Thursday, January 24, 2008

Zone of Possible Agreement

In Beyond Winning, Robert Mnookin discusses how parties may fail to reach an agreement even if it is valuable and efficient for them to do so. The problem is that parties may not be aware that there is a "zone of possible agreement," where the range of values that the parties assign to the dispute overlap, so that a settlement value acceptable to each party would also be acceptable to the other party. This situation is a classic call for facilitation by a mediator. How does the mediator increase the likelihood of a settlement where the parties' valuations overlap to create a "zone of possible agreement?"

Take as Mnookin does the example of a negotiation to sell a used car between two parties. The seller has a reservation value of $7,000, below which she will not sell the car to the other party. She has set $7,000 as her reservation value because she has identified her BATNA, her best alternative transaction to a negotiated agreement with this buyer, as a sale to a dealer at a "blue book" price of $6,900. Seller would like to get more than this easy-to-obtain "wholesale" price, and is asking a "retail" price of $9,500.

Buyer also has a reservation price above which he will not spend for this car. He has set this maximum price at $9,000, because he could purchase a similar used car from a dealer for $11,500. Buyer thinks the dealer's warranty and quality inspection of the car before sale is worth the incremental $2,500, but is willing to forgo it in order to pay the lesser price to seller. However, buyer would like to pay as little as possible, and he counters with an offer of $6,000.

In this case, the zone of possible agreement is $7,000-9,000, and any transaction in this range would be beneficial for both parties. There is a $2,000 surplus to be distributed, which is a measure of the potential economic benefit to each party to doing the deal in addition to simply acquiring or disposing of the car. It is in each party's self interest to obtain as much of that surplus as possible, and dividing up the surplus is a zero sum game. However, if each party is unaware of the other party's valuations and objectives, they run the risk of failing to reach a deal if they only seek to maximize their personal self-interest.

Mnookin identifies information asymmetries and strategic opportunism as the principal barriers to settlement even where parties share a zone of possible agreement. Information asymmetries concern the differences in knowledge that each party has about the other party's objectives and concerns, as well as about the quality of the good being sold. As Mnookin states, "[i]ronically, the more successful a buyer is at negotiating a bargain price, the more suspicious he should be that he is being sold a lemon." Strategic opportunism can be briefly identified as that urge each negotiator has to "win" the negotiation, to outdo the other party. Often a party will seek to manipulate the perception of the party's alternatives and "bottom line." To put it bluntly, each party seeks to not only do the deal but also exploit the other party to boot.

This is a useful example to explore how a mediator can facilitate a settlement...a settlement that is in the parties mutual self-interest to make. The parties might be able to agree that a "fair" price would be $8,000 (the middle point of the zone of possible agreement) if they can collaborate to understand each other's objectives and alternatives in a way that doesn't render them vulnerable in the process, and if any questions regarding the quality of the car could be answered by structuring a process that satisfies the buyer but doesn't create unacceptable transaction costs for the seller.

The best way to discover whether there is a zone of possible agreement without rendering each party vulnerable to the other party's opportunism is for the mediator to identify each party's valuation range separately in caucus, and apply any reality-testing that may be necessary based upon the mediator's understanding of the facts and issues presented. The mediator must also be willing to sniff out the difference between a true reservation price and a purported "bottom line."

The mediator will need to continue the separate caucusing until the mediator is ready to report in open session that a settlement is possible, because there is a zone of possible agreement. Once the parties are aware that settlement is achievable, the parties can then in open session begin to explore with some more confidence each others' interests in a way that seeks in a collaborative way to determine where the surplus may be "fairly" divided.

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