Using Decision Trees to Complete Your BATNA Analysis

0:09 we're looking at the unit on preparing 0:10 for negotiation 0:12 and it have at a very important question 0:15 which is how can i conduct a negotiation 0:18 analysis 0:20 we looked at a list of questions that 0:22 you should ask in completing 0:24 any analysis we then looked at a 0:27 specific problem that arises with 0:30 dispute resolution negotiation 0:32 and that is that your batna often 0:35 is litigation or perhaps arbitration and 0:38 therefore it's important to understand 0:40 what goes on in a litigation and some 0:44 fundamental differences 0:46 in a global economy between u.s style 0:48 litigation 0:49 and elsewhere now we're dealing with a 0:52 final 0:53 question relating to analysis of a 0:55 negotiation 0:56 and that is how can i use decision trees 1:01 to complete my batna analysis 1:04 a decision tree is a very useful tool 1:08 in doing the bad analysis and 1:11 beyond it's it's a very useful tool for 1:13 making all sorts of business decisions 1:15 so i hope that this 1:17 segment will be useful to you not only 1:20 in negotiation 1:21 but also in other aspects of 1:24 your personal life or your business life 1:27 so 1:28 let's start with this example 1:31 this happens to be a dispute resolution 1:33 example but i'll look at a deal making 1:35 example in a few minutes 1:37 let's say your company is sued a 1:38 supplier for 4.6 million 1:41 there's a 50 50 chance your company will 1:43 win 1:44 future legal and other expenses to 1:46 litigate the case total 1:48 400 000. during negotiations the 1:51 defendant has offered to settle the case 1:53 for 2 million 1:54 should your company accept the offer now 1:58 think about that for a second what does 1:59 your intuition 2:01 tell you if you use pure logic in 2:04 answering that question 2:05 you didn't use emotion you didn't 2:09 consider your attitude toward risk pure 2:11 logic 2:13 would it make sense for you to accept 2:16 the two million 2:17 dollar offer or to continue on 2:21 with your litigation where you might win 2:24 4.6 million okay write down your answer 2:28 you would 2:28 accept the settlement or continue with 2:30 the litigation 2:32 now let's look at how you can analyze 2:35 this question 2:36 by using a decision tree 2:40 a decision tree looks very much like a 2:42 tree 2:43 on its side and 2:46 the decision in a decision tree is 2:48 represented by a 2:49 square or rectangle as we have here 2:53 the decision is do you continue with the 2:55 litigation or do you settle 2:57 and then uncertainties in your decisions 3:00 are represented by circles and the 3:02 uncertainty is if you continue 3:04 will you win or lose so you start your 3:08 decision tree analysis with step one by 3:11 drawing a picture 3:12 of the decision and this is a very 3:15 useful tool 3:16 even if you never add numbers it's very 3:19 useful for clarifying your thinking 3:22 i use this tool constantly if i'm in a 3:24 meeting 3:25 and the conversation is drifting in 3:27 different directions 3:28 and it's unclear what this 3:31 decision is or what the uncertainties 3:33 are i find it very useful just in the 3:35 back of an envelope 3:36 to sketch out a decision tree to lay out 3:39 the options 3:40 but in this case we're going further 3:42 than this we're going to step two 3:44 which is to add the numbers so here are 3:47 the numbers 3:49 there's a 50 50 chance of winning 3:52 so you plug in the probabilities 3:55 if you win you will net 4.2 million 3:59 after deducting attorney's fees if you 4:01 lose you lose 4:02 400 000 whereas the settlement offer 4:06 is 2 million and then step 4:09 3 the final step is to calculate 4:13 weighted averages 4:15 so in this case fifty percent of four 4:18 point two 4:19 is two point one minus fifty percent 4:22 of four hundred thousand brings you to 4:26 a weighted average of 1.9 million which 4:28 is the expected value of continuing 4:31 and you can see here that that's less 4:33 than accepting the settlement offer 4:35 therefore logically you should accept 4:39 the settlement offer absent other 4:42 factors 4:43 so this gives you a nice tool for 4:45 analyzing 4:47 your badna in a dispute resolution type 4:50 negotiation such as this 4:53 decision tree analysis is also a very 4:56 useful 4:57 tool for doing a batna analysis when 5:00 you're involved in negotiating a deal 5:03 and here's an example let's assume that 5:06 you're 5:07 making a decision should you acquire 5:10 company a which has a 21 million dollar 5:13 value 5:14 or company b which has a 15 million 5:17 dollar 5:18 value the price is the same for both 5:21 companies 5:22 now if you stop there the decision would 5:24 be easy 5:25 of course you would acquire company a if 5:28 the price is the same as 5:29 for company b because of the different 5:31 valuation 5:32 however the problem is that if you 5:35 acquire company a 5:37 there's a 90 percent chance the 5:38 government will challenge the 5:40 acquisition 5:41 and a 60 chance the government will win 5:45 if the government wins the value of a 5:47 drops to 14 million 5:49 because of legal fees plus sell-off 5:51 costs 5:52 even if the government loses the value 5:54 drops 5:55 to 19 million because of legal fees 5:58 whereas if you acquire 6:00 company b there's not going to be a 6:02 government challenge we know that 6:05 so before you do a decision tree 6:07 analysis 6:08 what would be your gut reaction what did 6:11 your intuition tell you 6:13 about this decision would you 6:16 negotiate to acquire company a 6:20 or negotiate to acquire company b 6:23 please write down a or b 6:27 when i ask this question in class a 6:30 large majority 6:31 of the class usually picks 6:34 company b now let's try 6:38 a decision tree analysis of the same 6:40 decision 6:42 so you know now how to do a decision 6:44 tree analysis 6:45 remember the decision is the square 6:48 and the uncertainties are represented by 6:51 circles the decision tree looks like a 6:53 tree on its side 6:55 so draw a picture of this decision which 6:58 is step one 7:01 plug in the numbers and calculate the 7:04 weighted average 7:05 please hit pause while you do this and 7:08 then we'll compare results 7:14 this is what my decision tree looks like 7:17 for this decision the decision is do you 7:20 acquire company a 7:22 or company b and if you acquire 7:25 company a then you have two 7:26 uncertainties will the government 7:28 challenge the acquisition 7:30 and if the government does challenge 7:32 will the government win 7:33 or lose so that's the drawing of the 7:37 tree 7:38 and then you plug in your numbers 90 7:41 chance the government will challenge 7:43 10 percent chance no challenge 60 7:46 percent chance the government will win 7:48 40 percent chance 7:49 government loses if the government wins 7:52 the value drops to 14 million 7:54 even if the government loses the value 7:57 does drop a little to 19 million 8:00 whereas if there's no government 8:01 challenge company a is 8:03 worth 21 million so you plug in the 8:06 numbers 8:07 and then you do your weighted average 8:09 calculation 8:11 percent of fourteen plus forty percent 8:13 of nineteen 8:14 is sixteen ninety percent of sixteen 8:18 plus ten percent of twenty one 8:20 is sixteen point five so the weighted 8:23 average 8:24 or the so-called expected value of 8:27 acquiring company a 8:29 is 16.5 million which is still 8:32 quite a bit higher than the value of 8:35 company b 8:36 so if you'd use just a decision tree 8:38 analysis you know forgetting about 8:40 emotions forgetting about 8:41 attitude toward risk the logical 8:44 decision 8:45 would be to acquire company a 8:48 so in conclusion decision trees are 8:51 valuable tools for analyzing your bada 8:53 in both dispute resolution and deal 8:56 making negotiations 8:57 and this is a tool that you should also 9:00 use for making other 9:02 complex business decisions