Barry Nalebuff Presenation Slides

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A GUESSING GAME

I’ve picked a number between 1 and 100You get 5 guesses.

If you are correct on 1st guess, you get $100If you are correct on 2nd guess, you get $80If you are correct on 3rd guess, you get $60If you are correct on 4th guess, you get $40If you are correct on 5th guess, you get $20

Game is real

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A GUESSING GAME

Hint: Each time, I’ll say if you’re too high or too low

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My Prediction

50253743

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48

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11

DividingCosts

Negotiation

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AIRFARES

¤ Split the total»Houston pays $1,409»SF pays $1,409

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$666

$1,243

$909

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AIRFARES

¤ Split the total»Houston pays $1,409»SF pays $1,409

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AIRFARES

¤ Split Houston leg» Houston pays $666 + $909/2 = $1,120.50» SF pays $1,243 + $909/2 = $1,697.50

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$666

$1,243

$454.50$454.50

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AIRFARES


¤ Split costs proportionally» Houston pays 1,332/(3,818)*2,818 = $983» SF pays 2,486/(3,818)*2,818 = $1,835

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AIRFARES



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AIRFARES



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AIRFARES

¤ Split Total» Houston pays $1,409» SF pays $1,409» Problem is that this is more than Houston roundtrip



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AIRFARES

¤ Split Total» Houston pays $1,409» SF pays $1,409» Problem is that this is more than Houston roundtrip



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Two Extreme Positions

SF says to Houston: You pay $1,332. That’s what you would have paid anyway.

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What’s the best

argument for Houston?

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Two Extreme Positions

SF says to Houston: You pay $1,332. That’s what you would have paid anyway.

Houston says to SF: You pay $2,486. That’s what you would have paid anyway.

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AIRFARES

¤ NY --> Houston --> SF --> NY $2,818

¤ Total with two trips is $1,000 more

¤ NY --> Houston roundtrip $1,332¤ NY --> SF roundtrip $2,486

Total $3,818

The $1,000 savings requires both firms equally. If either doesn’t cooperate, then 1k is lost. Hence split savings.

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AIRFARES



¤ Split $1,000 cost savings» Houston pays $1,332 - $500 = $832» SF pays $2,486 - $500 = $1,986

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$666

$1,243

$743$166

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Quick Test

Runway Problem –Littlechild and Owen (1973)

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A B

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Runway Problem

Airline A needs runway of length 1Airline B needs runway of length 2

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A B

1

Runway Problem

A & B split cost of first legB pays cost of second leg

A pays 0.5B pays 1.5

Uber Pool

6A B

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Alice and Bob share an Uber from LAX

Alice gets dropped off first.

How should they split the $12 fare?

LAX Alice pays 3

Bob pays 3 + 6?

6A B

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Now what?

LAX

Alice pays 3

Bob pays 3 + 6?

6A B

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Do we split the fare in proportion to the one-way fares?

A pays 6/17 * $12

B pays 11/17 * $12

LAX

11

6A B

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What’s the Pie?

11 + 6 – 12 = $5

Alice paysBob pays

LAX

11

6A B

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What’s the Pie?

11 + 6 – 12 = $5

Alice pays 6 – 2.50 = $3.50Bob pays 11 – 2.50 = $8.50

LAX

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6AB

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Diversion version

Alice and Bob split first leg (Alice & Bob pay 3)Bob pays 6 by selfDiversion cost is 1 (12 versus 11 for Bob)

Who should pay cost of diversion?

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LAX

6AB

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Diversion version


Alice since Alice is out of the way

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LAX

A’

If only Alice lived here

6AB

Diversion version


Bob since Bob is out of the way

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LAX

B’If only Bob lived here

6AB

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Split diversion cost: they are equally out of the way

Alice pays half diversion cost: 3 + 0.5 = $3.50

Bob pays 2.5 + 6 = $8.50

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LAX

6

A

B

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What if Alice gets in first, then picks up Bob, then gets out along the way?

A exits

11 9B exits

6

No agreement: Alice pays 11 & Bob pays 9Agreement: Total cost is 6 + 6 + 6 = 18

Pie = 20 – 18 = 2

Alice pays 11 – 1 = 10Bob pays 9 – 1 = 8

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A

B

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A exits

11 9B exits

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Diversion Version

Alice pays full 6 – since he is aloneAlice pays 3 (splitting second leg with Bob)Bob diversion effect is (12 – 11) => Bob pays Alice 0.5Alice diversion effect is (12 – 9) => Alice pays Bob 1.5

Alice pays 6 + 3 – 0.5 + 1.5 = 10

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A

B

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A exits

11 9B exits

6

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What is the Pie

¤ Agreement A + B get 300 – 50 = $250

¤ No Agreement A gets 100 – 50 = $50

B gets 200 – 50 = $150

No Agreement Total $200

¤ Hence the pie is $50

What is the Pie

¤ Agreement A + B get 300 – 50 = $250

¤ No Agreement A gets 100 – 50 = $50

B gets 200 – 50 = $150

Thus A gets $50 + $25 = $75

B gets $150 + $25 = $175

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Merger

Case

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Joint Purchasing¤ Gazette proposes splitting gains proportionately: 2 for

Gazette to 1 for Post

¤ Post says split them the other way (Post gets 2/3rds!). It is Post extra volume that saves Gazette money. Hence Post should get all of that gain. Gazette can keep savings created by its ability to lower Post costs.

¤ Above is rhetorical argument. Point is that both gains should be split evenly.

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Symmetry

Every argument can

be turned around

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Cost Savings

¤ Gazette has better know how =>gets to keep full $1m savings

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Cost Savings

¤ Gazette has better know how =>gets to keep full $1m savings

¤ Post brings to the table worse costs. If costs were lower, less savings to be had.

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Macro Perspective

¤ Current values are 10m and 22m.¤ New joint value is 41.85m¤ Create 9.85m¤ Split gain evenly¤ Gazette pays 10 + 4.925 =

14.925m¤ If Post walks away, 9.85m is lost

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TCC and HT

¤ Coke purchasing power helped Honest reduce the cost of plastic bottle from

19¢ to 11¢.

¤ On 100 million bottles that’s worth

¤ Who should get this gain?

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TCC and HT

¤ Pay market multiple on sales up to $XXm

¤ Pay 0.5 * market multiple on sales thereafter

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Rio Tinto & BHP

¤ $30 billion of synergies

¤ Market caps: $160b and $250b.

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Power in Negotiations

¤ Doesn’t exist!

¤ Once you define the Pie, the two are symmetric.

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What Might it Mean?

¤ Token example

¤ 101 tokens. Each is worth

¤ $1 to Alice, 1¢ to Bob

¤ Does that mean Alice gets 1 and Bob gets 100 – so that they both end up with $1

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What Might it Mean?

¤ Token example

¤ 101 tokens. Each is worth $1 to Alice, 1¢ to Bob

¤ No. Alice is then giving up $100 while Bob is giving up 1¢. Why look at equality in payoff versus sacrifice?

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Physician Group Purchase

¤ One buyer (Hospital)¤ Two physician groups¤ V(0) = 0 no deal¤ V(1) = 100 buy one group¤ V(2) = 120 buy both

¤ If doctors merge, then 120 or 0¤ H gets 60; doctors get 60 (30 to each)

Zincit

¤ New drug for Acid Reflux.

¤ Zums has offered $20m. They plan to use drug as dietary supplement so no FDA approval required. This is their best offer.

¤ Zincit will apply for FDA approval. If approved, will earn profits of $120m. If not, then will make $20m.

¤ Seller thinks chance of approval is 60%.

¤ Buyer thinks it is 10%.

What is the Pie?First cut: Increasing profit from 20m to 120m in event of

approval

So it is $100m. Split it: 50m to each

Simple deal: Pay $20m upfront + 50% of profits above $20m

Probabilities are irrelevant

More Pie?To maximize the pie, seller should get $100m bonus if

FDA approval.

Worth $60m to seller and costs buyer $10m.

Best case for Seller / worst for Buyer: $15m upfront + $100m bonus

Worst case for Seller / best for Buyer: –$10m signing + $100m bonus

Midpoint: $2.5 upfront + $100m FDA bonus

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What is the Pie?Two levels

Level 1: Buy company and create chance of getting extra $100m

That suggests $20m upfront + $50m bonus

Level 2: Trade upfront for more bonus

Small Business & Entrepreneurship

Barry Nalebuff Presenation Slides