Dealmaking

1. Negotiauctions: The dominant dealmaking mechanism in today's competitive marketplace

A negotiauction is the commonplace situation in which negotiators are fighting on two fronts—across the table for sure, but also on the same side of the table, with known, unknown, or possible competitors.

Combining auctions and negotiations. Negotiauctions have become the most common mechanism for buying and selling assets in our increasingly competitive global marketplace. They blend elements of both auctions and negotiations, creating a complex dynamic where dealmakers must manage competitive pressures from both across the table and on the same side.

Real-world examples. The book provides numerous case studies illustrating negotiauctions in action:

• The sale of Cable & Wireless America
• The bidding war for ABN AMRO
• The Frasier TV show contract renewal

Importance for dealmakers. Understanding the concept of negotiauctions is crucial for modern dealmakers. It allows them to:

• Recognize the true nature of complex deal situations
• Employ more effective strategies and tactics
• Create and capture more value in transactions

2. Preparation is key: Understand parties, interests, and alternatives

A starting point in preparing for any negotiation is to think carefully about the parties to the negotiation and their interests.

Four essential elements of preparation:

1. Understand the parties involved
2. Identify their interests
3. Assess alternatives to agreement (BATNA) for all sides
4. Analyze incentives of people at the table

BATNA analysis. Best Alternative To a Negotiated Agreement (BATNA) is crucial in determining your bargaining power. In negotiauctions, BATNAs can be fluid and complex. For example, in the Frasier negotiation, Paramount's BATNA was selling the show to CBS, which influenced their reservation value.

Incentives matter. Understanding the personal incentives of individual negotiators, not just organizational goals, can provide valuable insights. For instance, in the Frasier case, Marc Graboff's incentives as a new NBC executive influenced his negotiation strategy.

3. Process setters: Balance auction and negotiation elements strategically

As a process setter in a negotiauction, then, your unique challenge is to determine which source of competitive pressure to utilize, and when.

The BASC framework. Use the Bidders, Asset characteristics, Seller profile, and Contextual factors (BASC) framework to determine whether to lean towards auction-like or negotiation-like mechanisms at different stages of the deal process.

Evolving deal dynamics. Process setters should be prepared to adjust their approach as factors change:

• Number of bidders decreases
• Difference in valuations among remaining bidders becomes more important
• Value-creation potential increases

Examples of process evolution:

• Auction-then-negotiate: Common in complex service contracts
• Negotiate-then-auction: Typical in car buying scenarios

4. Process takers: Employ game-changing moves to reshape deal dynamics

The critical task for process takers is to reshape the deal process, and even take control if they can—so-called game-changing moves.

Three types of game-changing moves:

1. Setup moves
2. Rearranging moves
3. Shut-down moves

Importance of game-changing moves. The relentless pursuit of these moves distinguishes great negotiators from merely good ones in negotiauctions. They allow process takers to:

• Gain leverage in the deal
• Create and capture more value
• Overcome disadvantages in the initial deal structure

Example: Frasier deal. The introduction of perpetual license fees was a game-changing move that reshaped the entire TV show renewal negotiation process, creating value for both networks and studios in the long run.

5. Setup moves: Establish favorable terms of entry into negotiauctions

Setup moves shape the game from the outset.

Key aspects of setup moves:

• Typically made at the beginning of a negotiauction
• Aim to extract concessions for entering the deal process
• Must be better than the process setter's perceived BATNA to succeed

Martha's Vineyard house purchase example:

• The Townsends used multiple setup moves:
  1. Agreeing to play only if the second round was best and final
  2. Conditioning their bid on the existence of another offer
  3. Requiring a "precise dollar figure" from other bidders
• These moves helped them secure their dream house at a lower price

Corporate examples:

• Apple's setup move in acquiring AuthenTec prevented a bidding war with Samsung
• Dell's failure to make a strong setup move in the 3PAR acquisition led to losing the deal to HP

6. Rearranging moves: Reconfigure assets or parties to create additional value

In negotiauction situations, effective players are constantly assessing the viability of rearranging moves, which I define as moves that reconfigure the assets or the parties, or both, in ways that create additional value in the deal.

Types of rearranging moves:

1. Rearranging parties (e.g., forming consortiums)
2. Rearranging assets (e.g., splitting or combining assets)

Examples of successful rearranging moves:

• ABN AMRO sale: RFS consortium (RBS, Fortis, Santander) rearranged parties to make a winning bid
• Arora's Heathrow T5 hotel deal: Partnering with Sofitel to win the contract
• LKQ's acquisition of Pittsburgh Glass Works: Buying the whole company and selling a portion to Vitro

Considerations for process setters:

• Hub-and-spoke approach: Control information flow if confident about deal structure
• Peer-to-peer approach: Allow bidders to communicate if uncertain about value creation opportunities

7. Shut-down moves: Prematurely end same-side-of-the-table competition

A shut-down move is a move that prematurely cuts off same-side-of-the-table competition.

Key factors for successful shut-down moves:

1. Timing: Must be made when the process setter's perceived BATNA is weak
2. Credible threat: Must worsen the process setter's perceived BATNA
3. Clear communication: Choreograph the move carefully

Examples of shut-down moves:

• New York magazine sale: Bruce Wasserstein's last-minute bid
• MCI acquisition: Verizon's press release (though initially unsuccessful)
• Toys "R" Us sale: KKR club's deal protection measures

Degrees of shutting down:

• Can be absolute or partial (e.g., breakup fees, matching rights)
• Information asymmetries can amplify effectiveness (e.g., Dell Inc. buyout)

8. Beware of the winner's curse in common value auctions

The winner's curse problem tells us only that the winning bidder will lose, on average, unless bidders adjust their strategy to reflect the problem.

Understanding the winner's curse:

• Occurs in common value auctions where all bidders are trying to estimate the same value
• Winning bid is likely to be an overestimate of true value
• Not related to emotional factors or irrational escalation

Strategies to overcome the winner's curse:

1. Identify if you have an "edge" in valuation
2. Look for sources of private value or synergies
3. Adjust bids downward to account for the curse

Real-world examples:

• Coin jar auctions in executive education classes
• Offshore oil drilling rights auctions in the 1950s
• Hillary Clinton's book auction

9. Effective bidding strategies in sealed-bid and open-outcry auctions

To bid in a disciplined way, you trade the likelihood of winning against the profits from winning.

Sealed-bid auctions:

• Use MBOO (Maximum Bid of Others) analysis to balance probability of winning and profits
• Consider all costs and benefits in setting your reservation value
• Be aware of potential "all-pay" features that affect your BATNA

Open-outcry auctions:

• Start with your full reservation value and adjust as new information emerges
• Be prepared to rationally update your valuation based on others' bids
• Guard against irrational escalation and emotional factors

Bidding tactics:

• In sealed-bid auctions, avoid "winging it" and use analytical tools
• In open-outcry auctions, consider sniping to protect your information advantage
• Be disciplined about walking away when bids exceed your (updated) reservation value

10. Legal considerations: Navigate the shadow of the deal in negotiauctions

Legal issues often arise in the deal process itself. This is especially true in negotiauctions.

Key legal areas to consider:

1. Using fictitious bidders: Generally illegal if specific claims are made
2. Reneging on process commitments: Can be legally binding in some cases
3. Bidding through others: Usually legal, with some exceptions
4. Bidder collusion: Illegal if it hinders competition, but some rearranging moves are permissible

Balancing legal and strategic considerations:

• Be aware of potential legal issues without overly constraining deal tactics
• Understand when to consult lawyers during the negotiauction process
• Recognize that some seemingly off-limits moves may actually be legally permissible

Examples of legal implications:

• Martha's Vineyard house purchase: Potential fraud in fictitious competing offer
• NCS HealthCare sale: Court invalidation of Genesis's setup move
• Wachovia sale: Legislative intervention to override Citigroup's exclusivity agreement

Last updated: August 9, 2024