell:  They knew we were gonna bug them.

Detective Frazier:  Damn right they knew.  And they knew how.  Worse than that, they wanted us to bug them so they could send us on this wild goose chase.

That was a good negotiation play from the hostage taker’s point of view.  The hostage takers prepared for the police and led them down the garden path.  If you prepare for your negotiation, perhaps you can do the same thing.

[1] Gawande, A.  “Piecework,” The New Yorker, 27 March (2005).

[2] Honan, W. H.  “Donald G. Sanders Dies at 69; Brought Nixon Taping to Light,” The New York Times, 29 September (1999).

[3] Gallant, S. R. “Documenting Your Intellectual Property and Defending It,” PharmaTopo, 1 January (2022).  pharmatopo.com/index.php/2022/01/01/lessons-learned-documenting-your-intellectual-property-and-defending-it/

[4] Gallant, S. R. “Use a Wingman,” Discussing Terms, 17 December (2022).  discussingterms.com/2022/12/17/negotiation-tip-use-a-wingman/

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

The post Preparation for a Negotiation appeared first on discussingterms.com.

A year and half ago, I wrote a short post pointing out that Berkshire Hathaway and the S&P 500 Index now have approximately the same return, year after year.  The illustration I used at the time was:

The figure shows that Warren Buffett and Charlie Munger were killing it in the 1960s and 1970s—the Berkshire Hathaway founders regularly exceeded the S&P 500 by a wide margin.  By the 1990s, the rest of the world had caught up with Berkshire Hathaway.  And, in the 2000s, Berkshire sometimes bests the S&P 500, sometimes not.

Return on investment is a negotiation between the investor and the company or institution receiving the investment.  If the investor is not satisfied with the proposed return, they can take their money elsewhere, but how do they know when to pull their funds?  What are some benchmarks for healthy growth?  This week’s post will compare the returns from different classes of investments.

Disclaimer:  This post is not intended as investment advice.  Readers should review their investment decisions with a professional prior to making any change to their portfolio.

Thinking About Returns

Individual equity investments rise and fall, but in the long-term diversified stock indices only rise.  Two common stock indices are the S&P 500 index which tracks the 500 largest companies listed on exchanges in the United States and the Nasdaq Composite index which tracks the stocks listed on the Nasdaq exchange.

The figure above shows the value of these two indices from January 2002, after the Dot-Com bubble burst in the year 2000, to the current date.  That period includes the Subprime Crisis of 2007 to 2010, as well as the Covid run up of internet stocks and the downturn of 2022.  Fitting a simple interest rate model with annual compounding to the data produces the following approximate rates of growth:

Inflation was 2.6% per annum averaged over that time period.  So, the inflation free growth of the two indices were 3.3% and 6.3%.  By including the periods of slow growth following 2000 and 2007, as well as selecting the data points in January, after any annual profit taking, these rates are relatively conservative.

Since a goal of creating these numbers is to make predictions about how the future might be, we might take a different view.  Perhaps, we believe that the future will look more like 2014 to 2024, rather than 2002 to 2013.  Here are curve fits to the more recent time period:

More optimistic rates of growth result:

That is a pretty large swing, and that is the challenge of forecasting returns—deciding what data set is relevant while creating the model.

Other Classes of Investments

So far, we have talked exclusively about stocks.  What about other classes of investments?

If you plan a purchase in the near future—a house or some land—then bonds can be a good short-term investment.  At the current moment, US Treasury bonds have an inverted yield curve (5.8% for 3 months, 4.39% for a year, and 3.67% for 5 years).  In general, stocks should do better than bonds over the long term—as can be seen by comparing Treasury bond yields with the stock market returns listed above.

Real Estate Investment Trusts (REITs) are a bit like mutual funds.  They are managed investments in certain sectors of the real estate market.  The returns from REITs have been impressive in the past.  Here is a comparison of the REIT American Tower Corporation (AMT) versus the Nasdaq Composite index:

Recently, REITs have taken a hit, as the entire country changes how it lives and how it does business.  Many companies have reduced their main office footprint and increased remote work.

The key challenge to real estate investments (other than as your own personal dwelling) is that real estate appreciates more slowly than stocks.  Between 1991 and 2013, average home prices rose by a factor of 4.3 (as reported in the Home Price Index published by the Federal Housing Finance Agency (FHFA)).  That sounds impressive, until you realize that the S&P 500 index rose 17.7x over the same period.  According to data reported by the United States Federal Reserve (fred.stlouisfed.org), between the beginning of 2005 and the end to 2023, commercial real estate prices in the US rose by 2.1x.  Over the same period, the S&P 500 index rose 4.1x.

Clearly, there are some winners in the real estate market.  Some developers specialize in spotting distressed real estate on the edge of growing cities, renovating the buildings and flipping them for impressive profits.  However, these kinds of projects require careful and continuous management by the investment manager and by the investors.  The challenge is to locate the rose among the thorns.

Cryptocurrencies have attracted a lot of attention recently.  Brokers such as Fidelity have made investing in cryptocurrencies much easier.  Here is a graph of Bitcoin value since 2014 and the Nasdaq Composite index; the Nasdaq Composite disappears against the x-axis because the swing in Bitcoin is so great:

Of course, caveats apply—cryptocurrencies can be difficult to trade, and on some level they are Ponzi schemes (since they create no new value—gains by one group of investors must be offset by losses by another group of investors).  As long as you are playing with a small amount of capital, and not your life savings, the risk seems small—like going to Las Vegas.

Comparison to Other Investors

One of the opportunities offered by the Internet is to benchmark our returns versus those of professional investors.  At the top of this post, we discussed the fact that Berkshire Hathaway has been tracking the S&P 500 lately.  How about other investors?

Recently, public disclosure laws have allowed us to see into the investments of our legislators, such as Representative Nancy Pelosi and Senator Ted Cruz.  Representative Pelosi’s husband is a businessman who owns a real estate and venture capital firm.  During his time at Harvard Law School, Senator Cruz was a Fellow in Law and Economics, and his wife held a position at the Investment Management Division of Goldman, Sachs & Co.  So presumably, the Pelosi and Cruz family investment decisions are informed by a high degree of governmental and business expertise.  Their data has been reported through the ETFs NANC and KRUZ [1] since March 2023; here is a comparison versus the Nasdaq Composite and S&P 500 indices:

The Cruzes are experiencing returns that are below the S&P 500.  99% of their holdings are in stocks with a fairly even split between sectors (22% in tech, 16% in industrials, 15% in financial services, 10% in energy, 10% in healthcare, etc.).  The Pelosis are tracking the Nasdaq Composite.  91% of their holdings are in stocks with a strong preference for technology (45% in tech, 12% in consumer cyclical, 11% in communications, 9% in financial services, 8% in healthcare, etc.)—their composition is quite similar to Nasdaq.  So, the Pelosis are probably feeling pretty good about themselves, and the Cruzes are kicking themselves a little.

Another investor who may be kicking himself is Bill Gates.  He has $6.2B in Canadian National Railway (CNI).  Since January 2022, CNI is -4.3% in value—if you add the regular dividends that the railway pays, an investment made at the beginning of 2022 is about even.  In the same time period, the Nasdaq composite fell during all of 2022, but it has rebounded and is net positive 14.3% over the period.

The point is that picking individual stocks (as opposed to buying stock indices) is a high degree of difficulty activity—up there with brain surgery and rocket science.  Even well-educated, well-resourced investors get things wrong.

“F…Me, Once This Thing Gets Going in the Wrong Direction…”

Investment is not just an individual activity—it involves hundreds of millions of people and trillions of dollars.  You can make the right investment decision, but if the market is against you, you can still lose money.  Cathie Wood founded ARK Investment (ARKK) as an exchange traded fund (ETF) which would invest in disruptive technology—she wanted it to be a kind of large-scale venture capital company [2].  In early 2020, six years after the founding of ARK, investors started to pile on, running up the company’s value over 8 months.  But, then in November 2021, just prior to the 2022 overall decline in technology stocks, investors turned against ARK:

An investor who purchased ARKK in mid or (even worse) late 2020 may have taken a severe beating, depending on when they chose to get out.  The only way to overcome these large market forces is to purchase an investment at an attractive price and hold the investment over the long term—through whatever market noise may occur in the interim.

The Dream of Higher Returns

The grass always looks greener on the other side of the fence, right?  Venture capitalists are the smartest of the smart investors with the best access to financial information.  Average investors look with envy at the folks in private equity, assuming that their returns are as fat as their promotional materials imply.  What returns are possible when the entire world is open to you as an investor?

A quick sketch of how an investor buys into a venture fund is:  1) an investor selects a firm which is raising capital and commits an investment for 10 years, 2) the venture firm collects fees—typically 2% for the first 5 years, and less in the remaining years—while the firm invests the bulk of the funds in small companies with unique abilities to grow, 3) at the end of 10 years, the investments are sold and the initial investment is returned to the investors, 4) the remaining money is split with the general partners of the venture firm getting 20% or sometimes 30% and the limited partners (i.e., the investors) receiving the remainder.  Most limited partners are retirement funds or other large institutions, but high-net-worth individuals constitute a few percent of the limited partners.

In 2011, Andrew Metrick and Ayako Yasuda made an interesting study of venture capital [3].  They had two sets of data covering the period 1989 to 2008—one set from Cambridge Associates (CA) and the other from Sand Hill Econometrics (SHE).  The CA data set was an upper bound on average venture capital returns because it was affected by survivor bias.  The SHE data set was a lower bound on average venture capital returns.  The key word is “average”—venture capital returns can vary widely depending on the luck and skill of the venture capital firm.  An investor (“limited partner”) in a venture fund has some degree of control of the skill of the firm based on research and selecting the best available firm, but the investor has little control over luck.  Not every venture firm has the opportunity to invest in Uber—only the ones that happen to get the unicorn’s pitch.

What Metrick and Yasuda found regarding average venture capital returns is tabulated below with the Nasdaq Composite for the period 1989 to 2008 included for reference:

So, it is possible to earn more than the Nasdaq Composite on a regular basis, but there are some requirements.  In venture funds, typical investments by limited partners are at least between $1M and $5M, and the money must be committed for 10 years.  Also, since returns vary widely from fund to fund, to get the average return listed in the table above, several separate investments would be required to diversify risk.

Conclusions

To summarize the main points of this post:

1. Pick people, not stocks:  Whether you are investing in an individual stock, a stock index, a mutual fund, or in a venture capital fund, you are in effect hiring people to grow your money.  If you pick the right people, your money will have the best chance of growing.
2. Over the long run, markets rise:  Even an investment in the Nasdaq Composite made at the high point just prior to the Dot-Com Bubble bursting in 2000 went back into the black by 2015.
3. People in the US have great investment options:  This was the subject of a previous post [4].  Not all countries have great stock markets, but the US is fortunate to have more than one excellent stock exchange.

[1] Alemany, J.  “Investors, worried they can’t beat lawmakers in stock market, copy them instead,” The Washington Post, June 1 (2024).

[2] ARK Invest.  “Big Ideas 2021,” research.ark-invest.com/hubfs/1_Download_Files_ARK-Invest/White_Papers/ARK%E2%80%93Invest_BigIdeas_2021.pdf.

[3] Metrick, A. and Yasuda A.  Venture Capital and the Finance of Innovation, Wiley (2011).

[4] Gallant, S. R. “Economic Development and Stock Markets (1 of 2),” DiscussingTerms, June 27 (2024), discussingterms.com/2024/06/27/economic-development-and-stock-market-growth-part-1/

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

The post Are You A Better Investor Than Warren Buffett? appeared first on discussingterms.com.

In the first part of this 2-part post, some best governmental practices to support economic growth were listed:  reasonable levels of taxation, regulation to support business competition, freedom from corruption, etc. [1].  These types of policies make a good deal of sense, but surely, some policies must be more important than others.  The question is how to determine which policies are key to growth.

In other words, why do the US Nasdaq, Taiwan, and Indian National and Bombay exchanges appear toward the top of this above diagram?  And, why are the Mexican, US, Indian, and Indonesian economies farther toward the right on the diagram?  Today’s post answers those questions.

Caveat:  DiscussingTerms does not provide formal financial advice, and readers are advised to consult a strategic, legal, or financial advisor prior to making any decision about investing.

Economic and Stock Market Databases

To look at the sources of growth and limitations on it, DiscussingTerms created two databases—one for national economies [2] and one for stock markets [3]:

• The database of national economies includes 146 nations for which economic data was widely available.
• The stock market database consists of 22 stock markets.
• The dependent variables are:
  • For the database of economies, % GDP growth in the most recent year.
  • For the stock market database, stock market % growth over the last 5 years.

The independent variables were chosen to represent a host of national economic factors—they included:

• Government:
  • Taxes as a percent of gross domestic product (GDP).
  • Democracy:  This the Economist’s Democracy Index.
  • Ease 2020:  This is the World Bank’s Ease of Doing Business Index.  This index was controversial due to some nations attempting to inappropriately influence their own ranking, and so it was discontinued in 2020.  DiscussingTerms included it as a point of comparison, cognizant both of its data being somewhat dated, and the methodological problems in the overall database.
  • Economic Freedom:  The Heritage Foundation and The Wall Street Journal’s Index of Economic Freedom which ranks the protections provide by governments for individual free enterprise activity.
  • Military spending as a percent of GDP.
  • Effectiveness Index:  This is the World Bank’s index of nations based on quality of public services, civil service, policy formulation and implementation.
• Economics:
  • GDP.
  • GDP per capita.
  • Immigration:  Net migration rate; if a country is losing population, this index becomes negative.
  • Imports:  Imports in millions of USD.
  • Exports:  Exports in millions of USD.
  • Population.
  • Foreign direct investment (FDI):  Foreign direct investment in millions of USD.
  • Unemployment rate.
  • Inflation rate.
  • Logistics Performance Index:  The World Banks’ index of performance for customs and transportation infrastructure.
• Society:
  • Honesty:  Transparency International’s Corruption Perceptions Index (CPI).  DiscussingTerms will be referring to it has “Honesty” because the highest scores go to countries with little corruption, like Finland with a score of 87—so it’s really an honest index.  (If you name it for what it is, that makes it easier to remember how it works.).
  • Global Competitiveness:  The World Economic Forum’s Global Competitiveness Index.  The index was discontinued in 2020.  It turns out that the index is highly correlated with the Honesty Index (Correlation Coefficient = 85% for the countries surveyed).  After statistical analysis, Honesty was found to be more useful for its ability to predict GDP growth than Global Competitiveness.
  • Women’s Inequality Index:  This is UN’s Gender Inequality Index (GII).
  • Education:  This is the Education Index published by the United Nations Development Program.
  • Gini:  The Gini ratio is a measure of the statistical wealth inequality within a country.
  • Patent Applications:  The number of patent applications by an individual country through the international patent system—a measure of scientific innovation.

Statistical multiple linear regression was used to determine which variables were important to economic growth [4].

GDP Growth Rate

Using multiple linear regression, six independent variables in the database of 146 national economies were found to be statistically significant in determining GDP growth percent [5,6]:

Some points to note about the table are:

• The confidence levels are high, so it is unlikely that the results occurred by chance.
• GDP per capita has a negative regression coefficient, indicating that as GDP per capita rises, economic growth is limited.  This common observation that developed industrial economies grow more slowly could be because:  1) high wages drive some companies to establish manufacturing operations in low wage countries or 2) workers in high wage economies are making choices to do less work, prioritizing other aspects of their lives such as family and leisure while slowing economic growth.
• Inflation has a negative regression coefficient, indicating that inflation acts as a drag on economic growth.  Economists tell us two contradictory things about inflation:  1) it limits economic growth by driving up interest rates and increasing uncertainty and 2) it increased economic growth by encouraging spending.  The negative regression coefficient shows that overall inflation is damaging to economic growth, and central bankers are correct in attempting to limit it.
• Effectiveness Index looks at quality of public services, civil service, policy formulation and implementation.  Because the coefficient is positive, it indicates that more effective government encourages economic growth.
• Democracy Index:  The Economist’s Democracy index rates governments based on pluralism, civil liberties, and political culture.  This coefficient is negative, so democratic governments have slower growth.  This may indicate that commitment to labor unions, environmental protection, and other regulations slows growth, but presumably those are things that most people want—so this may be the price we pay for democracy.
• Logistic Performance index (LPI):  The World Bank’s LPI has a negative coefficient.  On the surface, one would think that better ports and roads increase growth, but it may be that higher LPI is correlated with variables that slow growth (like high per capita GDP and democracy).  This is a hazard of linear regression—some variables with low P values are merely correlated, rather than causative.  At the very least, this observation is interesting because many would expect a strongly positive coefficient—the negative coefficient could signal that even in economies with low LPI, businesses are skilled at compensating for poor logistics.  Perhaps, strategies such as building dedicated private roads when national road networks are filled with potholes allow businesses to continue to grow.
• Unemployment has a negative regression coefficient, indicating that full employment is a useful goal in maximizing economic growth—it is difficult to build a vibrant economy in which there are two populations (the “haves” and the “have-nots”).  This economic observation undergirds the rationalization of investment in education, public health, and infrastructure—to bring up the entire nation and avoid the haves supporting the have-nots in perpetuity.

The model predictions and residuals (i.e., model prediction minus actual value) appear below.  As can be seen from the figure, the residuals are quite small with a few exceptions—on average the residuals have a magnitude of 19% of the model prediction.  A small number of countries (for example, India and Niger) are what could be called “positive” deviations, with growth increases significantly greater than the regression model predicts.  Others (for example, Argentina, Ecuador, and Haiti) are what could be called “negative” deviations, with growth increases significantly less than the regression model predicts.

Stock Market Growth Rate

In suggesting that democracy may not always be compatible with the highest levels of economic growth, the last section was a little disappointing.  This next section is more encouraging for democracy.  Applying multivariable regression to stock market growth [3, 8], two separate independent variables were shown to be statistically significant:

Some points to note about the table are:

• The confidence levels are statistically significant, so it is unlikely that the results occur by chance.  Also, the coefficients are high (as high as the highest coefficients in the 146-nation economic database statistical analysis), so these are strong effects.
• Democracy Index has a positive coefficient which presumably shows that innovators, entrepreneurs, and investors like to create new companies in nations with a degree of transparency and rule of law.
• Military Spending has a positive coefficient, indicating that stock market companies benefit from military spending.  It’s not an effect measurable in increased growth of the overall economy in the 146-nation database.  Perhaps, stock market listed companies are better able to position themselves to benefit from military contracts for logistics and civilian support services to the military.  An important caveat is that actual military conflict is a huge waste of national resources—having a bunch of shiny tanks may help a country’s stock market, it is generally a terrible mistake to employ the tanks in battle because wars quickly spin out of control destroying lives and national economies.

The model prediction and residuals (i.e., model prediction minus actual value) appear below:

Some points to note about the figure are:

• The model captures the general trends for the market growth rates, though residuals are relatively higher compared to the model of 146 national economies.  The magnitude of the residuals is on average 55% of the model prediction.  Still, the model is quite good for a two-variable model, attempting to capture a complex behavior across stock markets.
• India, Taiwan, and the US Nasdaq markets represent significant “positive” deviations due to factors that are not captured by the model.  Stock markets like Philippines, Thailand, and the UK are significant “negative” deviations.  Comparison of governmental actions supporting competitive markets in the positive and negative deviation countries would likely be enlightening.  Undoubtably, the Indian, Taiwan, and US Nasdaq markets benefit from such legislation and regulations.  If these features are quantifiable, an improved model could be generated which reduced the residuals.
• “Delisting” is a complex issue that undoubtably has an effect on stock market returns [9].  In delisting, high performing companies are sold to private equity, either before or after becoming public companies.  It is noted here as being relevant and maybe the subject of a future post on DiscussingTerms.

So, What About All Those Other Variables?

The variables which strongly affect growth were the focus of the discussion above, but what about all the other variables that did not rise to statistical significance?  Here are some thoughts:

• GDP growth is not the only motivation to undertake a national program.  Democracy, economic freedom, improved roads and ports, reduced corruption, and increased numbers of useful inventions are ends in themselves that do not need to be justified based on economic arguments.  They can be justified based on:  1) how democracy increases a population’s experience of human rights and equality, 2) how economic rights increase individuals’ ability to provide for their families and communities, 3) how functioning transportation networks offer citizens a greater variety of goods and services, 4) how corruption destroys people’s sense of solidarity and faith in justice, and 5) how investment in higher education leads to not only increased numbers of patents, but to improvements in society by application of science, engineering, and medicine to the problems that confront a nation.  Not everything can be measured out in dollars—though economic measures are important.
• Taxes are a topic that receives frequent attention in the context of economic growth.  The fact that taxes did not reach statistical significance is likely an indication of the limited efficiency of taxation as a mechanism of national investment.  Investment in education, ports and roads, and other sensible national investments undoubtably boosts the GDP, but other uses of taxes can be a drag on the economy (such as continued spending on programs that the government has already terminated [10] and spending on military conflict).

Conclusions

Some of the key variables to support economic and stock market growth include:  low inflation, government effectiveness, low unemployment, and democracy.  These are all values that can be included in national legislative and regulatory priorities.  Other variables undoubtably have a positive effect, though one that is harder to measure.  These include:  support for education, public health, and support for infrastructure, as well as engagement with the world economy and encouragement of investment.

[1] Gallant, S.R.  “Economic Development and Stock Markets (1 of 2),” June 27 (2024).  discussingterms.com/2024/06/27/economic-development-and-stock-market-growth-part-1/

[2] Table of 146 economies:

[3] Table of stock markets:

[4] Orlov, Michael L.  “Multiple Linear Regression Analysis Using Microsoft Excel,” Chemistry Department, Oregon State University (1986).

[5] GDP Growth model statistics for 146 economies:

[6] The data was scaled to values between 0.0 and 1.0 prior to regression.  This allows the coefficients to be more easily compared.  Scaling was performed using the formula:

Scaled data = (Original data – Min value)/(Max value – Min value)

[7] Gupta, S., Davoodi, H., and Alonso-Terme, R.  “Does Corruption Affect Income Inequality and Poverty,” IMF Working Paper, May (1998).

[8] Stock market model statistics:

[9] Ljungqvist, A., Persson, L., and Tåg, J.  The Incredible Shrinking Stock Market: On the Political Economy Consequences of Excessive Delistings,” European Corporate Governance Institute (ECGI) – Finance Working Paper No. 458/2016, IFN Working Paper No. 1115

[10] Congressional Budget Office.  “Expired and Expiring Authorizations of Appropriations for Fiscal Year 2022,” August 2022.  (www.cbo.gov/system/files/2022-08/57760-EEAA.pdf)

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

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DiscussingTerms has been thinking about economic growth as economies expand in the post-Covid-19 world.  Clearly, some things are the same:  people still need homes, durable goods, and food.  Other things are changed, perhaps forever:  remote work has become more common, and the role of city centers in the economy is being questioned.

In today’s post, DiscussingTerms takes a step back to look at economic metrics and consider what they mean for national economies and for individual investors. This is the first of a 2-part series.

Caveat:  DiscussingTerms does not provide formal financial advice, and readers are advised to consult a strategic, legal, or financial advisor prior to making any decision about investing.

Background

Economic development and stock market growth both constitute the outcomes of negotiation processes.  In the case of national economic development, gross domestic product (GDP) growth is supported by four types of activities:

• Government and society:
  • Reasonable levels of taxation, regulation to support business competition, freedom from corruption
  • Maintenance of utilities, highways, ports, and transportation services
  • Support of an advanced education system, participation of women in the economy
• Regional diplomacy:  Low military spending, absence of military conflict
• Investment:  Private sector investment from local investors and/or international investors
• Markets:  Engagement in the world economy

In the case of business growth of public and private companies, increased enterprise value is supported by the sensible national policies listed above, as well as by three additional factors:

• Entrepreneurs:  A community of business founders and leaders who can develop and execute business strategies to deliver products and services their clients want and to deliver returns to their investors.
• Access to Capital:  Banks and investors (international investors, private equity, angel investors, retirement funds, brokers, and individuals) provide the funds for businesses to establish themselves and expand.
• Workers:  Businesses need managers, scientists and engineers, financial specialists, regulatory staff, logistics personnel, manufacturing and maintenance staff, and others with the training and experience to allow companies to achieve their strategic goals.

Data on Economic Growth

DiscussingTerms was reviewing the data on stock market growth and comparing it with national GDP growth—some interesting trends popped out [1].  Here is a graphical presentation of the data:

Some points to note about the graph:

• On the vertical axis, appears stock market index growth percent for 24 major stock markets.  The specific stock market indices are noted in the table which appears as a note [1].
• On the horizontal axis, appears GDP growth percent for the specific nation in which the stock market is located.  For instance, Toronto Stock Exchange is located in Canada and seen on the plot near Switzerland and Saudi Arabia.  Most countries have a single stock exchange, but a few have more than one.
• The red diagonal dashed line is the line of equal stock market and GDP growth.  So, markets which appear above the line are growing faster than the GDP of their country, and the markets which appear under the line are growing slower than the GDP of their country.
• The two red sold lines are at the 100% growth limits.  Economies to the left of the vertical red line (Japan, South Africa, and South Korea) shrank over the last 5 years.  Stock markets below the horizontal red line (Hong Kong, Thailand, Philippines, Malaysia, and China (SSE)) lost value over the last 5 years.

One way of thinking about this plot is that stock markets and overall economies do not necessarily move in synchrony.  Stock markets which appear above the diagonal dashed line are pulling up overall economic performance, while stock markets appear below the dashed line hold back economic growth.

Stocks Which Promote Growth

Let’s consider some of the stocks that drive growth in markets:

• Nasdaq is an exchange that has had tremendous growth (221%) over the last 5 years.  Leading Nasdaq stocks include:  Microsoft, Apple, NVIDIA, and Amazon are key stocks in e-commerce and technology with strategies to enter AI and other growth areas of the economy.
• Important companies in both the Bombay and National stock exchanges are:  Reliance Industries (a conglomerate with interests in petrochemicals, as well as telecommunications), Tata Consultancy Services (a major IT services company), HDFC Bank (a major Indian bank), and ICICI Bank (another major Indian bank).

These companies are dynamic—seeking to expand and develop new business strategies to allow long term growth.  This type of company contrasts with companies that are typically thought of as low growth companies—companies caught in older stagnant areas of the economy, without strategies for competing beyond national borders, engaging in “rent seeking behavior” to maintain revenue.

Middle Class Investment

Wealthy families will always have options for what to do with their capital—including investing overseas.  But, middle class families often have fewer options.  Let’s contrast two national economies, one with rapid growth in its stock market and one without rapid growth in its stock market.  In both cases, middle class families may be able to earn more than their daily requirements for food, lodging, clothing, healthcare, education, and other immediate needs.  But, what they do with their surplus capital differs markedly:

In the case of a rapidly growing stock market, a virtuous circle results with middle class investments helping to power economic growth.  In the case of a slow growing stock market, assets of middle-class families may be trapped in dodgy low growth investment schemes.  Certainly, some investments outside the stock market can provide growth—family businesses undoubtably power dynamic local economies in low and high per capital GDP countries—but, the investment options are significantly narrower.

Conclusions

In countries like the United States, Taiwan, India, Japan, South Africa, Germany, and others, the stock markets are lifting up the overall economy.  This is an important dynamic to nurture which governments can encourage through best practices in legislation and regulation, intelligent diplomacy, and economic policy.

[1] Table of stock market data:

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

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When I bought my first car, just as I was about to sign the paperwork.  The dealership brought in “the closer.”  A closer is a person who you have not met before.  You may have spent a substantial amount of time with your counterpart—in my case, it was the salesman who showed me various models and took me on a test drive of the model I wanted.  The idea of using a closer is that, without an emotional connection, the closer can be hard nosed driving the final bargain.

As I sat across the desk from the closer, she made it clear that even though the antitheft system was an integral part of the car, it had not been included in the price I was quoted.  So, I actually need to pay more.

Fortunately, I had an ace up my sleeve.  When I was talking with the salesman, I said to him, “Would you write down the number I need to put on the check?”  So, I had the price that he had promised me.  I looked the closer in the eye and said, “That’s not the price I was quoted.  You need to talk with your salesman.”

In short, I prepared for the closing during the negotiation.  I had also researched the price ahead of time.  It was such an oddly specific number, that the salesman had said, “Where did you get this number?”  He knew that I had found his true bottom line.

In today’s post, we discuss tips for closing a deal.

Two Types of Negotiations

Broadly speaking, there are two types of negotiations—those in which relationship is important and those in which it is not.  The California car dealership I described above was an example of the first type of negotiation—they did not really care if I walked away from the negotiation feeling a little burned.  Since I was not going to purchase another car for five to ten years, any repeat business I might bring them was long away.

An example of the second type of negotiation is salary negotiation.  The employee wants the most she can get out of the negotiation, but she will also have to work with her supervisor in the coming months and years.  Ideally, the employee preserves the relationship with the supervisor by presenting reasonable salary expectations.  A summary of the tactics and processes appropriate for the two different situations is:

In both types of negotiations, your side should have gamed out the negotiation in advance.  The difference is that the two disparate goals (outcome maximization versus relationship preservation) lead to different tactics and processes.

Time and Timing

One important aspect of the process is time and timing:

• Will there be rounds of negotiation?
• How soon will responses be expected?
• When can a final result be expected?

Whether deadlines are real (for example, a specific time when a product is required) or artificial (for example, a deadline to conclude a due diligence process), they create a sense of urgency that can allow hard decisions to be made more easily.  Consider time and timing as important details of the negotiation to be agreed on in advance.  An example of time working in favor of an agreement is Day 12 of the Camp David Peace Accords negotiation—so much had already been invested in the negotiation that it was impossible for each side to walk away, but at the same time, it was impossible to keep so many national leaders in one place indefinitely—decisions had to be made quickly.

Keep Your Eye on the Ball

In a long negotiation, it is possible to become lost in the negotiation process.  Asking “why are we here” and “what are we trying to achieve” can help when the goal becomes obscure.  Consider the case of the negotiation to end White minority rule in South Africa.  For the African National Congress, the goal was always eventual majority rule.  So, in 1992, when the question of a 5-year government of national unity came up, it was easier for the ANC to say yes to less than they wanted because they saw that they would eventually reach the goal of majority rule.  In that case, agreement on a government of national unity along with amnesty for political crimes was critical to closing that round of negotiations.

Bring in the CEOs

The negotiation team has often done all that it could to bring two sides together, but they cannot quite bring the deal to a close.  Chief Executives often have a better sense of what their companies can tolerate versus what it cannot.  CEOs may be able to make concessions and claim critical outcomes in a way that lower-level negotiations cannot.

Agree on the Big Picture

Business deals often start with a term sheet—a bullet point listing of material terms and conditions to an agreement.  The advantage is that a term sheet fixes the major features of a deal, but it leaves the final terms to be negotiated subsequently.

Announce a Settlement

This is a high stakes strategy, but sometimes the glare of publicity is what is required to close a deal.  Announcing a settlement combines several of the above strategies at once.  Usually, there is an agreement on the big picture—this allows the parties to have confidence that a deal can be done.  At the same time, an announcement of a settlement creates an artificial deadline.  It will rapidly become clear that the deal has not been inked if the remaining negotiations drag on, and rivals may have time to swoop in and sabotage the deal once the true status of talks becomes clear.

Look at the Details

Yes, it’s important to think about the big picture, but details are also important.  You may be tired from negotiating each term, but you still have to read the final agreement and make sure there are no surprises.  And, you need to be ready to stand your ground if the other party tries to insert a last-minute claim.

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

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How do you bargain with a country with whom you are technically at war?  That was the dilemma facing Israel and Lebanon last year.  In October 2022, the two countries reached a deal addressing the maritime border separating the two Mediterranean nations, allowing the natural gas reserves adjoining the border to be developed.  Today’s post involves many themes of negotiation:  mediation, stakeholders not at the table, anchors, urgency, and international law.

National Rights in the Near Coastal Seas

How do nations know what to expect with respect to maritime rights?  This question lies at the heart of the negotiations between Israel and Lebanon.  There are a broad set of principles laid out in the United Nations Convention on the Law of the Sea (UNCLOS) which were negotiated in the decades following World War II.  Some of the features defined within UNCLOS are included in this schematic diagram:

Coastal nations can claim rights in the waters adjacent to their territory based on the distance from the shoreline.  A coastal nation may define laws and regulation and exploit resources within 12 nautical miles of the coast—the territorial sea.  For reference, it is possible to see approximately 5 miles to sea from the coast—so the extent of the territorial sea is somewhat beyond the coastal horizon.  In addition, customs, taxation, immigration, and pollution laws may be enforced a further 12 nautical miles—the contiguous zone.  This prevents for example smugglers from hanging just beyond the territorial sea and sprinting in to drop off contraband.  Out to 200 nautical miles from the coast, a nation has the sole right to exploit natural resources—the exclusive economic zone (EEZ).

These principles are clear, but issues can become muddier when national waters overlap, when two nations disagree on the interpretation of UNCLOS, or when negotiating countries are not parties to UNCLOS.  In the eastern Mediterranean, Lebanon is party to UNCLOS, though Israel is not.  Nevertheless, UNCLOS represents a standard against which bargaining positions can be measured.

The Israel-Lebanon Maritime Border

The Israel-Lebanon land border has been a flash point in the recent past, chiefly during the 1970s and 1980s with probing attacks from Lebanese territory and Israeli sponsorship of proxies within Lebanon.  PLO attacks preceding Israeli invasions in 1978 and 1982, and Hezbollah attacks preceding Israeli invasion in 2006.

In the early 2000s, gas exploration took off in the eastern Mediterranean.  Off the coast of Israel, natural gas discoveries started in 1999, but the two discoveries that changed Israel’s energy future were the 2009 discovery of the Tamar field (estimated at 310 billion cubic meters of gas) and the 2010 discover of the Leviathan field (estimated at 620 billion cubic meters of gas).  Tamar, Leviathan, and other discoveries along Israel’s coast have allowed the small nation to target production of 40 billion cubic meters per year which places it in the top 25 exporters of natural gas in the world.

To exploit any natural gas discoveries adjacent to Israel’s north and Lebanon’s south, a maritime border had to be established.  With a defined border, blocks could then be delineated within coastal waters, and international energy companies would be able to bid for exploration and commercialization rights.  In 2010, US diplomat Frederic Hof began mediation between Israel and Lebanon to establish the maritime border.  At that time, the Karish and Qana fields were unknown.  In the absence of data about offshore natural resources, both parties advanced proposed borders:

Per UNCLOS, maritime borders of neighboring countries are drawn perpendicular to the coast.  With some slightly different assumptions, Israel offered Line 1 and Lebanon offered Line 23—both lines ostensibly perpendicular to the coast at the Israel-Lebanon land border.  (Note:  the above map is representative of the general features of the parties’ positions, but the lines on the above map were not drawn with GPS accuracy.)  In a classic split the difference solution, Hof proposed an intermediate line between Line 1 and Line 23.

The discovery of significant gas reserves along the maritime border of Israel and Lebanon dramatically raised the stakes for any negotiation.  In 2013, the Karish field (estimated at 85 billion cubic meters of gas) was discovered.  Subsequently, the Qana field (possibly up to 400 billion cubic meters) was also discovered.

In 2011, the Lebanese government commissioned a study from the United Kingdom Hydrographic Office (UKHO) which resulted in Line 29.  In 2020, the Lebanese side proposed Line 29 in response to maritime border talks stalling.  This may have been a negotiating tactic to cast doubt on Israel’s development of the Karish field.  Line 29 never became part of the formal Lebanese bargaining position—it hung in the background when talks resumed later.

Parties

This dispute was a two-sided negotiation with some interesting parties not represented at the bargaining table:

• Lebanon:  Lebanon is a nation that has been divided by civil war and visited by foreign militaries, including the Israeli Defense Force, Syrian Army, and Palestinian Liberation Organization.  Additionally, Hezbollah represents a proxy force for Iran and Syria.  The country has racked up huge financial obligations ($100B in debt) without proportional benefit to its people.  Natural gas revenue would not eliminate Lebanese indebtedness, but it would be a move in the right direction.
• Israel:  Israel has a vibrant economy which was hampered until the early 2000s by a lack of energy independence.  With increased economic ties to the regional economy, Israel hopes that diplomatic progress will follow, leading to more normal relations.  Thus, natural gas is not merely a tool for increasing GDP, to Israel, it represents a potential tool for the advancement of peace efforts.
• United States:  Through its good offices, the United States has invested significantly in these negotiations as a part of its Middle East regional and European political strategies.  The US hopes that natural gas revenue will help stabilize the tenuous domestic political situation in Lebanon.  And, the prospect of additional inputs of liquid natural gas (LNG) into energy hungry Europe is an added bonus in the wake of the Russo-Ukrainian war and loss of Russian natural gas supplies.
• Hezbollah:  On July 2, 2022, launched three drones toward the Karish gas field, asserting its role as a stakeholder not represented at the bargaining table.  The drones were shot down by Israeli forces, but the message was clear—Hezbollah could make production of natural gas difficult if the border issue was not settled.  However, lest it appear that Hezbollah was angling for improved relations with Israel, the primary motivation of its stand was likely that the deteriorating economic situation in Lebanon weakened the group’s political power in the small nation [1]
• Israeli Opposition:  In retrospect, we know that Benjamin Netanyahu was victorious in the Nov. 1, 2022 Israeli elections following the maritime border deal.  But, at the time of the negotiation, he was in opposition and just another stakeholder not at the bargaining table.  He made his dislike of the deal very clear in the press.  Presumably, he had two reasons for criticizing the deal.  First, Hezbollah had supported the deal with its drones, so he viewed the agreement as a capitulation to Hezbollah military action.  Second, the bargain was struck by Yair Lapid’s government, and he no doubt felt obligated to cast shade on his rival.  Since the agreement was completed, he has been quoted as saying that he will “neutralize” the agreement—he however did not say that he would abandon or disavow it.

Issues

In a sense, the issues involved in this negotiation were deceptively simple.  Examining the maritime map of the Israel-Lebanon border, the issue seems to be literally one of how to slice the natural gas cake, but that ignores other issues that represented challenges and opportunities in the negotiation.  One of the most important strategies of negotiation is to perceive all the issues at hand in order to take advantage of hidden breaks.  Some issues and opportunities confronting the Israeli and Lebanese negotiators included:

• Ossified Negotiating Positions:  In any negotiation that proceeds for an extended period of time, the positions of the principals risk becoming hardened and inflexible.  In the case of this negotiation, the first attempt at mediation in 2010 had been followed by a long period without any progress.
• Regional Rivalry:  Israel’s northern border has been the site of recurrent violence since Israeli independence in 1948.  It can be tremendously difficult to work constructively with an old rival.    
• Urgency of the Moment:  As in the case of Nixon’s opening to China [2], the Israel-Lebanon maritime border negotiation benefited from some unique circumstances that created one-time incentives toward breakthrough.  These include:  1) With global warming becoming an issue, hydrocarbon producing nations are under pressure to extract resources from the ground or leave them forever in place.  If Israel and Lebanon do not pump out the Karish and Qana fields in the next few decades, it is possible that the opportunity will pass, like money left on the table.  2) The Lebanese treasury is under massive pressure as Lebanon’s GDP craters.  3) Both the Israeli and Lebanese governments were in flux.  Israeli elections followed in late 2022 and the Lebanese government was in a caretaker role.  So, neither side had time to spare before they might lose power.  4) Israel was ready to bring the Karish field into production in 2022, but without an agreement, there was risk of military attack on gas infrastructure from the Lebanese side of the border—something the Israeli military could deal with but which it no doubt preferred not to.  5) In the wake of the Russian invasion of Ukraine, the world was short of natural gas due to the Russian supply to Europe being interrupted.  So, negotiation of new natural gas agreements would be easy and lucrative from the supplier point of view.

Negotiation

Early mediation efforts in 2010-2012 by US diplomat Frederic Hof were described above.  Unfortunately, although the issues had been explored, no concrete progress had been made.

Negotiations restarted in October 2020 with mediation by Assistant Secretary of State for Near Eastern Affairs David Schenker.  The Lebanese asserted Line 29 which fell outside of the previously discussed Lines 1 and 23.  This was what might be called a late-stage anchor.  Early anchors can improve the bargaining position of a party [3].  Late-stage anchors signal one of two things:  a shift of the balance of power in the negotiation toward the party offering the anchor or a willingness of the party offering the anchor to blow up the negotiation.  Talks quickly deadlocked with the Israeli Energy Minister Yuval Steinitz tweeting hyperbolically [4], “Lebanon has changed its stance on its maritime border with Israel seven times.”

Amos Hochstein was appointed as the new US mediator in October 2021.  A US diplomat born in Israel, Hochstein was familiar with the region, as well as having familiarity with US departments affected by the negotiation (the White House, State, Treasury, and Energy).  A new mediator can often get stalled negotiations moving, and in this case, that seems to have been critical.  He was able to shuttle between the two sides and apply pressure for compromise.

The US pressured the Lebanese side to abandon Line 29; nevertheless, the Lebanese side seems to have benefited from the late-stage anchor.  The final line swung from the split-the-baby Hof line of 2010-2012 negotiations to the Lebanese offered Line 23—a victory for the Lebanese side.

Interestingly, there is another interpretation of what happened in the negotiation.  The Israeli side relinquished some territory that it had earlier claimed (Line 1), but it gained some prospect for peace on its northern border.  The agreement places two valuable economic assets along that border (Karish for the Israelis and Qana for the Lebanese), creating a powerful disincentive to future military conflict on Israel’s norther border.  So, this may have been a sea-for-peace trade.

Once the new maritime border had been agreed on, the question became:  how much of the gas is on the Lebanese side of Line 23 and how much is on the Israeli side?  This was a theoretical question because the field remained unexplored at the time.  The answer the two sides agreed to was in effect 83% on the Lebanese side and 17% on the Israeli side.  The final deal was signed at the end of October, just prior to Israeli elections, and included the features:

• The first 5 kilometers are defined by the buoy line set by Israel for maritime security, farther out, Line 23 governs.
• 17% of profits from the Qana field go to Israel.
• US to mediate royalty disputes.

Conclusions

There are so many interesting themes to the Israel-Lebanon maritime border negotiation.  They were ticked off in the discussion above (mediation, stakeholders not at the table, anchors, urgency, international law).  One that bears additional reflection is the negotiation model.  There are several negotiation models that apply to various bargaining situations (competitive, problem solving, compromise, allocation).  Clearly, some see this negotiation as competitive—for instance, Netanyahu has made it clear that he thinks Israel conceded to Hezbollah—he is embracing a competitive view of the negotiation.  But there are other aspects.  Israel compromised regarding the final line—a consideration that may (or may not) pay off in the long run in terms of improved relations with the US (who appreciated the support of its diplomacy) and with Lebanon.  There was an allocative aspect to the negotiation—which country would receive what fraction of the gas reserve?  Allocative negotiations often proceed in the face of imperfect knowledge of the size of the asset, but this type of negotiation is benefited as more information is provided.  Given that the undersea gas fields of the eastern Mediterranean were better understood in 2022 than 2010, this increased knowledge aided a final settlement.

[1] Marsi, F.  “What to know about the Israel-Lebanon maritime border deal,” Al Jazeera, Oct 14 (2022).

[2] Gallant, S.R.  “Opening to China,” DiscussingTerms, Dec. 1 (2022).  discussingterms.com/2022/12/01/opening-to-china/

[3] Gallant, S.R.  “Making an Offer,” DiscussingTerms, Jan. 9 (2023).  discussingterms.com/2023/01/09/negotiation-tip-making-an-offer/

[4] Daily Sabah.  “Israel accuses Lebanon of changing stance on maritime border,” Nov. 20 (2020).

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

The post <strong>Israel-Lebanon Natural Gas Deal</strong> appeared first on discussingterms.com.

When you are in the midst of your next negotiation, you may be:  1) wishing that you had made a stronger opening and thinking about how tough the negotiator across the table is, or 2) fixated on how thirsty you are and longing for a little bit of sunlight in your cramped meeting room.  If you are concentrating on 2), you are thinking about your environment, and you are distracted from the heart of the negotiation.  Ideally, the negotiating environment supports the negotiation process.  Today’s post discusses how to set up a productive environment and also how to skew the environment to favor your side.

Paris Peace Accords—a Table for Adversarial Negotiations

In January 1973, the Paris Peace Accords were signed with the goal of ending the Vietnam War and establishing peace in Vietnam.  There were four parties at the table for the negotiation:  North Vietnam, South Vietnam, the communist forces in South Vietnam (PRG), and the United States.  There are two stories about the negotiation environment.  The more well-known story is that of the shape of the negotiation table [1].  In the photo above, you may notice that there is a large round table with two smaller rectangular tables to the left and right.  This configuration of the three negotiation tables accommodated the various needs of the parties to recognize or not recognize the status of the different parties in the talks, and establishing this table shape required much negotiation.

The less well-known story of the Paris Peace Accords is that the actual negotiation took place secretly between Henry Kissinger for the United States and Le Duc Tho for the North Vietnamese government at a house in the suburbs of Paris.  The table shape at the real negotiation was rectangular with the United States on one side and North Vietnam on the other side, something like this diagram:

This is the classic negotiation table.  The rectangular table has some advantages:  1) lots of room to place papers and other resources between the parties for easy access, 2) equal status for both sides—it’s very well designed for negotiations involving two parties, 3) a feeling of solidarity among representatives of one side, 4) the easy ability to make side comments to one’s own team, and 5) if things get heated, the table also functions as something of a protective barrier.  But, a rectangular table has one big disadvantage, it emphasizes that there is a dispute at hand—the two parties begin and end the negotiation glaring across the no man’s land of the negotiation table—this arrangement can support posturing rather than resolution of differences.

2012 G8 Summit—a Table for Problem Solving

In May 2012, the G8 leaders met at Camp David, MD to discuss global and economic issues.  At the table seen above were:  United States President Barak Obama, French President François Hollande, Canadian Prime Minister Stephen Harper, Italian Prime Minister Mario Monti, Japanese Prime Minister Yoshihiko Noda, President of the European Commission José Manuel Barroso, President of the European Council Herman Van Rompuy, German Chancellor Angela Merkel, Russian Prime Minister Dmitry Medvedev, and British Prime Minister David Cameron.  This is a different type of negotiation—a problem solving forum based on long-term mutual relationships and alliances between the participating countries and authorities.  Some features of this bargaining environment include:  1) informality—in general sessions which occur at Camp David are conducted in shirt sleeves, rather than in suits, 2) collegiality—the participants know each other and generally like each other, and 3) commonality—many of the issues discussed by the participants have single solutions which benefit all the G8 members (or, in the case of tough issues, have downsides which bite all the countries equally).  The participants are seated around a circular table (emphasizing equality, rather than hierarchy).  In the photo, they are participating in side conversations, though presumably some portions of the summit were more formal and structured.  Support staff surrounds the main table—presumably a live audio feed permits transcript preparation and participation of other staff in separate areas of Camp David.

Camp David Accords—a Chance to Decompress

From 5 to 17 September 1978, Egypt and Israel met with United States mediation at Camp David to negotiate peace between these two long-time adversaries.  The initial four days had not gone as well as President Jimmy Carter had wanted.  In a reversal of their plan, Carter and the Americans stepped out of the role of mediation and put together an American-backed peace proposal on Day 5.  Then, to remind the participants of what was at stake, Carter organized a field trip on the morning of Day 6—the negotiators visited the site of the pivotal and bloody American Civil War battlefield at Gettysburg (the unspoken message was:  if you don’t sort this out, more people could die in Egypt and Israel like they did at Gettysburg).

It was a bold and non-traditional move by Carter (virtually every aspect of the Camp David negotiations was), and it seems to have had the needed effect of allowing some time away and an opportunity for the participants to reflect prior to returning to the hard adversarial negotiations before them.  By September 17, they had agreed on a groundbreaking peace agreement.  Carter had relatively little control of the Egyptian and Israeli bargaining positions and behavior during the summit, but he did control substantially the environment, and he used that control skillfully.

Jeane Kirkpatrick—Make Them Come to You

Jeane Kirkpatrick was an American academic, Cold War strategist, and the 16^th United States Ambassador to the United Nations.  In the mid-1980s, literary agent Irving Lazar thought he could create a million-dollar book deal for Ambassador Kirkpatrick after her appointment as ambassador ended, but there was one catch—she did not want to “hawk” her book [2].  So, she refused to meet with publishers.  Given that publishers were used to actually meeting the author to whom they were offering a fat advance, this created a problem, but Lazar came up with an ingenious solution.

Lazar had a posh apartment on the east side of Central Park.  He was able to get Kirkpatrick to commit three hours to meeting publishers, and he set up the meetings at his apartment.  After an hourlong meeting, Lazar threw out the first publisher and invited in the second.  At the end of the day, Lazar had an $850,000 book deal for Kirkpatrick.  Lazar recounts that the Kirkpatrick negotiation changed the way that he did business, ”After that, when I had a major client, I settled him or her in my living room and had the publishers in.”  He called it the “home team advantage.”

Lazar was in effect running an informal bidding war among the publishers that the publishers probably sensed, even if they didn’t pass the rival bidders in the hallway of Lazar’s apartment building.  Taking absolute control of the negotiation environment is a way of demonstrating physically which party has the stronger bargaining position—seizing the environment is a show of force.

Issues to Think About

Environment is a grab bag—essentially everything about a negotiation that isn’t rules, strategy, or behavior is environment.  Here are some environmental considerations to bear in mind:

• Layout:  Above are two options for room layout around the same rectangular negotiation table.  In the lefthand layout, the table is surrounded closely by the walls of the room.  In this room, participants are unlikely to stand up, except to leave the room.  In the righthand layout, the table is adjoined by a sideboard with refreshments, there is generous space to walk about, and there is a balcony with sliding glass doors on the right.  Participants in the negotiation may engage each other at the table, standing together in the room, while getting refreshments from the sideboard, or on the balcony.  The righthand layout will lead to a higher quality of interaction.
• Food and Drink/Hospitality:  Many of the stories about the former President of Syria Hafez al-Assad as a negotiator focus on how uncomfortable he tried to make the other side.  His thinking seems to have been that if the other side was uncomfortable, they might give up and concede aspects of the negotiation.  I am not going to insist that he was wrong, perhaps his experience showed him that his methods worked.  What I will say is that there is strong data that kindness helps in human interactions.  The practice of giving gifts seems to create a psychological need for reciprocity.  This effect is so strong that many hospitals have guidelines against receipt of gifts by doctors from pharmaceutical representatives—the thinking is that even small gifts can alter prescribing patterns in healthcare professionals.  This phenomenon may be worthy of reflection during planning for food and drinks, lodging, and other considerations associated with a negotiation.
• Support Services:  Consider whether the negotiation will require:  administrative staff, audiovisual equipment, transcription services, computers, additional rooms for breakout sessions, communication with other sites or home offices, transportation for the participants, etc.
• Agenda:  The traditional agenda for a business negotiation is:  facility tour, lunch, negotiation, wrap-up.  Other types of negotiations have their own rhythm and pace.  What is the best negotiation agenda for the topic at hand?
• Product:  What is the product of the negotiation to be?  Typically, a short written document memorializes the results (a diplomatic communiqué, a letter of intent, etc.).  How will this be produced and signed?  How much time is required in writing—can some aspects be pre-written with key information filled in at the end of the negotiation?

Breaking the Spell of Environment

We have talked about how to set up the environment to be neutral or to be skewed to your team’s benefit.  But, we don’t always control the environment—what do we do if the environment is wrong somehow or is tilted against us?  Here are some ideas:

• Make sure you are in the right place:  We talked about the Paris Peace Accords at the beginning of this post.  The South Vietnamese side was in a bad position—the United States representative Henry Kissinger was negotiating secretly with the North Vietnamese without the South Vietnamese side present.  You do not want to be in the South Vietnamese position.  So, try to be absolutely sure that there is not another separate behind-the-scenes bargaining session undermining your side’s position.
• If the environment is wrong, fix it:  Figure out what is wrong, then make a change.  Move the table, bring a computer in and gather everyone around it, take everyone out to lunch or dinner together, turn up the heat or turn on the A/C, get someone to bring in a blueprint or a whiteboard—whatever it takes to get the negotiation moving in the way you need it to go.

There’s a great scene in the HBO series Winning Time which gets at the environment problem.  Earvin “Magic” Johnson and his father are having lunch with Jack Kent Cooke and Jerry Buss.  Cooke has sold the Los Angeles Lakers to Buss, but the deal is not completed.  During the lunch, Cooke wants to show how powerful he is by upstaging Magic Johnson at every turn, but he only succeeds in antagonizing Johnson and his father.  Jerry Buss sees things going sideways, and as the lunch ends, he says, “I’m going to walk you fellas out.”  Presumably, he tells Johnson to ignore Cooke—because as we know, Buss succeeded in signing Johnson and launching the Laker dynasty—something he could not have done without the generational talent that was Magic.  The lesson is:  if you see your deal going sideways because of the environment, you have to step up and change the environment.

[1] Herdeg, K.  Die Geschmückte Formel:  Harvard:  Das Bauhaus -Erbe Und Sein Amerikanischer Verfall, Friedr. Vieweg & Sohn, Braunschwig (1988).

[2] Lazar, I.  Swifty:  My Life and Good Times, Simon & Schuster (1995).

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

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Swifty Lazar was a great negotiator.  No story about him illustrates his negotiating skills more clearly than the tale of how Iriving Lazar became “Swifty Lazar.”  As told in Lazar’s autobiography, he was having lunch with the actor Humphrey Bogart [1].  Bogart asked him, “How many deals do you think you can make for me and in what period of time?”  Swifty replied, “I could make you three deals in one day.”  Within 24 hours, Lazar proceeded to do exactly what he had promised to Bogart, booking the actor with enough motion picture work for the subsequent three years and leading the actor to give Lazar the moniker “Swifty.”

“Swifty” was a sobriquet that accompanied Iriving Lazar through most of his storied career as a literary agent in New York and Los Angles.  His career was bookended by negotiating deals for Henny Youngman in the 1930s and Madonna in the 1990s.  Today’s post focuses on Irving Lazar the negotiator.

Swifty Was On Your Side

There is a professor Adam Grant at the Wharton School who has advanced the idea that helping others is the key to creativity and productivity [2].  Swifty was an original practitioner of the Grant philosophy.  As described by Lazar, when he started out as an agent, “Writers had never heard of an agent giving dinners for groups of eight to twenty in the most fashionable restaurants and picking up the check.  But I did it on a regular basis—what the hell, it was all tax-deductible.  My clients became my friends.  My friends became my clients.”

But, he didn’t limit himself to organizing salons, as he said, “I tried to make myself indispensable.  When I brought writers out to work in the movies, I organized everything for them—apartment, car, servants.”

By being the indispensable man, Lazar grew a fantastic network of friends and acquaintances that he could draw on when trying to make a deal.

Swifty Represented Everyone

The screenwriter Harry Kurnitz had an oft-quoted line about Swifty, “Everybody has two agents, their own and Lazar.”  This line is a little mysterious without some basic facts about talent agents.  Talent agents and literary agents negotiate movie deals and book deals for a 10% (more recently 15%) commission.  The agent typically receives the payments from a studio, takes their commission, and passes the remainder on to their client.

For most of his career, Swifty operated as a one-man talent agency, and he was working essentially all of his waking hours.  Starting at 11 in the morning he would begin calling various high level entertainment executives to test the waters on possible projects.  In the evening, he was socializing and gathering intelligence.  When he found an interested executive, he might make a deal for a studio to purchase a book by a prominent writer to be made into a movie.

The catch was that the writer was often already contracted to an agent other than Lazar.  Swifty made his money by taking 10% of the deal on top of the 10% that the writer’s own agent would make.  The writers were always impressed by the high dollar value of the deals Swifty put together, and as a result, they did not complain about Lazar’s fee.  The other agents were often embarrassed that Swifty put their deal together for them, but their embarrassment was salved by the receipt of their full 10% of the deal.

Lazar summed it up this way, “Sure, I had some charm.  But the reason I was able to poach so successfully was that I knew more, negotiated harder, and made better deals.”

Round Numbers And A Handshake

Lazar put together deals using two basic strategies:

1. Information:  Lazar had better information than anyone in Hollywood (and later when he moved back East, than anyone in New York City).  He knew what type of projects executives were looking for, and critically, what a given deal should be worth.
2. The Lazar Technique:  Swift would open with a strong offer, the most that a deal would conceivably support—a big round number ($150,000, $1,000,000, whatever was appropriate).  He was setting an anchor.  Once he had opened the negotiation, Lazar wanted to move quickly to an agreement, as he said, “When I’m negotiating, I prefer as brief a meeting as possible.”  The deal would be concluded in old Hollywood style based on a handshake.  Interestingly, Lazar rarely had contracts even with the writers he officially represented.  His role was framed by trust—trust from studio executives that he was bringing them good projects and trust from his clients that he was getting them a good price for their work.

Lazar operated in the middle—a risky place to be, but a place that he relished.  He wrote in his autobiography about a conversation with an acquaintance who had become disillusioned by his agency work in Hollywood, “What my colleague was missing was the obvious reality:  this is the greatest time in the world to be an agent.  As the studios have weakened, the agents have become more powerful.  They’re showmen, or they at least have the power to be. [1]”

Swifty Knew Which Way The Wind Was Blowing

Irving Lazar’s career was extraordinarily long by the standards of the entertainment industry.  He made two smart moves in his career.  First, he opened The Irving Paul Lazar Agency in 1947 to represent East Coast playwrights, and to a lesser extent songwriters, lyricists, costume designers, and directors, in Hollywood.  Throughout the 1950s and 1960s, the Hollywood studios were constantly on the lookout for new script ideas and new production talent—a need that Swifty could fulfill with his numerous personal connections within the literary and theater worlds.

But, as the 1960s progressed, the Hollywood studio system began to break down.  This affected Lazar’s business in two big ways:  1) as the churn of studio executives accelerated, it was harder to go to the head executive to get a deal done and 2) financial oversight at the studios became more pronounced, so it was harder to get the kind of quick meeting deals done that Swifty preferred.

So, in the 1970s, he made the second smart move of his career and moved back to New York from Hollywood to focus more on book deals.  The 1970s and 1980s were a time of interest in celebrity biographies.  Fortunately for Swifty, his long list of friends and acquaintances proved a fertile ground for the kind of book deals that led to best sellers.  By leading the pack out to Hollywood, and then back to New York, Lazar was able to define a unique kind of representation within the entertainment industry—the literary agent.

Swifty Could Be Tough

Lazar started out as an agent in New York City in the late 1930s, a time when organized crime played a significant role in jazz clubs, bars, and restaurants.  Because of that experience, Lazar could be the hard guy when he needed to be or wanted to be.

He wrote about an incident from the late 1930s when he was in his early 30s and just getting started as an agent.  He had put Count Basie’s band into the Famous Door, but he felt that the club’s owners were keeping too much of the take for themselves.  He rectified the situation by showing up late at the club several evenings and shoving his hand into the till, pulling out a few thousand dollars each time.

As life went on, Swifty—at least in his telling—developed a thick skin.  This makes sense, given his position in negotiations and in Hollywood.  Producer David Selznick once said of Lazar (at a dinner from which Swifty was absent), “There is one man who is not here who is single-handedly ruining the motion picture business as we know it.  The ridiculous prices he demands for books and plays and writers will surely be the end of us all [1].”

Lazar understood that as the man in the middle of the deal, he would be a magnet for any regret or hard feelings that developed during the negotiation or after, and he was capable of letting some of that criticism pass without need to say or do anything in response.  However, some of the most notorious incidents in Lazar’s life occurred when he did not let things pass.  Once when Swifty was in his late 50s, he got in a dustup with Otto Preminger at the New York restaurant 21.  Preminger held it against Swifty that Preminger had failed to secure the film rights to the novel In Cold Blood.  Some alcohol was involved, words were exchanged, tempers flared, and Preminger ended up being photographed with his head streaming blood from a gash caused by a glass that Lazar had smashed against Preminger’s skull.  Lazar ended up with a court appearance and a conviction on a misdemeanor, reduced from felony assault.

Conclusions

Irving Lazar was born in 1907 in New York City and died at his home in Los Angles, California in 1993.  In the intervening 86 years, he created a place for himself in negotiations on both coasts, making wealth for his clients and enjoying a special status as everyone’s second agent in Hollywood and in Manhattan.

[1] Lazar, I.  Swifty:  My Life and Good Times, Simon & Schuster (1995).

[2] Dominus, S.  “Is Giving the Secret to Getting Ahead?” New York Times, March 27 (2013).

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

The post <strong>Negotiators in Action:  Swifty Lazar</strong> appeared first on discussingterms.com.

On January 18, 2022, Microsoft announced a $68.7B purchase of the video gaming firm Activision Blizzard.  This is a very interesting tale of negotiation for two reasons.  First, in its SEC filing, Activision Blizzard gives us a peak into the negotiation that led to the sale.  Second, as of the writing of this post, the purchase is not completed because it has not yet received regulatory approval.  As a result, the deal could still be altered or even vetoed.  In today’s post, DiscussingTerms looks at the Activision Blizzard acquisition.

Acquisition as a Negotiation

Acquisition is a two-party negotiation (buyer and seller).  In the case of the Activision Blizzard, there are a number of parties not present at the negotiation table (stock holders, customers (users), and government regulators) who have the ability to affect the outcome of the deal.  Most acquisitions are adversarial or competitive negotiations.  Over time a zone of possible agreement is explored and, ultimately, a sale price established.  Representation is common with one or both sides represented by firms specialized in mergers and acquisitions.  (In the Activision Blizzard deal, Goldman Sachs provided financial advice to Microsoft, Allen & Company provided financial advice to Activision Blizzard, and Skadden provided legal advice to Microsoft.)

Activision Blizzard

Activision Blizzard is a company with many positive attributes.  Leading characteristics making the company an attractive takeover target include:

• Intellectual property:  Activision Blizzard’s stable of products includes some of the most well-known video games in the world:  Call of Duty, Guitar Hero, World of Warcraft, Overwatch, Candy Crush Saga, and others.
• Worldwide appeal:  Many cultural products have limited appeal around the world.  Activision Blizzard video games have transcended their point of origin, capturing 370 million users in hundreds of countries.

But, the company has had two significant problems:

• Corporate culture:  In July, 2021, the California Department of Fair Employment and Housing filed suit against the company, alleging sexual harassment and employment discrimination.  The scandal acted as a drag on the company’s stock price as investors manifested concern whether the company’s management could navigate past the legal crisis.
• Competition:  Activision Blizzard’s net revenue has grown in a steady linear fashion for more than 15 years, starting at about $1B in 2006 and reaching almost $9B in 2021.  However, the video game market is tremendously competitive.  As the third largest gaming company behind Tencent and Sony, Activision Blizzard faced major challenges, particularly in the areas of data analytics and machine learning.

Every corporation has two plans.  Plan A is to grow the business.  Plan B is to sell the business.  The five common motivations for a sale of a business unit or a company are:

1. To sell off non-core businesses
2. To flip an asset (in the case of private equity)
3. Insufficient capital to compete
4. Business (particularly small or medium) in which some faction of the owners do not wish to continue to own the business—the classic family business sale
5. Any business in which the current management team is not perceived to be able to maximize the value of the asset

Given the challenges faced by Activision Blizzard in the fall of 2021, the company fell into category 5).  We will see how this situation developed into a negotiation for sale in the discussion below.

Microsoft

Since 2012, Microsoft has experienced exponential growth, a remarkable decade-long record of success:

Microsoft’s cloud services business Azure has played an important role in this growth.  Though the tech sector, and the overall economy took a hit in 2022, growth is expected to continue once anxiety around inflation and concern about the situation in Eastern Europe subside.

The strategic question for Microsoft management is how can the company continue to fuel growth in the coming years?  Management’s answer was the $68.7B acquisition of Activision Blizzard.  The deal represents slightly less than 4% of Microsoft’s 2022 market capitalization.  There are several strategic motivations behind the acquisition:

• Stock price:  Activision Blizzard had led the 2022 fall off in tech stock prices by two quarters, making it an attractive acquisition target.
• Strategic technologies:  Activision Blizzard intellectual property has driven consistent high revenue.
• Synergy and growth:  Microsoft receives significant revenue from gaming.  Addition of Activision Blizzard’s $9B net revenue from 190 countries will increase Microsoft in both breadth and depth.  There is the possibility that the Activision Blizzard acquisition, coming on the heels of Microsoft’s acquisition of Bethesda Softworks, could lead to advances for Microsoft in the so-far ill-defined “metaverse,” allowing Microsoft to better compete versus Meta.
• Spoiling:  By completing this acquisition, Microsoft prevents any of its competitors from obtaining this value for themselves.

This purchase does come with some significant risks:

• Large acquisition risk:  Often large acquisitions underperform due to many complex and some poorly understood factors.  Strategic fit and employee retention are two major factors that if not present can tank a large deal.
• Regulatory risk:  Large corporate mergers and acquisitions are the subject of international regulatory interest.  Regulators could demand that Microsoft alter some aspects of the deal or even scotch the entire acquisition.

Negotiation for the Sale

Negotiation of a sale is a highly ritualized activity.  It begins with a Board of Directors decision to seek a sale, and proceeds through selection of an investment bank, preparation of supporting documentation, and development of a list of possible purchasers.  This leads to an approach to possible purchasers, provision of an information memorandum, an offer expressed in a letter of intent (LOI), due diligence, contract negotiations, a purchase agreement, and closing.

Fortunately for us, some of the important details of the negotiation for the sale are included in a filing with the Securities and Exchange Commission supporting the sale [1].  It is worth noting that Activision Blizzard and Microsoft have worked together for decades on gaming, so it is not unusual that senior executives would be meeting at the time the story in the SEC filing begins:

• On November 19, 2021, Bobby Kotick, chief executive officer of Activision Blizzard, and Phil Spencer, the chief executive officer of Microsoft Gaming, were meeting (following a Wall Street Journal article three days earlier which had alleged that Kotick had known for years about sexual misconduct at his company—the WSJ article is not mentioned in the SEC filing, of course).  One can imagine that the discussion between the two companies was probably tense following the WSJ article, given that the public scandal which had started over the summer of 2021 did not seem to be abating.  In that meeting “Spencer raised that Microsoft was interested in discussing strategic opportunities between Activision Blizzard and Microsoft and asked whether it would be possible to have a call with Mr. Nadella the following day.”  In this version of the story, Microsoft made the approach.
• On November 26, 2021, Microsoft made an all-cash offer of $80 per share.  ATVI had opened the week at $60.62 which meant that the Microsoft offer contained a $20 premium.  Activision Blizzard refused the offer, pointing out that the company had traded above $90 before the California DFEH suit.  Activision Blizzard was essentially arguing that its pre-scandal stock price should be used as a comparable for its current valuation.
• On November 28, 2021, Activision Blizzard countered with a range of $90 to $105.  I have always shied away from offering a range—it seems to me that by offering a range you are actually offering one number at the high or low end (depending on whether you are acting as buyer or seller).  Initially, Microsoft attempted to apply this interpretation, accepting the range on November 29 while noting that it would be more comfortable at the low end.
• However, the range seems to have been a good negotiation strategy on the part of Activision Blizzard.  Over the next two weeks, offers and counter offers at the ends of the range were exchanged.  Just prior to December 16, 2021, Kotick informed Nadella that Activision’s floor was now $95, an offer which was ultimately accepted by Microsoft.  In the end, the range became a device that allowed Activision to move the offer up from $90 to $95.

Looking through the SEC filing, it is fascinating to see the negotiation proceeding, almost as if one was a fly on the wall.  But, the bargaining between Activision Blizzard and Microsoft was not the only action going on.  In the SEC filing, it becomes clear that Activision Blizzard did have other suitors (referred to as “Company A,” “Company B,” up to “Company E” in the filing).  It may have been the discussions with the other possible purchasers that gave Kotick the confidence to establish at $95 floor in mid-December.

Applying cash flow analysis, rather than comparables, the sale price of $68.7B seems reasonable.  At $9B of net revenue annually (assuming that Microsoft only maintains revenue, rather than growing it) pays off the purchase price in a little over 7 years.  Of course, Microsoft expects synergies to significantly grow the value of this purchase.  Given that IT companies have historically been traded at valuations that cannot be justified by cash flow, this case is reassuring.

Regulatory Concerns

The Microsoft/Activision Blizzard deal is scheduled to close in 2023, provided that regulatory review proceeds successfully.  The result of the acquisition would be a new Microsoft division Activision Blizzard to go with Microsoft’s Xbox Game Studios, both divisions to be housed inside Microsoft Gaming and headed by Phil Spencer.

For regulators, there is a significant amount of grist for their mill:

• Wages:  Consolidation in the gaming industry represents fewer distinct workplaces and can depress wages for workers.  Microsoft has attempted to be out front on this issue by promising not to interrupt unionization efforts at Activision Blizzard.
• Vertical Integration:  Following Microsoft’s recent Bethesda Softworks acquisition, the games Starfield and Redfall were made exclusive to Xbox.  Regulators have traditionally opposed this type of vertical integration in which an advantage in one area is used as a lever in another related area.  These types of concerns harken back to the “bundling” of Internet Explorer with the Microsoft operating system which occurred in the 1990s and led to United States Justice Department Action

Numerous regulatory agencies around the world are looking at the acquisition, but it is the US Federal Trade Commission, along with the European Commission and the UK Competition and Markets Authority, that have the most power to block the deal.  It was this combination of three agencies that prevented the $40B sale of the chip maker ARM from the Japanese SoftBank Group to the US software and chip maker Nvidia in 2022.

On December 8, 2022, the US Federal Trade Commission filed suit to stop the Activision Blizzard acquisition, citing the anti-competitive nature of the transaction.  However, the suit is not a slam dunk.  In the case of Nvidia, both ARM and Nvidia do business in the small area of chip manufacture.  ARM intellectual property is used in Google, Microsoft, and Qualcomm chips.  In contrast, Microsoft and Activision Blizzard operate in different business areas of gaming (hardware versus software)—so making charges of monopolization stick may be more difficult.

Microsoft began making moves in December to blunt some of the criticism of the deal—signing a deal to ensure that Call of Duty will be on Nintendo consoles for the next decade.  At the current moment, it is unclear if the FTC has filed suit in order to go the distance in court or perhaps to increase its bargaining power and force concessions from Microsoft.

[1] Activision Blizzard, Inc.  Schedule 14a filed with the United States Securities and Exchange Commission.

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

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There are two reasons that people are hesitant to make the initial offer in a negotiation.  First, they may be unsure of the market value of the item they are trying to buy (or sell).  They are worried of significantly under or overstating the item’s value.  The fear is that the negotiator will telegraph to the other party that they are unprepared for the negotiation—and therefore ripe to be taken advantage of.  Second, the negotiator is worried that the other side will talk them down from their offer—that they will be “ground down” during the negotiation process.  The fear is that the other party has the power in the negotiation, and as a result, the other party will eventually get what they want.  Today’s post addresses the process of making an initial offer, discussing these and other fears.

Preparing to Negotiate

Preparing for a negotiation is a five-step process.  The steps include:

• Think about your personal/your organization’s goals—what do you want to achieve in the next few years?  Starting with this step puts the negotiation in perspective.
• Think specifically about your goals for the negotiation:  what is the best possible outcome you reasonably expect (one end of your range) and what you cannot tolerate (the other limit of your range, “your limit”).  This may require some research (i.e., step 3).
• What is the market of the object?  You can use many resources to answer this question:  internet, the other side’s competitors and customers, your friends and work acquaintances, industry pricelists and databases, comparable sales, etc.
• Does the other party see things differently?  Understanding the other side’s motivations is critical to a successful negotiation.  Do they have an emotional connection to the object?  Does this deal mean that they will be leaving or entering a particular area of business—how will that affect them financially and organizationally?  What do you know about what their range might be?
• Talk to your team, a friend, or a spouse about your goals for the negotiation.  Studies show that talking about goals helps humans invest in them emotionally and stick with them during difficulty.  Talking about the negotiation ahead of time will help you stick with your plan during the hard parts of the negotiation.

Making an Offer

The 2018 film Beirut is a movie about hostage negotiation.  In the climactic scene, two characters haggle over a hostage payment.  Skiles makes an offer, aware that the price he earlier negotiated is out the window because he is dealing with a new man he has not spoken with previously.

Skiles:  This is it. All I got.  ($2 million.)  I’m topped out. Deal speaks for itself.

Kidnapper:  You wouldn’t open with your best offer if your life depended on it.

Skiles:  Two point two-five.

Kidnapper:  Five million.

Skiles:  Three.

Kidnapper:  Four and a half is my floor.

Skiles:  Point blank, I have $3.9 million exactly.

Kidnapper:  Going once.

Skiles:  Why should Bashir be the only person to profit?

Kidnapper:  Going twice.

Skiles:  If you take the three-nine right now, I swear I will tell Bashir you settled for three-five.  You can go back to Arafat with your head held high and $400,000 in your pocket.

Kidnapper:  Deal.

What is driving Skiles in this scene?  First, he is spending someone else’s $4 million—he is willing to go up to that level, but he does not have any more money after that.  He has no incentive to spend less (none of the money will end up in his pocket), but he absolutely needs for the negotiation to succeed (he has no backup plan).  Starting at $2M allows him the room to negotiation inside of his range.  As he reaches his limit, he skillfully offers a consideration to the other negotiator which seals the deal.

So, what are the options for making that first offer?  They include:

• Wait for the other side to make an offer.  When you really do not know what the stakes are, there are advantages to waiting.  If you go first, then you could make a foolish offer—significantly far away from what the other side has in mind.  However, by remaining silent, you take a risk.  They could low-ball you, and you would have left a lot of money on the table.  This is called an anchor.  Even if the negotiation continues after the anchor is offered, and the deal improves, the deal can only move so far from the anchor—limiting the value you will receive.
• 60/80/90/Go.  When I was younger and traveling with friends in Central and South America, we would keep our money divided in convenient amounts in different pockets in case we had to do any bargaining—we did not want to pull out a big roll of cash.  For this method to work, you have to have an idea of a reasonable price for you to pay for an item.  First, you offer 60% of your price.  The seller reacts.  If there is no deal, you can come up to 80%.  If you still do not come to a deal, then you can come up to 90% of your reasonable price, but make as if this is really hurting you.  You can start to walk away at this point (either literally or rhetorically).  Sometimes that stratagem triggers a concession.  If not, there is still 100%.
• Focus on something else.  This strategy works best in salary negotiations.  It is common for an HR person in the initial interview of a job candidate to ask about salary requirements.  In spite of the troves of information that is available online, it can be hard to establish a good range when things like hiring bonus, commission, stock options, time off, and benefits start to come into the picture.  As a result, answering HR’s question can be hard.  Instead of naming a range, come back with, “I would like to be hired with a title of….”  Since many companies have salary ranges assigned by position, you have answered their question—at least within their company.
• Start off small.  I frequently negotiate agreements for contract manufacturing of pharmaceuticals.  Particularly, if both parties are new to each other, constructing a large manufacturing deal can be a challenge.  There are so many variables and so much risk—in order to have drug ready for shipping, there must be:  transfer of manufacturing procedure at small scale, transfer of analytical methods, scale up to full scale, the manufacturing run itself, packaging and labeling, and testing of the pharmaceutical.  Often, starting off with the first steps (small scale process and analytical method transfer) allows both parties to feel comfortable with each other before committing to the higher cost of full-scale manufacturing.  However, if you go with this approach, there is a significant risk—to prevent a bad deal down the road, you must have a fallback plan.  For example, in the pharmaceutical manufacturing world, you must have an alternative manufacturer lined up.  This allows you to walk away if the later negotiation with your initial manufacturer goes poorly.

Make Your Offer Look Good

Frequently, there are aspects of a deal that cost you little or nothing but provide reassurance to the other party.  One way of making a successful deal more likely is to play up these aspects of your offer.  You have financing already in place.  Your offer is all cash.  Your side is prepared to sign as soon as certain details are clarified.

This strategy requires empathy on your part.  What is the other side looking for?  How can you make your deal look as much like what they want as possible?

Also, if you are looking at their initial offer, beware of hidden unpleasantries.  As an example, in the pharmaceutical contract manufacturing business, the sponsor needs the raw data from the manufacturer.  Usually, raw data is supplied free or at some nominal charge.  An illustration of a hidden unpleasantry would be significant add-on charges for the raw data to be supplied by the manufacturer.  These kinds of concealed penalties need to be neutralized as they appear in the negotiation.

Conclusions

The negotiation process involves four steps:  1) preparation, 2) initial offer, 3) bargaining, 4) closing.  Ideally, you would perform all four steps with precision and skill, but that is not always how things go.  For example, perhaps you allow the other side to open, and you realize that they have anchored at a value that is very disadvantageous to you.  You can correct this by addressing the issue directly.  You say something like, “Clearly, we are very far apart,” or “This is a premium service.  Our clients pay significantly more than that.”  You have neutralized their anchor, and now it is your turn to place your anchor.

All of this should be done directly, with good humor, and a clear intention to resolve problems in the negotiation.

Disclaimer:  DiscussingTerms^TM provides commentary on topics related to negotiation.  The content on this website does not constitute strategic, legal, or financial advice.  Consult an appropriately skilled professional, such as a corporate board member, lawyer, or investment counselor, prior to undertaking any action related to the topics discussed on DiscussingTerms.com.

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