Multilateral Negotiations

1. Multilateral Negotiations Bargaining with more the two players

2. Coalitional bargaining Also called, �core� bargaining: the basis of added value We may not be able to pin down exactly what will happen in a negotiation But we can rule out certain outcomes That will allow us to figure out the range of possible outcomes Basic idea: Individuals and Groups should never get less than their outside option (= what the group could get if they split off & went on their own)

3. Basics of multi-party bargaining Each person or sub group should never get less than their outside option Because they can always �split off� and go their own way No individual or subgroup can get more than their added value (= the extra surplus their presence creates) Because all others can always �throw you out�!

4. The Core with 2 Players � How does this relate to 2-person bargaining? You will never get less than your BATNA, otherwise you�ll give up on negotiations and take your BATNA Depending on bargaining skill and the other factors described, you�ll get more or less of the surplus. (If you are evenly matched in skill, delay costs, and risks of breakdown, you�ll get half the surplus. But that is less certain than that you should never accept less than your BATNA)

5. The Core Consider the coalition of all players An allocation or competitive distribution just refers to a split of the total payoff available to all players An allocation is blocked if some individual or subgroup is better off separating and going their own way (i.e. the allocation does not give them their outside option) An allocation is in the core if it cannot be blocked by any individual or coalition

6. Airline JV example Three airlines, A, B and C are negotiating a joint venture By allying themselves, the airlines can offer business customers unbroken service from Europe, through the US to Asia (and back) An airline not joining the JV receives no surplus (BATNA = 0) Airlines A and C create no surplus alone A and B can generate $100m without C B and C can generate $150m without A If all three work together, a $200m surplus is generated Note: Airline B is critical to the JV This should influence what it gets as a result of negotiations

7. Airline example What is the �range of likely bargaining outcomes? Is an equal split likely? No! Under an equal split, A, B and C each get $200/3 ? $66.7. B and C get an aggregate payoff of $400/3 ? $133.3. But, B and C can produce $150 on their own Rather than take $66.7 each to join the big JV, they could form their own JV and get, say, $75 each! Can�t imagine B and C would ever freely agree to such a deal Essentially, A and C compete to obtain B�s productive services A competitive distribution is one where A and B together get at least $100; B and C together get at least $150; and the total $200 is divided up For example, if B got $150 and neither A nor C got anything, the stability requirement would be satisfied, but not the feasibility requirement On the other hand, B getting the whole surplus of $200 is competitive So is: B gets $50, A gets $50 and C gets $100 There are many other possibilities, some of which may be much more likely than others

8. Another example Suppose that there are three agents. Together they can generate $120 in value. Individually they can not generate any value. Any coalition of 2 agents can generate $100. Conclusion: there is no stable allocation � the core is �empty.�

9. The empty core problem What happens where there is an empty core? Solutions: This can be solved if one party �seizes the initiative� and acts first to commit to certain aspects of the bargain Change in ownership Repeated interactions

10. Lessons on multi-party bargaining The core sets the range of bargaining outcomes No player or sub group gets less than their outside alternative No player or sub group gets more than their added value But the core may not exist � unstable bargaining As before, in some cases a player can seize the initiative and set the rules of bargaining to favour themselves

11. Added Value A useful tool in multilateral bargaining

12. V � the total surplus The number of possible transactions in a market is HUGE Under arm�s-length transactions, freely undertaken, there is no reason for agents to engage in inefficient deals Any group of agents engaged in inefficient deals can do better � relative to any feasible compensation scheme under the inefficient regime � by switching to an efficient deal and splitting up the additional value among themselves No agent has a built-in advantage No one gets to make take-it-or-leave-it offers (agents negotiate until everyone is satisfied) No one has an information advantage (relative to knowing the available opportunities facing the various groups) So, think of the entire market as a team whose objective is to maximize the aggregate surplus (just like we did in the 2-agent case) This maximum quantity of economic value is V

13. Total Surplus Economic surplus = same idea as 2-agent case How is V measured?

14. Cooperative DM & Added Value Remember: To find the actions that maximise surplus, think of the bargaining players as a big team or a family, doing what�s best for the group. Added Value = roughly, the economic profit from you cooperating with the rest of the group maximise the pie, cooperate (Group & you) a new option! Others cooperate, but you don�t cooperate with rest of group

15. Your added value What is your economic contribution to the market? A certain amount of surplus can be produced without you Denote this amount V-you Since V is efficient, V-you must be less than V With you, V is possible Hence, the amount of value you contribute is V � V-you We call this difference your added value Denote this avyou Note: V-you is the maximum surplus all other agents can produce if you refuse to transact with them

16. What is your Added Value? Put simply,

17. You can�t get more than avyou ! Why will the other agents never agree to deal in which your a payoff surpasses your added value? Because, rather than agreeing to a deal in which ?you > avyou, the other agents can: Tell you to s*d-off, produce V-you, and Share it in such a way that they are all better off To put it differently, any distribution in which ?you > avyou fails the stability requirement because

18. Implication: limit their added value! A key aspect of modern strategy = try to limit the added values of other agents = make them dispensable! If the other agents� added values are small relative to yours, you may have the opportunity to appropriate a much larger share of the pie In fact, if they are sufficiently small, you may be guaranteed an economic profit (payoff above your BATNA) Suppose You must get ?you > BATNAyou! (why?)

19. Competitive Advantage Can the Added Value framework tell us something about what gives a firm a �competitive advantage� What is competitive advantage?

20. Our definition of competitive advantage ? Competitive alternatives guarantee appropriation above next-best alternative (in the context of the firm = liquidation value) This is not the firm�s objective, but it is a performance measure This is not the firm�s objective, but it is a performance measure

21. Example 1: Pure Bargaining Suppose you have one firm, F1, and one buyer, B1. The firm can produce 1 unit at zero cost The buyer only wants to buy 1 unit with WTP = $1 F1 and B1 both have AVs of $1 But the most F1 can guarantee itself through competition is $0. E.g., B1 makes a TIOLI offer to F1

22. Example 2: Pure Competition Outside options B1 can buy product from another for $0.50. F1 can liquidate assets for $0.50 TS = WTP � WTS = $0 Minimum F1 can guarantee itself is $0.50 which is equal to its (new) WTS No competitive advantage.

23. Example 3: Capacity Constraints F1 has one unit of capacity B1 and B2 value one unit each at $1 Outcome F1 sells to one buyer Can guarantee itself a price of $1 as B1 and B2 compete with one another F1 has a competitive advantage

24. Example 4: No capacity constraints F1 can produce 2 or more units B1 and B2 value one unit each at $1 Outcome F1 sells to both buyers Cannot guarantee a profit above $0. F1 does not have a competitive advantage

25. Summary Competitive advantage means you can appropriate surplus even if you are not a good negotiator. Need positive AV to appropriate surplus through bargaining Positive AV is no guarantee of appropriating surplus Need also to limit the AV of others and create competition If others� AV is limited then have a competitive advantage

26. Monopoly What is a monopoly and is it �bad�?

27. What is a monopoly? A monopoly is a market with a single producer. All of the substitutable products are controlled by the same player.

28. Examples Trains Water service Australia Post? Large employer in a small town Quality monopolies: Sony Trinitron, Nintendo Entertainment System Microsoft �

29. It�s All in the Cards I have 10 red cards 10 students each have 1 black card A red card and a black card together are worth $10 (paid by the Dean) Who will get what?

30. It�s Mostly in the Cards We get another chance to play the game But I find there are 3 red cards missing Pie is smaller by $30 Is everyone worse off?

31. Application: Several Customers Assume that there is a monopolist seller and three buyers. Also assume that there is sufficient capacity to cover all three customers. Seller�s costs are $2 per unit. Each buyer has a WTP of $8.

32. Surplus Created What is total surplus in this market?

33. Added Value of a Buyer What is the Added Value of Buyer 1?

34. Value Created AV of each buyer = $6 AV of monopolist = $18 ? What is the range that the price of goods can take, in each transaction? The monopolist derives no bargaining power from monopoly: it�s like one buyer facing one seller, for each unit. ? If prices split the difference, the price will be $5 and the monopolist will earn $9 = 3 ? $5 - 3 ?$2

35. Limited Supply Now suppose that the monopolist can only produce two units. Cost per unit is still $2. What is total value in this market? ($8 - $2) � 2 = $12 What is the added value of a buyer? ($8 - $2) x 2 � ($8 - $2) x 2 = $0! the Added Value of buyers has fallen drastically According to the core, the monopolist may earn $12 rather than $9.

36. Competition Among Buyers Potential competition from buyer 3: 3 is the �excluded buyer� : (s)he would like to replace 1 or 2 If either 1 or 2 leave the game, the seller can still sell to 3 No buyer is �needed� to sell a unit: each buyer has zero added value. However, the presence of excluded buyer 3 is very valuable to the monopolist: she pushes 1 and 2�s added value to zero, and they earn less.

37. �CORE� Bargaining: CORE bargaining = players never get more than their added value ? What do the buyers get if monopolist sells 2 units to 3 buyers, each with WTP of $8?

38. How much capacity? Usual trade-off is about uncertainty or variability in sales: Underbuild - lose sales Overbuild - pay for unused capacity Added-value trade-off Underbuild - limit customer�s added value Overbuild - every customer is powerful

39. Good vs Bad Monopoly Bad monopoly power refers to the practice of firms restricting output (or otherwise destroying value) in order to diminish buyers� added value. If a monopolist can capture most of the value without destructive strategies, this is bad for its buyers, but good for society. Name some �good� and �bad� monopolies

40. Water and Diamonds �Nothing is more useful than water; but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.� Adam Smith, Wealth of Nations, 1776. In 1776, diamonds were relatively rare.

41. Why are diamonds so expensive? Relative scarcity caused high value Created incentives to find new deposits. This was done over the next two centuries. There is now an abundance of diamonds. Why do they cost so much? DeBeers ...

42. The DeBeers Monopoly Almost all of the world�s diamonds sold through DeBeers� distribution system or Central Selling Organization (including Russia). DeBeers restricts supply: invites a selected number of dealers. If they try and speculate they are not invited back. DeBeers manages demand through marketing. How much longer will the monopoly persist?

43. Conditions for Monopoly Power When can a firm exercise monopoly power? Credibly restrict output (DeBeers) Reputation for output reductions (Disney) Insufficient plant (Nintendo) When can�t a firm exercise monopoly power? Banking, unions

44. Lessons for a monopoly A monopoly needs to consider the costs and benefits of limiting supply; Benefits: Get bigger slice of the pie Prestige value May gain free publicity May encourage customers to buy �slower moving� parts of range

45. Lessons for a monopoly A monopoly needs to consider the costs and benefits of limiting supply; Costs: Reduces total pie May effect customer relationship and future sales May create general buyer ill will Leaves a hole in the market that may encourage entry

46. Multiple buyers and sellers Three sellers, 1, 2 and 3, Capacities = one unit only Costs shown BATNAs = 0 Three buyers, A and B and C, Each buyer views sellers� products as identical But, they have different WTPs So, A will pay up to $7 for a unit of product from any firm Buyers value 1 unit only

47. Surplus-maximising deal Figure this out using marginal thinking: Does it create surplus to produce one unit? Arrange value-maximising transaction In this case, it is Seller 1 and Buyer B = 7 If so, does it create more surplus to produce a second unit? Here there are only 3 units; otherwise can keep going Useful approach: Graph WTP in descending and WTS in ascending order

48. WTP and WTS with many buyers and sellers

49. Surplus = V

50. Competitive Distribution (CD) How do you find a competitive distribution? (Feasibility) Maximise surplus (Stability) Ensure that each coalition is given sufficient value Could use linear programming (through Excel) Or rely on market clearing prices �

51. Easier to graph and use market-clearing prices

52. Market clearing prices ? CD At a price of $6, distribution of value is:

53. Market-clearing prices MCP ? CD in this special case Sequence of bilateral deals (no market depth; i.e., suppliers, distributors) Homogeneous goods, heterogeneous agents Any price between $5 and $6 generates a CD At $5 (lowest competitive price) Buyers appropriate their highest competitive value Sellers appropriate their lowest At $6 (highest competitive price) Buyers appropriate their lowest competitive value Sellers appropriate their highest Important: the maximum surplus an agent can appropriate is not always equal to their added value If other agents have sufficiently attractive alternatives to dealing with you, attaining your added value may not be possible Using market-clearing prices in this setup always gives accurate answers regarding the range of surplus an agent can attain Check to see that at a price above $6 or below $5, the implied CD is no longer competitive

54. Outcome with multiple buyers and sellers Result: Competition from the excluded buyer and seller limits range of possible prices If either buyer pays more than $6, excluded seller 3 will jump in with an offer to sell for a little less ? price will be pushed down below $6 If any seller gets less than $5, excluded buyer C will jump in with an offer to pay a little more ? price will be pushed up above $5. ? buyers will be paying similar prices (i.e., between $5 & $6) This is different from the result with a monopolist: With a monopolist, buyers can pay different prices, based on their WTP But with competition, the presence of excluded sellers puts a ceiling on prices

55. Perfectly competitive market Same setup as before, with a small change to buyer C This market is perfectly competitive! To demonstrate, show that there is one market clearing price! The resulting CD is unique

56. Graphical analysis

57. Interesting �

58. Any time the avs add up to V The market is perfectly competitive In the unique CDV, every agent gets exactly their av In such situations, agents are �full appropriators� Each agent gets exactly what he contributes CDV entirely determined by competitive forces PCM does not imply zero economic profit! It can be that all agents get zero surplus But it is not necessarily so This property holds for any unstructured, multi-party bargaining situation (i.e., of the type described in this lecture � not just the special case of bilateral homogeneous goods most recently discussed above) Useful fact: adding up ? perfect comp.

59. Understanding undergraduate S&D As more and more buyers and sellers join the market, there is less and less gap between the WTP of different buyers and the WTS of different sellers Lining up the buyers according to their WTP starts to look like a smooth line, not a �staircase� With many buyers & sellers, there is almost no variation in the possible prices that can be negotiated: If a seller tries to get a higher price, lots of sellers willing to sell for less If a buyer tries to get a lower price, lots of buyers willing to pay more ? the �law of one price�: in a big market, most transactions take place at very similar prices. Ex: Foreign exchange markets

60. WTP and WTS with 5 buyers and 5 sellers

61. WTP and WTS with many buyers and sellers With many buyers & sellers, there is almost no variation in the possible prices that can be negotiated

62. Summary Examining multilateral bargaining requires careful quantitative analysis Can use some rules (e.g., market clearing) to sometimes simplify the problem The main interest is in what actions might change negotiations �