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Designing Deals for Lasting Value

by David A. Lax and James K. Sebenius 

Negotiation involves the art and science of drawing up deals that create lasting value.  Deal design is an essential part of 3D Negotiation™ that is often overlooked.

Deal design is where the win-lose negotiator, in particular, comes up short.  To the win-lose type, the broad outlines of the deal are self-evident.  So the core challenge of negotiating lies in choosing the best tactics to win—to win the best price, the most generous terms, or whatever.

Deal design requires a systematic approach: when a proposed deal does not offer enough value to all sides, or when its structure won’t achieve its purposes, deal designers must go to work “on the drawing board,” sometimes solo, sometimes jointly.  Yet even when a deal can be made without clever deal design, creative deal designers can achieve an even better agreement for all parties.  Their deal designs create value, often unexpectedly, guided by general principles and specific techniques that are part of the 3D Negotiation approach.

Maybe we need to make a definitional aside, as we introduce this term.  “Back to the drawing board” sometimes has a negative connotation—that is, a starting-from-scratch connotation—that we don’t intend.  Rather, we use the drawing-board metaphor to invoke notions of creativity, invention, and fresh thinking guided by potent underlying deal design principles.

Smart people working at the drawing board sometimes can discover hidden sources of economic and non-economic value, then craft agreements—design deals—that unlock that value for the parties involved.  For example: Is it really a pure price deal?  Does some sort of trade between sides make sense and, if so, on what terms? Can we unbundle different aspects of what looks like a single issue, and give to each side what it values most? Should it be a staged agreement, perhaps with contingencies and risk-sharing provisions?  If there’s a contract involved, should it be an unusual kind of contract—one with a more creative concept and structure than we’ve used before?  One that meets ego, needs as well as economic ones?

The Value in Differences

Conventional wisdom says that we negotiate to overcome the differences that divide us. So, typically, we’re advised to find win-win agreements by searching for common ground. Common ground is generally a good thing. Yet many of the most frequently overlooked sources of value in agreement arise from differences among the parties. Deal-design principles can systematically point to agreements that create value by dovetailing differences.

For example, when Egypt and Israel were negotiating over the Sinai, their positions on where to draw the boundary were incompatible. When negotiators went beyond the opposing positions, however, they uncovered a vital difference of underlying interest and priority: the Israelis cared more about security, while the Egyptians cared more about sovereignty. The solution was a demilitarized zone under the Egyptian flag. Differences of interest or priority can open the door to unbundling different elements and giving each party what it values the most, at the least cost to the other: a core principle of deal design.

A good win-win negotiator may well come up with such creative agreements through focusing on interests, not positions, and brainstorming options.  The distinctive contribution of deal design, however, is to crystallize and much more systematically develop the underlying principles. ¹

Deal Designs that Bridge the Value Gap

Let’s look at an example of another kind of difference, focusing on how divergent forecasts can fuel joint gains.  Suppose an entrepreneur, who is genuinely optimistic about the prospects of her fast-growing electronics-components company, faces a potential buyer who likes the company but is much more skeptical than the entrepreneur/owner about the company’s future cash flow.  They negotiate in good faith, but at the end of the day, the two sides sharply disagree on the likely future of the company and so cannot find an acceptable sale price.

Instead of seeing these different forecasts as a barrier, a savvy deal designer would perceive opportunities to bridge the “value gap.”  One option would be a deal in which the buyer pays a fixed amount now and a contingent amount later, with the contingent amount determined by the future performance of the company.  Properly structured, with adequate incentives and monitoring mechanisms, such a contingent payment (or “earn-out”) can appear quite valuable to the optimistic seller—who expects to get that earn-out—but not very costly to the less optimistic buyer.  The seller’s willingness to accept such a contingent deal, moreover, may give the buyer the confidence he or she needs to go through with the deal.  The two-step payment process may make the deal sufficiently attractive to both parties—and more attractive than walking away.

As we demonstrate in our book, 3D Negotiation, a host of other differences make up the raw material that skilled deal designers transform into joint gains.  For example, a less risk-averse party can “insure” a more risk-averse one.  A more impatient party can get most of the early money, while his more patient counterpart can get considerably more over a longer period of time.  Differences in cost or revenue structure, tax status, or regulatory arrangements between two parties can be converted into gains for both.  If one party mainly cares about how a deal looks to a key constituency, while the other focuses on substance, the right deal design can create value for both.  Indeed, for a savvy deal designer, conducting a disciplined “differences inventory” is at least as important a task as identifying areas of common ground.

Deal design is just one of the three elements of our 3-D scheme of negotiation.  While our first dimension, tactics, focuses mainly on the interpersonal process at the table, deal design shifts toward substance and outcomes, often significantly away from the table itself.

The third dimension, setup moves—often the most potent actions a 3-D Negotiator can take—completes that shift.  It takes place entirely away from the table.

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David A. Lax and James K. Sebenius are the authors of 3D Negotiation – Powerful Tools to Change the Game in Your Most Important Deals (Harvard Business School Press, September 2006). For more information see their book website www.3dnegotiation.com and their business website www.negotiate.com.  

Adapted with permission from Harvard Business School Press from 3-D Negotiation: Powerful Tools to Change the Game in Your Most Important Deals by David A. Lax and James K. Sebenius. Copyright 2006 David A. Lax and James K. Sebenius. All Rights Reserved.

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Some links for your own research

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1 Here Fisher, Ury, and Patton (1991) are the trailblazers. Getting to Yes has done more to highlight the critical value of “interest-based” negotiations, as opposed to “positional bargaining,” than any other negotiation experts.  The first systematic exploration of the role of differences in deal design can be found in Sebenius (1980, 1984), and in Chapter 5 of Lax and Sebenius (1986), The Manager as Negotiator, New York: The Free Press.