Settlement Negotiations: Anchors Aweigh!

Buyers snatched up a weathered house on my street late last year, and I soon learned they intended to remodel and “flip” it for a profit. A couple of weeks ago, the house, completely remodeled with the addition of a swimming pool, went on the market for a price that frankly stunned many of us in the neighborhood. Naturally, everyone likes to make a profit, particularly if the whole point of buying the house was to fix it up, turn around and sell it. But, these “flippers” had set the asking price at a fantastic 3½ times the home’s original sale price, well outside what any of us thought was reasonable.

This was running through my mind when I came across an article in last Friday’s Wall Street Journal about the wisdom of pricing real estate too high or too low. The article cited a recent study in the Journal of Economic Behavior & Organization addressing the notion of “anchoring.” Discussing this study, the WSJ article said:

“The research explores a behavioral trait called ‘anchoring.’ That is a common tendency to rely on the first piece of information offered (the ‘anchor’) when making decisions. Once buyers have an anchor, they typically interpret other information involved in the sale around it.”

It struck me that this “anchoring” phenomenon must have some application in other corners of the negotiation world, including what I do, settlement negotiations. We toss around terms like “low ball” and “inflated demand,” but I’ve never given too much thought to the deeper psychological implications of the launching point for negotiations.

I decided to solicit some thoughts on this point from experts, so I asked two prominent Los Angeles neutrals, Mark Loeterman (mlmediation.com) and Jeff Kichaven (jeffkichaven.com), for their view on the notion of “anchoring.” First, though, I reflected how I receive an extremely high asking price when shopping to purchase a piece of property or commencing a settlement negotiation. I’ve never had the experience of shopping for real estate without some kind of budget. If a house is priced outside that budget, even factoring in some cushion for negotiations, I won’t even look at it.

In the context of settlement negotiations, a ridiculously high demand can have a similar effect. While I don’t usually have the luxury of passing or ignoring a settlement demand, an outrageously high demand can have the effect of “anchoring” in my mind the notion that the case probably won’t settle, at least until something drastic happens to force my opponent to be reasonable.

Both neutrals I spoke with echoed this as a legitimate concern when dropping anchor. Jeff Kichaven pointed out that, “Sometimes opening numbers are so high, or so low, that they seem untethered to the realities of the negotiation, and are dismissed out of hand.”

What to do? If anchoring works because it sets the stage for all negotiations that follow, but must not be so overreaching that it “alienates” (my term) the parties, then it makes sense to push the envelope, but not too far. As Mark Loeterman remarked, “For anchoring to work, set initial offers and demands at the far edge of the credible zone so they can be rationally defended and invite further bargaining.”

Otherwise, it is not clear whether an overly aggressive opening demand or offer can be forgotten or cloud the entire negotiation. As Jeff Kichaven pointed out, “The interesting question to which I do not know the answer is whether “absurd” numbers also influence the later negotiations, or whether they are truly forgotten, and forgiven, as the negotiation goes on.”

So, when commencing negotiations, drop anchor, but do it with care, lest you do more harm than good.