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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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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In today’s post, DiscussingTerms addresses how patent litigation is settled—using the example of biosimilar pharmaceuticals.  Biosimilars are the generic versions of expensive injectable medications like Remicade, Enbrel, and Humira.  Biologics and biosimilars are a rapidly growing segment of pharmaceuticals, so there is a lot at stake financially and medically.  The focus of this post is on how settlements are valued and how a zone of possible agreement between the parties involved in patent litigation can be established.

Background

Here is a quick introduction to biosimilar litigation:

• In 2009, the Biologics Price Competition and Innovation Act (BPCIA) was passed into law to create an approval pathway for generic versions of biological drugs (“biosimilars;” generic versions of medicines like Remicade, Enbrel, and Humira).  The reason that a separate approval process was required is that biological drugs are much more complicated to manufacture than small molecule drugs (like antihypertensives and antibiotics).
• Within the BPCIA are provisions which require the “patent dance”—disclosure of the biosimilar drug manufacturing process by the biosimilar manufacturer to the initial manufacturer (“innovator”).  This allows the innovator to consider whether any patents held by the innovator have been violated by the biosimilar drug manufacturer.  The reason it is called a “dance” is that there are several rounds of communication back and forth (like a dance).  If any areas of dispute cannot be resolved, litigation may follow.

This form of negotiation is a classic adversarial or competitive negotiation.  Demands, threats, and the use of power (through the courts) are expected in this negotiation.  The goal for each side is a “win”—the innovator wants to block the biosimilar from entering the market, and the biosimilar manufacturer wants to launch their drug as soon as possible to take market share from the innovator.

In these negotiations, accommodative behavior may rarely come into play (if by chance the two companies involved have other projects that they are working on together and want to preserve their relationship as a way of maximizing the return from the other activities that involve them); however, the norm in this type of negotiation is competition.

Assessing Risk, Cost, and Profit

Many business processes such as litigation [1] and option pricing [2] involve some degree of risk combined with possible costs or profits.  Such processes can be represented as trees of probability and value.  As an example, consider this tree describing the possible outcomes of BPCIA patent litigation over pegfilgrastim in 2020:

This tree structure considers the possibility that a purely hypothetical pegfilgrastim patent case was brought in 2020.  Though the tree is hypothetical, the values in the tree were estimated using real market and litigation data, as will be seen below.  Consider the following aspects of the tree:

• Structure:  The tree structure assumes that a case is brought by a plaintiff (i.e., innovator pharmaceutical company) against a defendant (i.e., biosimilar pharmaceutical company) for patent infringement in manufacture of pegfilgrastim.  The possible outcomes of this litigation are a verdict for the plaintiff or for the defendant (the two lefthand branches of the tree), and if the verdict is for the plaintiff, a range of possible penalties may apply (the two righthand branches of the tree).
• Probabilities and Penalties for Defendant:  To be as realistic as possible using publicly available data, DiscussingTerms developed a database of US district court BPCIA litigation [3].  In the database, ten cases were pursued all the way to a trial outcome, with seven determinations for the defendant and three for the plaintiff.  Using this data, the chance of a verdict for the plaintiff is 30% (versus 70% for the defendant).  In the case of a verdict for the plaintiff, 3 cases provided example penalties (two cases for patent infringement of Enbrel resulted in 9-year delays to the market when patent protection was upheld, and one case for patent infringement of Epogen resulted in a $70M penalty).  Assessing what the penalties might be imposed is case specific, these values from cases other than pegfilgrastim were used in the tree structure above purely as examples.  Of course, each litigation team would spend time creating a tree specific to their case.

• Rewards for Defendant:  Having considered the possible penalties, what about the rewards?  Pegfilgrastim is a biologic used primarily in supportive care of chemotherapy patients to boost their immune cell level.  Market projections for North America starting in 2020 are shown above [4].  Assuming that early entry into this market would lead to 50% market share and late entry would lead to 10% market share, the revenues for these two scenarios are shown in 4^th and 6^th columns.  The net present value (NPV) in 2020 for an early entry can be calculated at $4.7B (a late entry would yield $931M in value).  In the tree above, a late entry was assumed, so value for a verdict to the defendant is shown in the tree as $931M. (Note: Back in the day, entry date was part of the negotiation between a pharmaceutical innovator and a generic. The FTC now guards against such “pay for delay” agreements. The reason to consider early versus late entry here is that clinical and CMC considerations limit how quickly a biosimilar makes it to the market. It is worth examining whether and how entry date affects this type of negotiation. See the table of expected outcomes below for a comparison.)
• Value to the Defendant:  The value to the defendant is the weighted average of the possible outcomes:  (30% x 67% x $0)+ (30% x 33% x ($931M-$70M))+ (70% x $931M) which equals $737M.  This value exists as a purely theoretical amount—if the litigation is pressed to conclusion, the biosimilar company will receive one specific value ($0, $861M, or $931) depending on the verdict.  The ultimate value hangs in the air like the fate of Schrödinger’s cat.

• Value to the Plaintiff:  The tree looks different to the plaintiff (see 2^nd tree shown just above).  The probabilities of this 2^nd tree remain the same as those in the 1^st tree, but the outcome values differ.  If the defendant prevails, then the plaintiff receives nothing, so that branch is valued at $0.  A verdict for the plaintiff contains a 33% chance of a $70M judgement to the defendant.  A 9-year delay (67% change if there is a verdict for plaintiff) takes the defendant out of the North American market for pegfilgrastim, so the innovator may receive the value that would have been provided to the biosimilar company ($931M) if the innovative product is able to capture those sales.  The weighted average for this tree is:  (30% x 67% x $931M)+ (30% x 33% x ($70M))+ (70% x $0) which equals $194M.

The Negotiation

Litigation under BPCIA is an example of a multiparty negotiation (involving innovator company, biosimilar company, legislature, courts, insurance companies, doctors, and patients).  However, there are three parties with the most immediate sway in this type of negotiation (the two pharmaceutical companies and the courts).  Their positions are as follows:

• Courts:  The courts enforce guardrails on the negotiation.  The BPCIA mandates the patent dance, and both companies are required to negotiate in good faith during this process.  Failure to abide by the patent dance process can lead to penalties.  Also, the courts have found that certain types of settlements are anticompetitive and violate antitrust principles (see:  FTC v. Actavis, Inc., 570 U.S. 136 (2013)).  So-called “pay-for-delay” agreements, in which the innovator pays a generic or biosimilar company to stay out of the market, can be challenged by the FTC under these principles.
• Defendant:  The biosimilar company’s primary goal is to avoid achieving a $0 value.  To prevent this disastrous outcome, they would be willing to concede some value, but how much?  We’ll see below.
• Plaintiff:  The innovator faces a decline in revenue due to erosion of the price for pegfilgrastim and the entry of competitors taking market share.  Through this negotiation process, the innovator hopes to salvage some revenue from this product line which is reaching the end of its product lifetime for the innovator.  How much value might they be looking for?  Again, we’ll see below.

The zone of possible agreement (ZOPA) is a range of settlement values that satisfy both parties.  In this case, the settlement involves direct cash payments or a share of future revenue, but it cannot involve a pay for delay agreement.  What range might satisfy both parties?  Consider the following table:

In this table, the case of late entry into the North American market (10% share) is shown at the top of each entry; the case of early entry (50% share) is shown at the bottom of each entry in parentheses.  Both parties wish to avoid their worst outcome.  In each case (late entry and early entry), if the biosimilar company is willing to concede the difference between its best outcome and its expected outcome, the freed cash satisfies the innovator’s expected outcome.

Other factors will also come into play:  the relative strength or weakness of the patent infringement case, the bargaining position of the biosimilar company (are they short of cash or deep pocketed), the number other biosimilar products and their expected launch dates, etc.  However, this analysis does indicate that a zone of possible agreement between the two parties may exist.

Conclusions

Creation of a case-specific model of value which builds in the most relevant data on risk and potential cost and profit can be a useful tool of negotiation preparation.  These types of models help the negotiation team think several moves ahead in the bargaining process, as well as allowing the team to put themselves in the place of their adversary.

Some other issues to bear in mind include:

• Framing:  Whether a particular outcome is framed as gain or loss has strong psychological effect on humans.  Craver goes into this topic in some detail [1].  In considering a settlement, the litigant is well advised to consider emotional factors which influence their point of view.
• Hidden Costs:  It is important to consider all of the costs within this type of negotiation:  litigation costs, impact of the litigation on public perception (does the uncertainty of litigation frighten potential business partners or investors?), opportunity costs (do the rigors of preparation for a trial distract from other business activities?), etc..

All of these issues come into the decision of when and how to settle; however, as some wise person once said, “There’s always a number.”

[1] Craver, C.  Effective Legal Negotiation and Settlement, Carolina Academic Press (2020).

[2] Metrick, A.  Venture Capital and the Finance of Innovation, John Wiley & Sons, New York (2010).

[3] US District Court BPCIA Litigation, DiscussingTerms, December (2022):

[4] Research and Markets.  Global $4,037 Million Pegfilgrastim Biosimilars Markets, Analysis & Forecasts, 2015-2020, 2025F, 2030F, www.globenewswire.com/fr/news-release/2022/03/16/2404168/28124/en/Global-4-037-Million-Pegfilgrastim-Biosimilars-Markets-Analysis-Forecasts-2015-2020-2025F-2030F.html

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>Negotiating a Settlement:  Biosimilar Pharmaceuticals</strong> appeared first on discussingterms.com.

Today’s post is about the pricing of tickets for concerts, sporting events, and theatrical shows.  Everyone enjoys a good concert, but how did we arrive at a system that is at once so convenient and so expensive?

As recently as the mid-1970s, another different, but equally complex system existed.  Tony Dokoupil writes about it in his book The Last Pirate which tells the life story of his marijuana dealer father.  His father’s cover for his pot distribution business was working as a delivery driver for a concert ticket distributor.  “In a pre-digital world, you needed an advance man, someone to deliver paper tickets to all the places you could buy concert tickets in those days.  That meant record stores, but also restaurants, bars, clothing stores.  He left home each week with a satchel of tickets and returned with a satchel of cash.”

Back then, the streams of tickets and money were paper.  Today, the tickets and the money are largely electronic, but the same cast of characters was involved:  artists, venues, promoters, ticket distributors, brokers (“scalpers”), and buyers.  Because a lot of the deals are struck behind closed doors, it is not so obvious that a negotiation is going on, yet this is definitely a marketplace.  In this post, we wander around this interesting bazaar.

Parties

If you want a picture of all the parties involved in this multiparty negotiation [1], a good place to look is a figure originally generated by the attorney of the band R.E.M. in 1994 [2].  The occasion for generation of this schematic was a Congressional hearing about ticket pricing for concerts, athletic events, and theater shows [3].  DiscussingTerms has updated the figure and modified it to include flows of cash and tickets:

The figure attempts to lay out the complex relationships between the parties involved in a musical concert.  Cash flows are depicted in green (payments) and red (rebates (aka, “kick-backs”)).  Ticket flows are shown in black.  They include:

• Artist:  Artists such as Bruce Springsteen, Bad Bunny, and Beyoncé maintain contracts with their support staff (business manager, agent, personal manager, attorney, and tour manager).  They contract with other teams exclusively for the tour (personnel, production, transportation, and insurance).  And, they have separate revenue generating operations (merchandise and record distribution) that result in non-ticket cash flows to the artist and, in the cased of record distribution and promotion, involve rebates to the record label.
• Venue:  The auditorium, stadium, or other venue (think Red Rocks Amphitheatre) receives revenue from onsite services (parking, food, etc.), contracted fees from promoter, and rebates from the ticket distributor.  The venue frequently signs an exclusive deal with a promoter and/or a ticket distributor.  With these long-term contracts in place, venues generally have little leeway to negotiate contracts to bring in artists on their own.
• Promoter:  The promoter (think Live Nation) provides support services and insurance for the concert.  Historically, the promoter has fronted money for the event and provided publicity (“promotion”) of the event.  On the diagram, the “promotion” bubble is assigned to the ticket distributor because these distributors do a lot of promotion.  Promotion by the ticket distributor is a kind of rebate (or “kick-back”) from the ticket distributor to the promoter—reducing or eliminating one of the promoter’s expenses.
• Ticket Distributor:  The ticket distributor (think Ticketmaster) is at the center of many of the arrows in the figure.  The distributor makes payment to artist for the artist’s share of gate (green arrow), provides and allocation of tickets to the artist for distribution or sale by artist (black arrow), and gives a rebate to the artist from the fee charged by the distributor (red arrow).  The distributor also gives rebates to the promoter and the venue from the fee charged by the distributor (red arrows).  The distributor sells tickets to the ticket buyers (black arrow) and is paid by the buyers (green arrow).
• Secondary Distributors and Brokers:  Secondary distributors (think StubHub) and brokers are responsible for a vast secondary ticket market that includes tickets from:  1) fans who decide not to go to a show after paying for their tickets, 2) bots and other purchasers who never intended to attend the event, 3) the artists themselves and others who have received allocations of tickets as payment in kind from the ticket distributor.
• Ticket Buyers:  Ticket buyers include a range of types:  working class fans who are spending a big chunk of their entertainment budget, executives who are taking clients out to build a relationship for a business deal, straw purchasers who work on the behalf of brokers, and others.

The Negotiation

As noted above, ticket prices are the result of a multiparty negotiation.  Some features of this negotiation are:

• Volume:  Ticket sales is a huge international business.  Ticketmaster sold 115 million tickets in 2019.  Because of the tremendous volume of ticket sales, even small fees generate huge amounts of revenue.
• Rebates:  Rebates by the ticket distributor are a critical part of the negotiation over ticket prices.  For the venue and the promoter, the rebate from the ticket distributor can be the difference between profit and loss.  Budnick and Baron’s book Ticket Masters has an imaginary dialog that makes this clear [3]:

“So with Ticketron you now have a seventy-five cent service charge.”

“That’s true.”

“If you sign with us, it’s going to be a dollar and a half.”

“That’s terrible. Why would I want to do that?”

“Because you’re going to get a half dollar back.”

“Sounds great to me. Where do I sign?

• Competition:  It is an article of faith in America that competition leads to lower prices; however, because of the complex set of relationships in the event industry, competition and low prices may not be so closely coupled with regard to tickets.  Consider the case of two competing ticket distributors.  The first distributor offers rebates of $X to the artist, $Y to the promoter, and $Z to the venue.  The second ticket distributor increases its proposed distribution fee during its negotiation and uses the increase to double its rebates to the artist, promoter, and venue.  In many circumstances, the second ticket distributor will win the negotiation, leading to higher cost for the ticket buyer.
• Artists:  Artists are in an interesting and conflicted position.  For example, listen to an interview with Bruce Springsteen [4]:  “What I do is a very simple thing. I tell my guys, ‘Go out and see what everybody else is doing. Let’s charge a little less.’  That’s generally the directions.”  That sounds pretty good, but then Springsteen says, “This time I told them, ‘Hey, we’re 73 years old. The guys are there. I want to do what everybody else is doing, my peers.’  So that’s what happened.”  That is The Boss admitting that he went for the dollars this time around.  In comparison, what kind of position is a young band on their first major tour in to challenge rebates and ticket pricing?
• Buyers:  Tickets aren’t just about entertainment; they are also about social capital.  In Ticket Masters, a ticket broker recalled a story about football tickets [3], “I’d sell Super Bowl tickets ten months before the game.  Football season hadn’t even started, and we sold them to Merrill Lynch, Coca-Cola, Pepsi-Cola.  We had all the big accounts because they knew we could get the tickets.  So, they might say, ‘Get me 200 tickets between the thirty-yard lines at $4,000 apiece.’”  As seen in this story, a portion of the buyers are driving ticket inflation by demonstrating a willingness to pay more than retail for tickets.  This is one part of the reason that average ticket prices have risen well ahead of the Consumer Price Index (CPI) for decades.
• Front Row:  Not all the tickets are sold to the general public.  Many of the best seats are sold on the secondary market at substantially inflated prices.  These tickets are too good to go out the door at retail price.  Everyone gets a cut of these sales (the artists, brokers, ticket distributor, venue, and promoter) with the eventual buyers footing the bill through inflated price of admission for the event.
• Vertical Integration:  Vertical integration has become a significant part of the concert industry.  Live Nation manages artists (chiefly headliners), owns some venues and contracts long-term with other venues, promotes tours, and distributes tickets through Ticketmaster.  The process of vertical integration creates the conditions for self-dealing, a conflict of interest that can harm the positions of other parties within a negotiation.

Outcome of the Negotiation

Having considered the process of negotiation for ticket prices, let’s think about the outcome of the negotiation.  Currently, the average price of a concert ticket is $87.  As noted above, ticket prices have been rising faster than the CPI for decades.  That is the ticket buyer’s reality, but what about the ticket seller’s reality?

In 2010, Live Nation and Ticketmaster merged.  The two companies had complementary strengths.  Live Nation had depth in relationships with venues (owning or having long-term deals with many amphitheaters and stadiums), as well as having strong operations in promotion and management.  Ticketmaster was of course the heavy weight champion of ticket distribution.  Live Nation made a case for the merger saying that, as a company, it carried a lot of overhead, and it was in difficult financial straits.  This can be seen if we plot the value of Live Nation stock versus the S&P 500 index.  Over the period 2006 to 2010, the S&P 500 lost about 12% due to the Subprime Mortgage Crisis.  Over the same time period, Live Nation stock lost about 60%:

Clearly, that is the kind of adverse performance that drove Live Nation to think, “How can we improve this company as an investment (or we will be bought and broken up or simply go bankrupt)?”  Since the Ticketmaster merger in 2010, Live Nation’s financial performance has improved substantially:

In spite of the Covid-19 crisis, the S&P 500 went up 245%.  Over the same period, Live Nation went up 692%.  The gain in value of Live Nation was almost 3x that of the S&P 500.  So, acquiring Ticketmaster ended up being a pretty good deal for Live Nation’s investors.

Conclusions

Clearly, this is a complex issue.  There have been highly publicized Congressional hearings twice in the recent past (related to the Pearl Jam versus Ticketmaster litigation and to the Live Nation/Ticketmaster merger).  Ticket distributors regularly say that they are paid to play the part of the bad guy, absorbing negative publicity that would otherwise fall on promoters, venues, brokers, and artists.  And, they occasionally seem to relish the role.

Overpriced concert tickets do not generate the kind of social harm caused by other kinds of inflated prices (for example, patients who cannot afford health insurance or students who do not have access to high-quality schools).  After all, no one is forced to buy Bad Bunny concert tickets.  Of course, that is not a strong argument against government action on ticket pricing; however, if Federal regulators do act, they will need to take into account the complicated relationships of the event industry.  As seen in this post, the outcome of federal action may be difficult to predict or even counterintuitive in result.

[1] For a quick reminder of some of the elements of multiparty negotiations, see:  Gallant, S.R.  “Detroit’s Bankruptcy,” DiscussingTerms, December 10 (2022); https://discussingterms.com/2022/12/10/detroits-bankruptcy/

[2] “Pearl Jam’s Antitrust Complaint:  Questions About Concert, Sports, and Theater Ticket Handling Charges and Other Practices,” Hearing Before the Information, Justice, Transportation, and Agriculture Subcommittee, June 30 (1994).

[3] Budnick, D. and Baron J.  Ticket Masters:  The Rise of the Concert Industry and How the Public Got Scalped, ECW Press (2011).

[4] Aniftos, R.  “Bruce Springsteen Opens Up About Ticketmaster’s Dynamic Pricing: ‘Ticket Buying Has Gotten Very Confusing’,” Billboard, November 18 (2022).

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