More than from any other source, power and relative advantage in a negotiation stem from having a strong alternative. To say it plainly, your alternatives are those things you will consider doing if the deal you are working on falls apart or cannot be completed? The existence of a substitute action almost as good at the original deal leaves you close to invulnerable. That your alternative is relatively more desirable than the other guy’s gives you a significant bargaining advantage.
The idea of expressly identifying your very best alternative was developed at Harvard and is now used widely. This concept, referred to as BATNA (“best alternative to a negotiated agreement”) is familiar to virtually all students of negotiation. The genius of this notion lies in understanding that a whole bunch of good alternatives can actually mislead you. You cannot use them all but might be fooled by their cumulative weight into thinking your position stronger than it actually is. In reality, all you can do is implement the single best of them. Thus, it is the relative strength of your BATNA on which your negotiating power lies.
How can this negotiating concept help an investor? In considering any investment, you must decide how much it is worth. There are many ways to determine what The Street calls “fair value” – some of them are highly sophisticated while others are just silly. All of them purport to be objective measures of some quantifiable valuation. Ultimately, though, the work of an investor is subjective; you seek to pay less than it is worth to you. Indeed, all but the most befuddled investors are looking to “buy low and sell high.” No valuation metric can conclusively answer the most basic question: at what point is the price greater than what you should pay?
Consider the contribution that the concept of BATNA can make to your investing efforts. Instead of asking whether the price is right, or high, or “fair value,” you might inquire as to your alternatives. If I don’t invest in this deal, what else might I do instead? After examining all available possibilities, you can select the most favorable one and consider it your best investment alternative (BIA). Now you have something concrete to use for comparison. You also have a fallback position; if the investment under consideration falls through, you can substitute with your BIA instead.
This helps the investor in more ways than one.
It will stop you from making bad deals and help you evaluate the relative desirability of those investments you intend to make. With regard to the former, you will never invest in one thing when you have a more desirable substitute available. Thus, the act of evaluating alternatives and selecting your BIA will help you avoid overpriced vehicles, excess complexity, and various investment rip-offs.
An example based solely on price can illuminate the wider concept. An investor wishing exposure to a diversified group of Japanese stocks was considering the T. Rowe Price Japan Fund. That fund’s expense ratio was recently reported as 1.14% per year. Among the alternatives was the DFA Japanese Small Company Fund, which has an expense ratio of about half as much. This particular investor, very focused on costs, decided to buy the less expensive alternative. Of course, mutual fund expense ratios are not the only factor in picking such investments. The point is that regardless of what criteria you are using, gathering up your alternatives will help you compare and make wise choices.
Awareness of your best investing alternative can also sharpen your understanding of whether a deal is fabulous or merely “a little bit better” than other available choices. While a unique investment opportunity might legitimately require a substantial premium, something only slightly more favorable than its competitors should not command such a high price. An investor seeking to make a bet on the future of extremely well designed electric cars might be looking solely at Tesla Motors, Inc. The alternatives to Tesla are rather different in product, outlook, and prospects. If, on the other hand, her primary goal was to invest in a multinational automobile maker, she would find many alternatives including GM, Ford, Toyota, Volkswagen AG, and Nissan Motor Co. The existence of strong alternatives reduces the urgency of any one particular deal.
In summary, your life as an investor will be greatly improved if you take a page from the best negotiators. Know your alternatives and be clear on which is the very best choice among them. Use that knowledge to evaluate any investment you consider making. If, by chance, you find the alternative better than the original, you should switch them around. If the investment first contemplated is only slightly superior to the best alternative, be sure you are not paying too much. Only an investment that is genuinely unique will be worth paying extra for.