Principles of Contracts: Market Awareness

You walk into the grocery store to buy apples, but when you reach the produce section the apples are twice what they are across town, and the quality isn’t quite as good as you remember them from the other store. Do you buy them? Maybe, if you’re in a rush and apples are a must have for you today. Otherwise, you’ll hold off and go to the other store for your apples, because the inconvenience is less expensive than the extra dollar or two per pound you’d spend here. Maybe it’s not even an inconvenience, because you have another reason to be at the other store tomorrow.

What you’ve just done is a rudimentary cost/benefit analysis. In a business deal, everyone does this, and to negotiate effectively, you have to understand your market.

What Is A Market?

There are two kinds of markets: the broad, and the immediate.

The broad market is the social and economic context you’re operating in. What does the spectrum of going rates for your product or service (whether you’re buying or selling) look like today? What fundamental forces are at work that are pushing the price spectrum up or down? What’s the competition doing, independent of price, to make their products more attractive?

Lack of awareness of the broader market is very likely to lead you into paying too much, or into demanding too little or too much, none of which is desirable. If you don’t have answers to at least these basic questions, you don’t know your broader market context, and you’re not ready to make a deal.

The immediate market is the person you’re selling to–although almost everything I’m about to talk about applies equally to situations where you’re the customer. Perhaps it’s more accurate to say that your market is whatever person or entity you’re trading with. If you’re the customer, you’re selling them money for their goods, whereas if you’re the vendor, you’re selling the product and they’re selling the money.

When you sit at the negotiating table, the parties to the negotiation are each operating under different sets of internal constraints, externally imposed incentive schemes, and each has different sets of resources (cash, additional trade goods, time flexibility) that they can bring to bear to make or sweeten the deal.

The more you know about the other guy’s situation, the better negotiating position you’re in. You’re more likely to get the best deal he can offer, and you’re less likely to pooch the deal by demanding something unreasonable.

You Are A Spy

A spy? Well, not exactly. But, as Sun Tzu said, a battle is won or lost before either army takes the field. Preparation is everything, and in negotiation your preparation is intelligence collection.

How much of a difference can this make? Sometimes, it can make a difference measured in hundreds of percent.

Let’s say you’re in the market for a car, and you’re okay with a used car. Let’s assume you’ve done your due diligence on the car, and there’s no doubt that it’s in good mechanical condition. When you go to the lot to negotiate a deal, you think you’re there to buy a car, and the other guy is there to sell you a car.

But he’s not. Most used car dealers (and, for that matter, new car dealers) sell credit–the car is merely the medium for moving the promissory note. And the cars have to turn over fast. Because of inventory taxes, dealers have only a certain amount of time to turn around their inventory before it becomes more expensive to keep the car than to take a loss on the sticker price.

Combine these two factors with a third: sales people operate on commission, so their incentives are sometimes at odds with the dealer. A salesperson who doesn’t understand his boss’s business will have his commission at the front of his mind, and be looking at the deal with a decidedly short-term view, and thus he might be unwilling to make a deal that his employer will jump at.

Now, you walk on to the lot knowing this background. You’ve checked on inventory tax rates, you’ve picked a car that’s been sitting on the lot for long enough that the tax liabilities are looming (in a down economy, there are always good cars that go begging for a new home. In a booming economy, there often are as well, as people become more inclined to buy the latest and greatest rather than stick within their means). You know the car’s Blue Book value. You’ve done your intelligence work–exactly the same sort of work that diplomats and armies do before going into the summit or onto the battlefield. The job of a spy is to get as much relevant information as possible to maximize tactical advantage. As a party to a contract, this is your job, too.

And because you know the context the salesman operates in, the context his boss operates in, and the broader mareket context, you’re in a position to get the car for far less than asking price, while working the terms of the note so that the dealership makes out better than they would if they charged you a higher price. And, because you’re a canny shopper, you’ll have the budget to pay down the note rapidly so you don’t get screwed over by interest and depreciation, right? (Well, a man can hope. But effective credit management is a book of its own, and one I’m not qualified to write).

When You Face Your Market

As a person who grew up in a consumer culture that idolizes entrepreneurship but does not teach it, it’s tempting to think that prices are set by the vendor. They’re not. In any business transaction, the price is the result of very detailed, subtle, often subtextual negotiations and signaling.

Since time is at a premium in the west, we’ve become accustomed to paying sticker price, and the market is open enough that the sticker price on consumer items (like food) is often just fine. But don’t mistake the sticker price for anything other than an asking price, either in your grocery store, or when you’re buying a house, or when you’re negotiating a film option.

If you know your market — both the immediate and the global — you’re in a position to carry out meaningful negotiations. But if you don’t, chances are you’re going to come out with a deal that’s less than optimal.

Think like a diplomat, and prep like a spy.

Next time: Everybody Knows Peggy Lee (or Should)

Bookmark the permalink.