Friday, February 5, 2016

Precise Bids

New research from Keloharju and Hukkanen has one clear piece of advice: "When Negotiating a Price, Never Bid with a Round Number." The argument is that a round number signals that you have no clue what the true value is. A more precises bid indicates that you have done your homework and have a more precise estimate of the underlying value of the object. As a consequence, your counter-party is more likely to accept your bid. The graph reports the returns as a based on round number bids or not.
Another study by Jerez-Fernandez, Angulo, and Oppenheimer based on the TV show The Price Is Right examined the guesses contestants made for the market price of consumer products. Audience suggestions for bids ending in zero were least likely to be chosen.

5 comments:

  1. In the world of social psychology as it relates to finance, there are pros and cons to negotiating with a precise price versus a round number. I do agree that in most situations a round number bid gives the impression that the bidder does not know the true value of what they are bidding on whether it be an investment, real estate, vehicle purchase, etc. However, as Keloharju and Hukkanen noted in their study “If a bid is too precise, it may strike as strategic to the recipient, rather than being driven by superior information.” This would lead the recipient to suspect that the bidder is really not that informed.
    As noted in the textbook, in the strategic view of bargaining the ability to commit to a position gives one party bargaining power over rivals. If you make your move first with a precise bid, you can convince your rivals that you are confident and are willing to bargain hard. In the non-strategic view of bargaining, outside alternatives determine the terms of agreement. Bargaining power can be gained through the timing of the bid proposal. For example, a precise price offer on a new vehicle at the end of the month when commissions are typically paid, may entice a sales person to accept your offer more quickly and with less counter bargaining. This is also an example of time value of money.
    It is always good to do your homework before entering into bargaining negotiations, but wise to remember to not be too exact with your price bid.

    Nobel, C. (25 January 2016). When Negotiating a Price, Never Bid with a Round Number. Retrieved April 12, 2016 from http://hbswk.hbs.edu/item/when-negotiating-a-price-never-bid-with-a-round-number

    Froeb, L. M., McCann, B. T., Shor, M., Ward, M. R., (2014). Managerial Economics, a Problem Solving Approach, 4th Edition. Boston, Massachusetts: Cengage Learning.

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  2. In the world of sales, we refer to the idea of persuasion science or the ability to influence a person to say yes. It is based on scientific principles that show how universal factors in our decision making are subject to influence (Kim, 2014).

    One of the six common influences that affect our decisions is authority or the fact that “people will follow the lead of credible and knowledgeable experts” (Kim, 2014). By demonstrating authority using a more precise bid (and one that is closer to the perceived value of the item), then you are making a strategic move that shows you are more committed to a position.

    Your counterpart will recognize the bid as coming from an authority and respect the value you place on the item, so it may more readily accept your position (Froeb, 2014). If this is the case, then you will likely capture a high value or “bigger share of the gains” from the agreement (Froeb, 2014, p.208).

    References:

    Froeb et al (2014). Managerial Economics: A Problem Solving Approach. Australia: Cengage Learning.

    Kim, L. (2014). The 6 Scientific Principles Behind Influence and Persuasion. Retrieved April 22, 2016, from http://www.inc.com/larry-kim/the-6-scientific-principles-behind-influence-and-persuasion.html

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  3. This is an interesting theory to me, because without knowing this, my fiancé and I placed a bid on a foreclosed house following this theory. The house was placed on the market for $31,000 and had a closed bidding period. We knew that a number of other parties were interested in picking up the house, but had no idea what they had submitted for a bid. Even more stress was placed on us as the selling bank decided to close the bid much earlier than expected. We decided to place a bid of $51,000. We at first considered $40,000 but eventually settled for $51,000 assuming other parties might bid in the $40-50,000 range. Luckily, our bid won and we later found out another party bid $48,000.

    Although we did not formally lay out a decision tree like that seen in chapter 17, we clearly had to make a decision with uncertainty. We did not know how much really needed to be invested in the house or what it would eventually be worth. “When we’re uncertain about what value a variable will take, we identify the situations in which it takes on different values, list the possible values and assign a probability to each value” (p.218, Froeb). We took into consideration the value of the land based on nearby sales prices (a fairly reliable value) and of course looked at the sales price of houses in good conditions in the area to see what we could earn by investing. Some less reliable variables we had to assign a probability to included the possibility of drilling a new well, installing all new plumbing, building a new roof and the possibility of countless material investments.

    We ended up investing just over another $50,000 but a recent appraisal was near $150,000 suggesting we made the right choice by bidding $51,000. Luckily, we were able to avoid some uncertainties (for example digging a new well) and our competing bidders did not value the house higher than we did.

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  4. Pricing can be psychological to the consumer when considering a purchase. Businesses approach pricing from many different angles. Obviously a business wants to maximize its profitability for each unit sold. This is an important factor in developing a pricing strategy. But what about determining price also based on whether or not the consumer believes that the price represents a good deal? The article ‘When Negotiating a Price, Never Bid with a Round Number” discusses precise bids. According to the article, a precise bid can produce a more positive outcome then a round number bid based on research studies. The perception of this approach is that a precise bid may give the assumption that the seller has researched the price, thus is confident that the price demonstrated the correct value. Historically, businesses have used similar tactics by listing product prices utilizing .99. For example, when Best Buy runs a promotion on TVs, the price point may be 499.99. Although 499.99 is only .01 lower than 500.00, psychologically it appears to be a better deal than 500.00. Price-conscious consumers have become conditioned to believe that they are getting a good deal when they buy something with a price ending in .99 even if the markdown is minimal.

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  5. Precision when offering numbers is a key strategy that is underutilized throughout business when one is following the strategic view of bargaining (Froeb, p. 206). If one can make the first offer and force the other party to respond, you gain the first-mover advantage and being precise can be an advantage. Per Hukkanen & Keloharju’s study, there is an assumption by a recipient that a precise number is based on high knowledge and consideration and hence precision whereby a round number is an estimate or starting position. When one offers a round number you are almost sure to be challenged because it is statistically improbable.

    The real estate example of a bid of $1,000,000 versus $1,002,000 illustrates the point quite well and one is not surprised that counteroffers are much narrower when presented with a precise initial offer. Whether one is negotiating for a car or a house or to purchase a business – the principle is the same. This also applies in other ways. Precision in dates is suggested by Nobel that 365 days is more firm than saying we’ll review it in a year. I have taken it even further in my own business experience by using a decimal point such as 89.2% to signal precision which is even better than 89% which is far superior than 90%.

    It is not clear why more people don’t use this tool. When challenged, people routinely agree that the perception they create by round numbers is unfavorable but we must be “wired” to use round numbers as estimates if we fear being challenged. This signaling is a bad idea and shows a lack of commitment in bargaining and will lead to worse bargaining outcomes (Nobel, p. 1).

    References:

    Froeb, L. et al (2016), Managerial Economics: A Problem-Solving Approach, 4th edition, Boston, MA: Cengage Learning

    Hukkanen, P. and Keloharju, M., (2015), Initial Offer Precision and M&A Outcomes, Working Paper 16-058, Harvard Business School, downloaded from http://www.hbs.edu/faculty/Publication%20Files/16-058_27d73983-3441-4628-906c-10ce5fb7ac47.pdf

    Nobel, C., (2016), When Negotiating a Price, Never Bid with a Round Number, Harvard Business Review, dated January 25, 2016, downloaded from https://hbswk.hbs.edu/item/when-negotiating-a-price-never-bid-with-a-round-number

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