Est. time: 20 min.
- Understanding the economic and psychological dimensions of take-it-or-leave-it offers
- Recognizing the pros and cons of issuing an ultimatum
- Appreciating the nuances of bargaining power even in seemingly simple situations
Negotiations sometimes reach a point where one party issues a take-it-or-leave-it ultimatum. The other party then has to decide whether to accept the proposed terms, or to call the bluff of the person who made that demand. Ultimatums are critical moments where the outcome of the process can teeter between deal or deadlock.
Behavioral psychologists have gleaned important insights into the dynamics of such situations by studying how subjects complete a short exercise called the Ultimatum Game. Later in this module you'll see a summary of key findings, but first you'll have the chance to do the exercise yourself. Your responses will not be saved after you leave this site, so please be sure you have 20 to 30 minutes to complete this whole module. Otherwise, come back when you have enough time.
The Ultimatum Game
This short exercise has no right or wrong answer, but it does illustrate important negotiation concepts. The exercise here has two different versions. In order to make this random, please start with a version according to your date of birth. If you were born in an even-numbered year (such as 1954 or 1998), choose the Allocator Version. If you were born in an odd-numbered year (such as 1983 or 1997), choose the Recipient Version. After you have completed your assigned version, we encourage you to try the other one.
Behavioral economists, psychologists, and social scientists have long studied different versions of the game you just played. Their fascination lies in the fact that most people disregard its basic logic. In a narrow sense, people are irrational, though many of us would commend them for that.
Here’s the strict logic:
1. The person in the Allocator role should desire to maximize their payoff.
2. To achieve that goal, the Allocator needs to win the Recipient’s approval of the proposed split. (Otherwise both parties get nothing.)
3. It should be easy to win the Recipient’s approval since it would be irrational to refuse any positive number (as one dollar—or even a single penny—is worth more than nothing.
In practice, however, very few Recipients are willing to accept a minimal amount. Typically they demand between 25 and 30 percent of the stakes. There’s variation on both side of that median. Some Recipients would be willing to live with much less; a few others demand an even 50/50 split.
Strict economists might say that most Recipients are behaving irrationally. That assumes that the only thing to care about it is money, but many people also care about being treated fairly. If a large pie is being divided, they don’t want to be stuck with a few crumbs. They reject a deal out of pride and self-respect.
Then there’s the vengeance factor. The person who insists on receiving $30 and thus rejects an offer of $20 loses that money, of course, but has pleasure of inflicting an even greater loss on the Allocator who proposed that split.
Note that we started this analysis from the Recipient’s point of view. That’s partly because the Recipient has a choice to make. But it’s also because the Allocator’s decision should be informed by their assessment of what the Recipient is likely to do. It’s possible, of course, that some Allocators may be similarly concerned with fairness and not want to think of themselves as greedy. As a result, they may give a quarter, a third, or even half of the amount to the other side.
Other Allocators may be solely concerned with maximizing their own financial payoff, but even they must take into account the thinking of their counterpart. They may be motivated to offer more than a minimal amount—not out of generosity—but simply to increase the odds of having their offer accepted. This involves weighing tradeoffs:
- The more that the Allocator offers, the greater chance the Recipient will accept it; but
- The more the Allocator offers, the less they keep of the remains.
The challenge for the self-motivated Allocators is putting themselves in the shoes of Recipients who may think differently than they themselves do. Moreover, not all Recipients think the same way. A split that would be accepted by one person could be rejected by someone else. Even if the Allocator has perfect information, they have to consider their tolerance for risk. If they're gamblers, they might be willing to make an aggressive demand so that if the split is approved, there's a big payoff. On the other hand, if an Allocator is facing a lot of overdue bills, they may need to be more cautious so that they don’t end up empty-handed.
Now let’s bounce back to the Recipient’s point of view for just a moment. In addition to making a judgment about fairness, they must likewise think strategically by putting themselves in the Allocator’s shoes. Even if the Recipient is only concerned about maximizing their financial payoff, they should still think about how much—if at all—the Allocator cares about fairness. If it’s reasonable to expect that the Allocator will be fair to some degree, then the Recipient should ask for more than their minimum.
That’s especially true given the rules you were playing under. Recall that the Recipient would simply get the minimum that they stipulated, even if the Allocator in that particular round actually offered more. If instead, the rules said that the Recipient would get whatever the Allocator offered, then the Recipient would have nothing to lose by lowering their minimum. In the worst case, they would get their minimum amount, and often they would get a bonus. Of course, in anticipation of that strategy, Allocators might lower their offers. Nevertheless, the rules here were designed to prompt you to think harder about the rewards and risks of making more aggressive bids.
Thousands of articles have been written about the Ultimatum game over the years. There’s no need to distill all that research here, but it’s worth noting the implications of several different kinds of experiments that have been run.
- Varying the amount of the stakes. It appears that people (on both sides of the game) care about fairness whether the amount being divided is large or small. Recipients are willing to veto deals that they think are unfair, even if that means forgoing a large payoff.
- Multi-round versions of the game with the same pair of players. Here the strategy is different for the two parties. If each knows that there will be future rounds, each will be concerned about their immediate payoff, but also about longer term consequences. For example, a Recipient might veto reasonable proposals in the early rounds in attempt to force the Allocator to be more generous later. (At the same time, of course, the Allocator may try to signal their resolve by making meager offers.)
- Anonymity. Allocators are less generous (and Recipients less demanding) when they don’t know with whom they are dealing. Seeing someone in person may evoke more empathy on the Allocator’s part.
- Unknown stakes. In other studies, the Allocator knows the sum that is being divided, but the Recipient does not. Results show that fairness is relative. A Recipient who might be very satisfied getting $10 of a $20 pot could angrily reject $10 if that meant the Allocator would keep $90.
- Dictator game. In this version, the Allocator has total power and can force any outcome. The Recipient has no veto power. Even then, Allocators tend to give the Recipient something—though less than they do under the rules that applied when you played. That strongly suggests that many people do care about fairness for its own sake, not mere as a tool for winning other people’s assent.
Such findings, taken as whole, have implications for all types of negotiations. First, they confirm that fairness is a concern of many negotiators, though people vary widely with respect to what they think is fair. Second, perceptions determine feelings about fairness more than reality; your counterpart may reject a reasonable offer, erroneously believing that you could provide much more, even though that’s not the case. Third, you need to think about fairness strategically when preparing for and conducting a negotiation. The operative question isn’t how others should react to your offers; rather, it’s how they likely will.
Two final notes. The research briefly summarized here typically focuses on the quantitative side of ultimatums (how much is offered or demanded). But how an ultimatum is delivered surely matters, as well. A take-it-or-leave-it number that is expressed as a challenge invites rejection. One that explains why this is the best that you can do has a better chance of acceptance.
Then there is the matter of responding to ultimatums. Harvard Business School Professor Deepak Malhotra offers some surprising, but practical advice in his book, Negotiating the Impossible. "Ignore ultimatums," he says. "The more attention you give them, the harder it will be for the other side to back down if the situation changes."
When someone says "absolutely not" or "it’s against company policy," the natural impulse may be to ask why or for an exception—or to challenge the assertion itself. But it's often smarter to let the remark pass without comment. Your counterpart may have spoken in haste or may have been bluffing. Given time, they may soften their position—provided you haven't reinforced it. The worst thing to do is to rise to the bait. Don't ask if they really mean what they said. If someone paints themself into a corner, why hand them another bucket?
As you now can see, there is no right answer in the Ultimatum game. If you are the Allocator, a division that you propose may be accepted by many people but rejected by others. Likewise, if you are the Recipient, some Allocators may be willing to meet your minimum threshold while others will not. Nevertheless, whichever your role, there are helpful ways to analyze your options and make an informed decision.
- Think interactively: what is your counterpart likely to decide?
- Do not assume that your counterpart thinks the way that you do. Instead, consider both best- and worst-case scenarios.
- Fairness matters to many people, though not everyone. Even those who care about fairness have different perceptions about what is just.
- Although no counteroffers are possible in this game, the fact that the Recipient can veto a deal gives them a measure of power.
- In setting your figure, you must balance reward and risk. On the one hand, the more you ask for, the greater your potential gain. On the other hand, the more you ask for, the more likely you are to get nothing.
For more on this topic, explore the Brinksmanship module in this unit.
Deepak Malhotra, Negotiating the Impossible