Incentive

by Mr. Cheap

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It’s not terribly enlightening to assert that the threat of punishment or the promise of reward goes a long way to explaining people’s actions.  Similarly, it’s probably a pretty simplistic view of negotiation to say that it is understanding their perspective, then structuring incentives for other person to do what you want.  I’m not a very strong negotiator, but this forms the core (and almost the whole) of how I try to reach agreements with people:  I try to see the deal from their perspective, then suggest the deal be structured in a way that appeals to BOTH our self-interests.  The silly example from win-win deals of two women fighting over an orange can be viewed as an example of this.  They both had an incentive to possess the orange, but ultimately had rewards that were independent of each other (one to use the rind, the other to use the fruit).  The negotiation can be resolved by structuring the deal in terms that align with the incentive of the other party, i.e. “I only want the rind to bake with, if I give you all the meat to make juice, can I have the whole rind?”

What’s shocking is how often people ignore the incentive of the opposite party when negotiating (then can’t understand when the deal falls through).  Contractors who start a job then disappear for weeks or months on end are an example of this.  The home owner who wanted the work done clearly gave the contractor too much money up front (such that its not worth doing the job to get the balance).  The threat of a lawsuit to get their money back isn’t enough of a threat to get prompt work from the contractor.  Home-owners will gripe and moan about unethical, disreputable contractors, but ultimately I think the home-owner himself screwed up when he structured the deal.  When I had work done on my condo, I paid the painter after the work was done (through Sears) and I paid for the materials for the flooring then the labour once the work was done.  For everyone involved, our interests were aligned in getting the job done as soon as possible (for me to get tenants into the unit and for them to get paid).

I’ve seen people begging in negotiations where they’ll be telling some hard luck story why the person should give them a deal.  Maybe this works sometimes, but I can’t imagine it’s very effective.  Who cares why the person needs a good deal?  (remember, I am pretty hard hearted, so maybe this works on other people, just not on Mr. Cheap).  I saw people trying this in developing countries (“I love this knick knack but I don’t have enough money to pay for it and go on the swim with the dolphins trip.  Would you please, please, please accept less?”), and the vendors had no problem shaking their heads saying “no, sorry, full price”.  My technique was to offer what I was willing to pay, and when they said no I replied “thanks anyway, have a good day” and started to walk away.  Potentially losing the sale was a very good incentive for them to quickly reach an acceptable price.  Of course, I had to actually be prepared to leave, if I’d come back 10 minutes later, you can be sure I’d be paying full price.

One time when I was doing contract programming a gentleman was delighted that I could do the work he needed done, and told me he’d been looking for someone for months without any luck (I was shocked that anyone in business would put themselves into such a weak bargaining position).  I offered a fair price, based on my foolish perspective on pricing to which he responded with a series of e-mails commenting on “he’d find the money SOMEHOW” and “I can pay you instead of feeding my kids for a couple of weeks”.  I guess this was suppose to make me feel sorry for him and drop my price, but instead I got annoyed and worried that he wouldn’t pay his bill after I did the work (and I dropped him instead of taking the job).

Offering potential follow-up work, paying promptly, and being pleasant to work with are all excellent incentives to make a contractor give your work higher priority than other things on his plate.

One landlord I rented from showed me a place mid month and I said I’d take it from the 1st of the month.  After he asked me if I wanted to move in immediately (and I told him I didn’t as I had a place I was living) he said it was mine on the first, unless someone came by to take it sooner.  This clearly would be a great situation from his perspective.  He has an incentive to start collecting rent as soon as possible, so having a guaranteed tenant to start on the first, and the option to take someone sooner, is an ideal situation.  From my perspective, I had an incentive to line up an accommodation for the next month, and I wasn’t particularly keen to have to start looking for a place a couple days before the end of the month when he let me know that someone had taken it sooner.  I thanked him and told him I’d have to rent from someone who could guarantee me the place at the start of the month.  I told him to give me a call at the end of the month if he hadn’t found someone, and if I hadn’t rented elsewhere I’d take his place  (at which point, he figured having me was better than a chance at someone else and said the place was mine on the first if I wanted it).  Immediately, seeing things from his perspective, I realized the threat of having me rent from someone else (and him losing the tenant in front of him for a potential tenant who may or may not show up) was the way to get the deal done.  Having the option to rent to someone else was a foolish thing for him to even try to get, since considering it for even a second from my perspective there’s no way any tenant would have agreed to it (and it slightly soured our relationship from the start).

From psychology the theory of mind deals with developmental stage where people start to understand that other’s have a different mental representation of the world than themselves.  Unless someone is a child (below 3 or 4 years old) or suffers from a developmental disorder (such as autism spectrum disorder) there’s no excuse why they can’t understand other people’s perspective on a conflict and structure a deal that appeals to the other side.  This doesn’t guarantee agreement (or even a good deal), but ignoring this is a recipe for prolonged conflict.

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{ 7 comments… read them below or add one }

1 nobleea

good post mr cheap. well written with interesting anecdotes.
i’ve got some books on hold at the library on game theory. looking forward to reading through them.

2 plonkee

Yes, I’ve always wondered why people think that there needs will cause me to give stuff away. I mean, sure, if I already care about them, but when they’re a complete stranger? I prefer to be fair, but that includes being fair to me.

3 Steve in Montreal

Great post and most timely I might add. There is a chance I may be laid off soon and I’ll be negotiating my severance for sure using this.

4 jesse

Here’s another anecdote about a hotel room. I had a hotel room booked in advance for $99/night on Saturday. We went to the front desk on Saturday afternoon to book the room for the next night but the manager said the rate jumped to the weekday rate of $300/night. Pissed off of course we said that was too much and wanted the same rate as Saturday. No dice, no movement on price. We decided for that price we would pack up and go to another hotel for Sunday night and were about ready to do so the next morning. The city had lots of vacancies.

We went down on Sunday morning to check out and all of a sudden the room was available again at $99 for that night. What changed? Who knows but my guess is they weren’t going to be even close to full occupancy and needed to fill the room. The night before they were still hoping for some last minute corporate booking. The key was us willing to accept an alternative, namely moving to another hotel. My wife said that given how wonky the hotel rates were, they should throw in a free breakfast as punishment for trying to screw us over, but whatever. The hotel was a biggish chain so it could be their rates were pre-programmed into the computer but I wonder if they were just being dicks about it.

In any case, we have to now discount any future stays with this hotel chain because we can’t trust them. No way are we staying there again unless the deal is beyond their competitors’ rates. There’s a lesson here in negotiations. If you don’t trust the other person you either need a screaming deal or the deal never gets done, just as we discount stocks or bonds based upon credit ratings and wouldn’t touch many with a twenty foot barge pole.

5 jesse

Another consideration, speaking of incentives, is the commission structure so popular for financial advisors. Many make their money on insurance and mutual fund kickbacks. If the fees are not explicit and fixed, you are relying on disclosure and a pretty good sign there’s a “scamish” quality to the business relationship. This is because you may be sold an inferior product because they are being paid out or if you don’t buy their insurance schemes they likely will see you as a low margin account and not pay much attention to you. Remember: insurance is extremely lucrative so it’s hard to say if half these guys really have your best interests at heart if they’re pushing this crap on you.

The one I like is the famous x% annual commission. The argument goes that if your money grows, they get rewarded blah blah blah. That’s not how it has to work. You should expect the same level of advice whether you have $50K or $500K. They are prepared for this, though. Above some limit they can “talk to their guys” and “get you inside deals” that only the high rollers get. B.S. They know all the lines and are looking for the juicy commission schedule. The other trick is they “charge out” at $50/hr or something ridiculous to make the commission look sweeter from your perspective.

Go for flat fee all the way if you want to use these services. The deal is: if their advice is good, you’ll keep paying them. If their advice is bad, you won’t be returning their calls. If the advisor keeps pushing for commission structure, call them on it and thank them for their time.

6 Jerry

Time was, people could be taken at their word… but that time has past. The example of the contractor who will accept money up front – and then not do any work – may be commonly seen, but it’s disgusting. There is no longer any insurance that you will get what you pay for unless you structure your deal correctly, which leads to a sad commentary on modern society.
Jerry

7 jesse

Jerry, I hear you but even 40 years ago there were dishonest vagrants floating around looking for work. The handshake comes from a network and has always been earned, not given, on large deals like a major renovation. Handshakes for strangers is the start of a business relationship that lasts years or decades and doesn’t start by signing away the house. Like friendship it starts small and is built. Perhaps the flux and fluidity of community can no longer support this.

Perhaps it speaks to the need for us to re-connect with people, not the phone book or the internet.

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