Past Examination Papers – Negotiation D
Examination
Case Questions
Case Question 1 – Midlothian United Football Club
The owner of a football club, Midlothian United FC, is in debt to the bank. Excluding the cost of servicing its bank debt, the club makes a small operating profit. The owner wants to sell the club and has quoted a price of £2.20 a share and a buyer is willing to buy, and has offered a price of £1.20 a share.
The buyer's major problem is that with the club in debt to the tune of £3 million and a need to service the debt (£300000 a year approximately), money paid to buy the owner's shares reduces his ability to cover the debt, because the payment to the owner will reduce the money available for investment in the club. Hence, he has to find a way of paying for the owner's shares at a (lower) price acceptable to the owner and structured in such a way as to minimise an immediate cash drain on his resources.
The present owner is eager to sell his 2 million shares (but not at any price) because the bank is pressing for a reduction in the overdraft debt and he needs the capital he has tied up in the club for his other ventures, mainly in property development. He is presently supporting the club's debt with a personal guarantee to the bank of £1 million, secured against his other business assets. The bank would want the buyer to take on this personal guarantee when the current owner withdrew his guarantee in the normal manner on the sale of his shares.
The buyer has proposed that he spread payments to purchase the club over ten years because he must split the purchase price into a deposit and a series of annual payments. How big a split and how long the part payments are spread are negotiable.
There is also the possibility that the buyer would go for control (51%) but not total ownership of the club (perhaps with an option to buy at a later date the remaining 49% of the club), assuming the owner could be persuaded to accept such a deal (which depends on how badly he needs cash for his property developments) and providing he wishes to remain a minority shareholder in the club.
If the new owner could make cash available from his remaining resources to lower the overdraft from the bank he could reduce the club's debt charges and increase the likelihood that he can generate a trading profit more quickly.
Questions:
- What are the issues in this negotiation?
(8 marks)
- How might the issues be set out in a Negotek PREP Planner format?
(8 marks)
- What are the interests of the buyer and seller?
(8 marks)
- What might constitute a bargain from the buyer to the seller?
(8 marks)
- Could the buyer suggest something be done in regard to the current owner's personal bank guarantee that would address both their interests?
(8 marks)
Total of 40 marks
Essay Questions
Essay Question 1
How does the concept of the negotiator's surplus assist the analysis of practical negotiation problems?
(20 marks)
Essay Question 2
What can Prisoner's Dilemma teach practitioners about negotiation behaviour?
(20 marks)
Essay Question 3
In what ways can negotiation be seen as a tactical contest?
(20 marks)
(Total of 60 marks)
END OF PAPER
Solutions
Note from the Examiner: These answers are skeletal guidelines only. Though they contain the major points sought, the student's response should provide further insight into many of the points. Simply repeating the major bullet points does not necessarily demonstrate the required level of understanding of the subject.
Solutions to Case Questions
Case Question 1 – Midlothian United Football Club
- What are the issues in this negotiation?
(8 marks)
Adefinition of negotiable issues is expected: these constitute the agenda of the negotiation and cover all the joint decisions to be agreed by the parties and over which one or both of them have discretion. Issues are intended to deliver the interests of the parties.
3 marks
The negotiable issues in Midlothian United FC include:
- The price to be paid for the shares
- The number of shares to be purchased
- When the purchase price is to be paid to the owner
- The personal guarantees to the bank for the club's debt
- The proportion of shares to be bought plus an option.
5 marks
- How might the issues be set out in a Negotek PREP Planner format?
(8 marks)
The negotiable issues have to be identified and then prioritised. The price per share, while important, may be less important than when payment is made. Thus, when payment is made could be a High priority (a must get decision), while price per share is of a Medium priority (it might be important but not a walk away decision). Keeping the current owner's guarantees in place may be more important (Medium priority) than reducing the overdraft (Low priority and unlikely to be a walk away decision) because the former could allow some latitude with the latter.
2 marks
Setting out the negotiable tradables in a Negotek PREP Planner format produces:
Tradables / Priority / Entry / ExitPayment timing / H / All of it spreadover 10 years / Deposit now, rest over 8 years
Price per share / M / £1.20 / £1.90
Seller's guarantees / M / Valid for 9 years / 3 years
Control not 100% / L / 51% / 80%
4 marks
For each issue the negotiation range must be determined, running from the Entry to the Exit position. Negotiators decide on their entry points by a judgement as to what is credible to the other negotiator in the circumstances. The entry point must be defensible when challenged. Their exit point is determined on the basis that anything beyond it is unacceptable and could cause a walk away decision depending on the importance of the tradable.
2 marks
- What are the interests of the buyer and seller?
(8 marks)
For a pass mark candidates will be expected to define ‘interests’ and not merely to identify the interests in the particular question. They will also be expected to demonstrate that they are not confused between interestsand issues.
Interests are the motivation(s) for why a person prefers one solution to another; issues are what a person wants. Issues are ways of delivering a person's interests. Interests are concerns, hopes, fears and the overall objectives a person has in a disputed situation.
2 marks
The seller's interests include maximising the profit on his investments. Midlothian United FC is in debt to the bank for £3 million, requiring a £1 million personal guarantee, therefore selling it to release capital and the personal guarantee makes sense, particularly if there are alternative investment projects in property that could generate profits. It is in his interests also to lower the risk that if the investment in the club failed, this would cause a large financial drain and the calling in of the personal guarantee, and the risk that his other investments could be seized by creditors.
3 marks
The buyer's interests are to acquire a potentially profitable investment (if it was better managed) on terms that do not jeopardise its future success. Pay too high a price and only the buyer benefits (gains cash and relief from debt obligations). Structure the purchase carefully – low overall price, divided into a small deposit and long time to pay out of future earnings – and the buyer could turn the investment into profit by trading out of debt.
3 marks
- What might constitute a bargain from the buyer to the seller?
(8 marks)
The buyer has offered £1.20 a share but will have to move upwards. He can move higher if he can split the purchase price than if the seller insists on payment in full.
If the total price paid for the owner's shares was, say £2 million, this would produce an immediate income for the owner of, say, £1 million now and a continuing income for 8 years at, say, a rate of £125000 per year, plus interest.
2 marks
If the buyer went for control (51%) but not total ownership of the club (with an option to buy the remaining 49% of the club), this could reduce the purchase price to, say, £1 million, to be paid as £500000 now, and the balance paid over 8 years.
2 marks
The candidate is expected to state clearly what constitutes a bargain: a bargain is a specific proposal in an IF–THEN format, consisting of a specific condition followed by a specific offer, which if the other party accepts, terminates the negotiation.
2 marks
An example of a bargain relevant to this case study is required, though the content may vary from candidate to candidate. One such bargain might be:
‘If you accept a . part payment of £500000 followed by the balance of £500000 over 8 years for 51 % of the shares, then I would undertake to purchase the remaining 49% of your shares in year 9 at their fair market value for cash and make you Life President of Midlothian United Football Club from signature of the agreement.’
2 marks
- Could the buyer suggest something be done in regard to the current owner's personal bank guarantee that would address both their interests?
(8 marks)
The new owner could benefit if the current owner were to keep in place his personal guarantees to the bank, at least for some time ahead. Personal guarantees are normally backed with tangible assets (property, a pension fund, shares in blue chip companies, government bonds, cash on deposit, etc.). Keeping the current owner's guarantee of £1 million to the bank provides some comfort to the bank if the new owner were to mismanage the assets and releases his own funds for investment in the club (which may already be pledged to support the purchase price).
2 marks
There are several problems with this suggestion. The seller may wish to release his guarantee because he wants to support his other (profitable) ventures. He is at risk of the new owner's management skills to the same extent that the bank is comforted!
2 marks
This puts the seller in a stronger negotiating position with the buyer, for which he can trade on other issues, such as raising the total selling price he extracts from the new owner (however it is part paid). He can expect more per share if he is risking his £1 million guarantee.
2 marks
However, the seller's desire – perhaps of high priority because of the debt finance obligations he is planning with the bank for his property projects – to be relieved of these guarantees to the bank, puts the buyer in a stronger position to lower the total price and improve the payment terms. If he ‘reluctantly’ accepts he must give his personal guarantee instead.
2 marks
Solutions to Essay Questions
Essay Solution 1
How does the concept of the negotiator's surplus assist the analysis of practical negotiation problems?
(20 marks)
Candidates are expected to demonstrate a clear understanding of the ‘geometry’ of the negotiator's surplus and are expected to illustrate the answer with at least one accurate diagram similar to those found in Module 2 of the Text. They should show how the concept of the negotiator's surplus assists a practical negotiator to analyse a negotiation problem. To do this they must explain how the surplus is constructed and define the negotiation range, the entry and exit points and how they explain a negotiator's behaviour.
Negotiation implies movement because unless the negotiators move from their opening or entry positions, they cannot reach agreement (unless their entry points coincide!). Negotiators usually begin with a gap between their aspirations – the seller looking for more than the buyer is initially preparted to offer and the buyer initially offering less than the seller is seeking.
2 marks
The gap between the negotiators' entry points is defined as the negotiation range. Normally, the negotiation range is revealed in the early exchange of offers and demands between the negotiators and sometimes it is known, because they are negotiating to divide a fixed sum between them, such as a known profit or a known revenue stream.
2 marks
That they are prepared to move does not mean they will move indefinitely. The implication is that they are prepared to move only up to a point. Further movement beyond this point – their exit point – is unlikely in the existing circumstances.
The negotiators' exit points determine whether a negotiated outcome is likely. The exit points may not meet, in which case there is a gap. The most the buyer will pay is less than the least the seller will accept. In this case, unless one or both move their exit points, an agreement will not occur. For agreement, the exit points must at least meet. The least the seller is willing to accept must equal the most the buyer is willing to pay.
2 marks
Most cases where agreement is possible involve the exit points of each negotiator overlapping – the seller is willing to accept a lower price than the most the buyer is willing to pay.
Negotiators do not normally know the exit points of each other. They know their own, of course, but can only guess at the other's exit point. Much of negotiation behaviour consists of each negotiator trying to convince the other that they have reached their exit point, though this is seldom absolutely true.
2 marks
The overlap in exit points constitutes the negotiator's surplus.
Consider a situation where the seller opens at $15000 and the buyer at $13000. The negotiating range consists of $15000 - $13000 which equals $2000. (Any accurate arithmetical example is acceptable).
Suppose the least the seller would accept (s) is $13800 and the most the buyer would pay (b) is $14300, then the negotiator's surplus is $14300 minus $13800 which equals $500. Whatever price they agree upon between $13800 and $14300, for necessarily the price must be bounded by that range unless somebody moves the exit price, the agreed price will divide the $500 surplus between them.
For example, suppose they agree on a price of $13900. This is $1 00 more than the least ($13800) the seller was prepared to accept and $400 less than the buyer was prepared to pay ($14300). The buyer's surplus is $400 and the seller's surplus is $100. Similarly, for any other price between $14300 and $13800 (inclusive).
It is possible that the negotiation will result in the buyer being forced to go to his or her exit price of $14300. In this case the buyer receives zero surplus and the seller captures all $500 of it.
Negotiation is about dividing the available surplus, usually under conditions in which neither knows if a surplus is available, or how big it is, because they do not know each other's exit point.
For an agreement price (p*) to exist, it is necessary for s = b or s < b. When s > b, p* is not possible. Yet negotiations open with the condition that s > b. The dynamics of negotiation behaviour consist of exploring whether there is a surplus by transforming incompatible prices in the range where s > b into price p* in the range s = b or s < b.
3 marks
The absence of knowledge of the other party's exit position can contribute to the failure to settle on terms within the settlement area. Without knowledge of the other party's exit price, the size of the settlement area is unknown. Hence, a party whose current offer is within his/her own negotiation (within his/her entry and exit points) is in a position to settle only if the other party accepts the offer but the other party may be resisting a move from close to his/her entry point in order to emphasise the cost to him/her of movement. If the other party moves to a point within the first party's negotiation range the first party now knows that a settlement is possible. He/she may not, however, choose to agree to the other party's current offer just yet in order to a) emphasise how much it costs to close the gap between them, or b) to explore how much further the other party will move across the settlement area (as if he/she were searching for the other party's exit point).
It is observable that tensions between the negotiators can rise when each views the other's current offers as a test of his/her own resolve and each is incentivised to push for further movement in order to gain more surplus for him or herself. If they both pursue this strategy we can expect tensions to rise, even to the point of a breakdown and the consequential failure to obtain any surplus.
2 marks
The concept of the negotiators surplus is an analytical device to interpret aspects of behaviour in a negotiation. The fact that exit prices are unknown does not preclude its usefulness. In fact, the unknowability of the other negotiators' exit price is the precise problem which the analytical device aims to use to explain negotiating behaviour. Much negotiation behaviour is about finding out the most the buyer will pay (his/her exit point) without disclosing the least the seller will accept (his/her exit point) (and vice versa for the buyer dealing with the seller). The parties are exploring the settlement range and seeking to acquire all of the surplus for themselves.
When negotiators are in a hurry, or the outcome is comparatively trivial, they will tend to judge an offer against their exit point and accept or reject it quickly. A street or market trader selling oranges can quickly assess an offer price against a minimum profit price from the oranges and, if positive, can choose to accept the offer without more ado. If the item is more valuable – an antique lamp – the trader may choose to work harder to get the offer improved – improve the profitability, and thereby his share of the surplus, of the sale.