Negotiating to a Billion-Dollar Business with Barry Nalebuff, Founder of Honest Tea and Milton Steinbach, Professor of Economics and Management at Yale | Part of building a big business is negotiation. We negotiate all the time – with our employees, customers, partners, and our investors. But what if our model of negotiation is wrong? What if there is a different way to split the pie? Based on both extensive game theory research and his own personal experience building Honest Tea, Barry will share with us a new way of thinking about negotiations. Think Talmud not Zero Sum.

2. 2
A GUESSING GAME
I’ve picked a number between 1 and 100
You get 5 guesses.
If you are correct on 1st guess, you get $100
If you are correct on 2nd guess, you get $80
If you are correct on 3rd guess, you get $60
If you are correct on 4th guess, you get $40
If you are correct on 5th guess, you get $20
Game is real

3. 3
A GUESSING GAME
Hint: Each time, I’ll say if you’re too high or too low

4. 4
My Prediction
50
25
37
43

5. 5
48

6. 6

11. 11
Dividing
Costs
Negotiation

12. 12
AIRFARES
¤ Split the total
$1,243
» Houston pays $1,409
» SF pays $1,409
$666
$909

13. 13
$666
$1,243
$909

14. 14
AIRFARES
¤ Split the total
$1,243
» Houston pays $1,409
» SF pays $1,409
$666
$909

15. 15
AIRFARES
¤ Split Houston leg
» Houston pays $666 + $909/2 = $1,120.50
» SF pays $1,243 + $909/2 = $1,697.50

16. 16
$666
$1,243
$1,243
$454.50
$4$5646.560
$454.50
$454.50

17. 17
AIRFARES
¤ Split Houston leg
» Houston pays $666 + $909/2 = $1,120.50
» SF pays $1,243 + $909/2 = $1,697.50
¤ Split costs proportionally
» Houston pays 1,332/(3,818)*2,818 = $983
» SF pays 2,486/(3,818)*2,818 = $1,835

18. 18
AIRFARES
¤ Split Houston leg
» Houston pays $666 + $909/2 = $1,120.50
» SF pays $1,243 + $909/2 = $1,697.50
¤ Split costs proportionally
» Houston pays 1,332/(3,818)*2,818 = $983
» SF pays 2,486/(3,818)*2,818 = $1,835

19. 19
AIRFARES
¤ Split Houston leg
» Houston pays $666 + $909/2 = $1,120.50
$1,243
» SF pays $1,243 + $909/2 = $1,697.50
¤ Split costs proportionally
» Houston pays 1,332/($666
3,818)*2,818 = $983
» SF pays 2,486/(3,818)*2,818 = $1,835
$592
$317

20. 21
AIRFARES
¤ Split Total
» Houston pays $1,409
» SF pays $1,409
» Problem is that this is more than Houston roundtrip
¤ Split Houston leg
» Houston pays $666 + $909/2 = $1,120.50
» SF pays $1,243 + $909/2 = $1,697.50
¤ Split costs proportionally
» Houston pays 1,332/(3,818)*2,818 = $983
» SF pays 2,486/(3,818)*2,818 = $1,835

21. 22
AIRFARES
¤ Split Total
» Houston pays $1,409
» SF pays $1,409
» Problem is that this is more than Houston roundtrip
¤ Split Houston leg
» Houston pays $666 + $909/2 = $1,120.50
» SF pays $1,243 + $909/2 = $1,697.50
¤ Split costs proportionally
» Houston pays 1,332/(3,818)*2,818 = $983
» SF pays 2,486/(3,818)*2,818 = $1,835

22. 23
Two Extreme Positions
SF says to Houston: You pay $1,332. That’s
what you would have paid anyway.

23. 24
What’s the best
argument for
Houston?

24. 25
Two Extreme Positions
SF says to Houston: You pay $1,332. That’s
what you would have paid anyway.
$1,243
Houston says to SF: You pay $2,486. That’s
what you would have paid anyway. $742
$99

25. 26
AIRFARES
¤ NY --> Houston --> SF --> NY $2,818
¤ Total with two trips is $1,000 more
¤ NY --> Houston roundtrip $1,332
¤ NY --> SF roundtrip $2,486
Total $3,818
The $1,000 savings requires both firms
equally. If either doesn’t cooperate, then
1k is lost. Hence split savings.

26. 27
AIRFARES
¤ Split Houston leg
» Houston pays $666 + $909/2 = $1,120.50
» SF pays $1,243 + $909/2 = $1,697.50
¤ Split costs proportionally
» Houston pays 1,332/(3,818)*2,818 = $983
» SF pays 2,486/(3,818)*2,818 = $1,835
¤ Split $1,000 cost savings
» Houston pays $1,332 - $500 = $832
» SF pays $2,486 - $500 = $1,986

27. 28
$666
$1,243
$743
$166

28. 29
Quick Test

29. Runway Problem — Littlechild and Owen (1973)
Runway Problem –Littlechild and Owen (1973)
36

30. Airline A needs runway of length 1
Airline B needs runway of length 2
1
Runway Problem
A B
1

31. A & B split cost of first leg
B pays cost of second leg
1
Runway Problem
A B
1
A pays 0.5
B pays 1.5

32. Uber Pool
Uber Pool
37

33. Alice and Bob share an Uber from LAX
Alice gets dropped off first.
How should they split the $12 fare?
A 6 B
6
LAX Alice pays 3
Bob pays 3 + 6?

34. A 6 B
6
Now what?
LAX
Alice pays 3
Bob pays 3 + 6?

35. Do we split the fare in proportion to the
one-way fares?
A pays 6/17 * $12
B pays 11/17 * $12
A 6 B
6
LAX
11

36. What’s the Pie?
11 + 6 – 12 = $5
A 6 B
Alice pays
Bob pays
6
LAX
11

37. What’s the Pie?
11 + 6 – 12 = $5
Alice pays 6 – 2.50 = $3.50
Bob pays 11 – 2.50 = $8.50
A 6 B
6
LAX
11

38. A 6
B
11
Diversion version
Alice and Bob split first leg (Alice & Bob pay 3)
Bob pays 6 by self
Diversion cost is 1 (12 versus 11 for Bob)
Who should pay cost of diversion?
6
LAX

39. A 6
B
11
Diversion version
Alice and Bob split first leg (Alice & Bob pay 3)
Bob pays 6 by self
Diversion cost is 1 (12 versus 11 for Bob)
Alice since Alice is out of the way
6
LAX
A’
If only Alice lived here

40. A 6
B
Diversion version
Alice and Bob split first leg (Alice & Bob pay 3)
Bob pays 6 by self
Diversion cost is 1 (12 versus 11 for Bob)
Bob since Bob is out of the way
6
LAX
B’
If only Bob
lived here

41. Split diversion cost: they are equally out of the
way
Alice pays half diversion cost: 3 + 0.5 = $3.50
A 6
B
11
Bob pays 2.5 + 6 = $8.50
6
LAX

42. What if Alice gets in first, then picks up Bob,
then gets out along the way?
6
A
B
6
A exits
11 9
B exits
6

43. No agreement: Alice pays 11 & Bob pays 9
Agreement: Total cost is 6 + 6 + 6 = 18
Pie = 20 – 18 = 2
Alice pays 11 – 1 = 10
Bob pays 9 – 1 = 8
6
A
B
6
A exits
11 9
B exits
6

44. Diversion Version
Alice pays full 6 – since he is alone
Alice pays 3 (splitting second leg with Bob)
Bob diversion effect is (12 – 11) => Bob pays Alice 0.5
Alice diversion effect is (12 – 9) => Alice pays Bob 1.5
Alice pays 6 + 3 – 0.5 + 1.5 = 10
6
A
B
6
A exits
11 9
B exits
6

45. 47

46. What is the Pie
¤ Agreement A + B get 300 – 50 = $250
¤ No Agreement A gets 100 – 50 = $50
B gets 200 – 50 = $150
No Agreement Total $200
¤ Hence the pie is $50

47. What is the Pie
¤ Agreement A + B get 300 – 50 = $250
¤ No Agreement A gets 100 – 50 = $50
B gets 200 – 50 = $150
Thus A gets $50 + $25 = $75
B gets $150 + $25 = $175

48. 50
Merger
Case

49. 51
Joint Purchasing
¤ Gazette proposes splitting gains proportionately: 2 for
Gazette to 1 for Post
¤ Post says split them the other way (Post gets
2/3rds!). It is Post extra volume that saves Gazette
money. Hence Post should get all of that gain.
Gazette can keep savings created by its ability to
lower Post costs.
¤ Above is rhetorical argument. Point is that both gains
should be split evenly.

50. 52
Symmetry
Every argument can
be turned around

51. 53
Cost Savings
¤ Gazette has better know how =>
gets to keep full $1m savings

52. 54
Cost Savings
¤ Gazette has better know how =>
gets to keep full $1m savings
¤ Post brings to the table worse costs. If
costs were lower, less savings to be
had.

53. 55
Macro Perspective
¤ Current values are 10m and 22m.
¤ New joint value is 41.85m
¤ Create 9.85m
¤ Split gain evenly
¤ Gazette pays 10 + 4.925 = 14.925m
¤ If Post walks away, 9.85m is lost

54. 56
TCC and HT
¤ Coke purchasing power helped Honest
reduce the cost of plastic bottle from
19¢ to 11¢.
¤ On 100 million bottles that’s worth
¤ Who should get this gain?

55. 57
TCC and HT
¤ Pay market multiple on sales up to
$XXm
¤ Pay 0.5 * market multiple on sales
thereafter

56. 58
Rio Tinto & BHP
¤ $30 billion of synergies
¤ Market caps: $160b and $250b.

57. 59
Power in Negotiations
¤ Doesn’t exist!
¤ Once you define the Pie, the two are
symmetric.

58. 60
What Might it Mean?
¤ Token example
¤ 101 tokens. Each is worth
¤ $1 to Alice, 1¢ to Bob
¤ Does that mean Alice gets 1 and Bob gets
100 – so that they both end up with $1

59. 61
What Might it Mean?
¤ Token example
¤ 101 tokens. Each is worth $1 to Alice,
1¢ to Bob
¤ No. Alice is then giving up $100 while Bob
is giving up 1¢. Why look at equality in
payoff versus sacrifice?

60. 69
Physician Group Purchase
¤ One buyer (Hospital)
¤ Two physician groups
¤ V(0) = 0 no deal
¤ V(1) = 100 buy one group
¤ V(2) = 120 buy both
¤ If doctors merge, then 120 or 0
¤ H gets 60; doctors get 60 (30 to each)

61. Zincit
¤ New drug for Acid Reflux.
¤ Zums has offered $20m. They plan to use drug
as dietary supplement so no FDA approval
required. This is their best offer.
¤ Zincit will apply for FDA approval. If approved,
will earn profits of $120m. If not, then will make
$20m.
¤ Seller thinks chance of approval is 60%.
¤ Buyer thinks it is 10%.

62. What is the Pie?
First cut: Increasing profit from 20m to 120m in event of approval
So it is $100m. Split it: 50m to each
Simple deal: Pay $20m upfront + 50% of profits above $20m
Probabilities are irrelevant

63. More Pie?
To maximize the pie, seller should get $100m bonus if FDA
approval.
Worth $60m to seller and costs buyer $10m.
Best case for Seller / worst for Buyer: $15m upfront + $100m bonus
Worst case for Seller / best for Buyer: –$10m signing + $100m bonus
Midpoint: $2.5 upfront + $100m FDA bonus

64. 73
What is the Pie?
Two levels
Level 1: Buy company and create chance of getting extra $100m
That suggests $20m upfront + $50m bonus
Level 2: Trade upfront for more bonus