What is the Winner’s Curse?

Why walking away is sometimes your best bet in business negotiation.

By — on / Conflict Resolution

Imagine that while exploring an outdoor bazaar in a foreign country, you see a beautiful rug that would look perfect in your home. While you’ve purchased a rug or two in your life, you’re far from an expert. Thinking on your feet, you guess that the rug is worth about $5,000. You decide to make a bid, but a low one. You engage the merchant in some pleasantries and then make an offer of $1,000. She quickly accepts, and the negotiation is complete. How do you feel as you walk away? Pleased with your purchase—which was, after all, far cheaper than you expected—or uneasy about it?

Most people who put themselves in this situation feel uneasy, sensing that the rug is not as good as they thought it was before agreeing to the price. The winner’s curse describes a common paradox in negotiation: winning something you wanted, then realizing that the other side’s acceptance tells you some disappointing news about what you just bought.

Identifying the winner’s curse

There are two main reasons that the winner’s curse is such a common—and dangerous—trap, even for professional negotiators:

  1. Your gains depend on the other side’s acceptance. When we bid on something, our gains depend on acceptance by the other party. This acceptance is most likely to occur under conditions undesirable to the bidder and favorable to the seller. Across many types of negotiation, most people fail to make this connection. Groucho Marx demonstrated his grasp of the winner’s curse when he said that he didn’t want to belong to any club that would have him as a member.
  1. The other side knows more than you do. After falling victim to the winner’s curse, you’re likely to notice that the other party—who is almost always the seller—was much better informed than you were about the terms of the deal. When you’re bidding on a commodity you know little about, your uncertainty is heightened. When you’re presenting this bid to an informed opponent, your expected return from the transaction will decrease dramatically. The average rug merchant will accept your offer only when the rug is worth less than your estimate.

How to avoid the winner’s curse

For bidders in a negotiation, the odds of falling victim to the winner’s curse are quite high. Often, the key to avoiding the trap is to incorporate the decisions of the other side into your own decision. Unfortunately, this is often easier said than done. But the negotiating strategies that follow will help you avoid becoming the next victim of the winner’s curse:

  1. Put yourself in the other guy’s shoes. Extensive research suggests that the winner’s curse results not from an inability to think about the decisions of other parties, but from our failure to do so in specific situations. Whether you’re haggling over a car, a house, or a piece of jewelry, before making an offer, imagine that your opponent will accept it immediately. Consider how you might react to such an acceptance. Will you feel elated or uneasy? Now ask yourself, “Does his acceptance tell me anything about the value of the commodity? Does he know something I don’t?” By asking these questions, you’ll recognize when you’re at an information disadvantage and adjust your bid accordingly—or refrain from bidding altogether.
  1. Develop—or borrow—professional expertise. To avoid the winner’s curse, you may need expert help, such as a mechanic’s unbiased evaluation of a used car, a professional inspector’s assessment of a house, or a consultant’s informed judgment about the value of a target firm. More generally, any negotiator facing a better-informed opponent in an important transaction should seek to lessen her information advantage. In the world of mergers and acquisitions, a deal is often contingent on due diligence that allows the acquirer to learn more about the actual state of the target. Too often, this stage is viewed as a legal formality. Wise managers use the due-diligence process to verify that the target is as sound as they expect it to be.
  1. Talk face-to-face. The interpersonal relationship created during face-to-face meetings can improve deals for buyers and sellers alike, and decreases the chances that one or both will walk away from the table. Communication creates trust and allows for the type of information exchange that can’t occur when bids are made at a distance. The buyer, typically the less-informed party, can gain valuable knowledge by conversing with the seller.

By taking these essential steps to boost your negotiating skills, you’ll improve your odds of not only winning your most important negotiations, but feeling like a winner as well.

Adapted from the article “The Winner’s Curse” by Harvard Business School professor Max H. Bazerman, first published in the Negotiation newsletter.

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