Dealmaking – Guhan Subramanian
Negotiating with multiple buyers(auctions) for one or more products/service.
Differences in expectations about the future often create value in negotiations.
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Contingency contracts have three major benefits:
- They align incentives.
- They allow the parties to diagnose the honesty of the other side.
- They enable the parties to share the risk.
When to Auction, When to Negotiate
An auction is a mechanism in which the seller is a passive participant after the process has been set, and the primary source of competitive pressure arises from competition among buyers.
Negotiation is a mechanism in which the primary source of competitive pressure arises in across-the-table dynamics between buyer and seller.
Factors To Consider: Seller Profile
Auctions are a much faster process than negotiations.
If there is a specific window of opportunity to sell, or the asset is deteriorating as time passes, auctions are preferable.
Auctions are faster and riskier. They sometimes “bust,” in which nobody shows up; or, even worse, only one bidder shows up.
Negotiations are safer bets. They allow you to test the water as you make your way to a better outcome.
Factors To Consider: Contextual Factors
Broad-based processes like auctions are difficult to keep secret.
Negotiations are much more private.
A frequent concern during M&A deals is to broaden the search process in the sale of a company for fear that the employees will find out, start looking for new jobs, and the value of the company drops.
Transparency: The appearance of a level playing field among bidders.
Auctions are a more transparent process than private negotiations.
Open Outcry Vs Sealed Bid
Open outcry auction: Bidders know the high bid at all times, and have the option of beating it.
Sealed bid auction: Bidders submit written bids and do not know what others bid, or (often) how many bidders there are before the winner is revealed.
There are four factors to consider here:
- The number of potential bidders.
- The degree to which bidders’ valuations are “affiliated”.
- The degree of bidder risk aversion.
- The need to deter collusion among bidders.
Number of Potential Bidders
- The minimum number of initial bidders in an open-outcry auction is five or six
- Less than five bidders and better to conduct a sealed auction where a lack of transparency means bidders may bid against themselves.
- A sealed bid auction can create the perception of competition even when there isn’t one.
Playing The Game As Process Taker: The Winners Curse
Winner’s curse: The feeling that you overpaid simply because you were the highest bidder.
Reflect on all the costs and benefits of winning or losing the auction in calculating your reservation value.
Costs often include much more than price. Could be your reputation, or competitive advantage in the marketplace.
The only scenario that matters is the one where you win. Think to yourself, “Am I comfortable paying this price, even if it turns out that I overpaid?”
Bidding in Sealed Bid Situations
The key is to bid high enough to win, but low enough that you preserve as much profit as possible from the deal.
Determine how your chances of winning increase with your bid.
Choose the bid that maximizes your expected profit = Probability x Profit
Bidding in Open-Outcry Situations
- Continue bidding up to your full reservation value.
- Whenever common value plays a role, bidders should rationally “update” their reservation value during the course of the bidding. E.g. the layman bidder takes cues from an expert with insider knowledge.
- Three factors fuel “competitive arousal:” intense rivalry among bidders, time pressure, and the presence of an audience.
Tip For Open-Outcry Situation
Writing down your reservation value
Ask yourself, “What do I know now that I didn’t know at the beginning of the auction?” If you don’t know anything new, then you should drop out of the auction.