Art of Bargaining



I find bargaining with street peddlers and merchants highly challenging. My mom on an average can haggle 30% lower than my very best effort.
Interestingly, I am far more educated and professionally qualified than my mom. And I am often called upon at work to analyse multi-million dollar procurement deals and help them negotiate the best possible price.

Bargaining is an art and as I try to understand this failure of mine and the uncanny success of my mom, it is an interesting problem nevertheless.

Let's assume I am walking on a narrow stretch in South Delhi in my home country India when suddenly my eyes fall upon the most beautiful scarf. It's bright orange with beautiful hand crafted glass pickings. I know I have to get one and gift it to a certain someone. So I ask the merchant, how much is one, and he immediately replies " 500 Rupees Sir" (~11 USD).

Obviously my gut feel says it shouldn't be more than 100, so I reply back in our local language "Bhaiya hum to yehin ke hain. Sau rupai le leejiye. Usse zyada nahin ( Brother, I am from here. I am not paying more than 100) ". Our discussion continues and 5 mins later, we seal it at 150. I return home satisfied with a neat 70% reduction from his initial quoted price, but before I can celebrate, my mom returns with two such scarves at 80 Rupees each.

Amazing right. To deduce the above, I follow my mom, the next time to find out how she did it and construct my hypothesis. So here it is.

Defining Bargaining
Let's define two parties- A Buyer  and a Seller. Both of them have personal incentives to negotiate for the best possible price. Assuming this a niche good, and no one else in the vicinity sells exactly the same scarf, we would call the Seller a Monopolist.

This single buyer and seller situation is trickier than a competitve market, since competition can drive prices towards an equilibrium, nullifying any need for negotiation. And the goods in question are niche, non comparable items with no fixed marked price.

Perceived Value of the traded good
Compared to my mom, I value the scarf more, for it's an opportunity to impress the ladies. Imagine this pickup line, "Well, I was rushing for some urgent work when I saw this and thought how wonderful it would look on you. Hope you like it".

I would love to get the scarf (with all the other ancillary benefits) at 100Rs, but I can compromise till 150. This is my utility enhancing, perceived value of the scarf. Anything less, I would be happier. Anything more, I am better off not purchasing.
On the other hand, the only reason my mom is interested in it is a fact that long back I had told her to help me get something nice for my colleagues at work, each time I visit India. Her perceived value is my emotional gratitude to her for remembering my request. Let's not quantify mother's love by assigning a value to it.

This difference in perceived value leads to two things. Firstly, it makes me quote a higher first lowest bid (100 in my case whereas it was 50 in my mom's), after which I can only bid up. Secondly, I have a higher risk of losing the scarf if the exchange falls apart with the seller deciding not to sell, or not to quote below 150 ( my price tolerance limit). On the other hand, my mom has nothing to lose.
We economists call it a first degree price discrimination where the Seller (Monopolist) tries to ascertain our individual price tolerance, in order to extract the maximum value that each of us are willing to pay. The bargaining process is just a tool to assist him in deducing this perceived value.

Perceived Value of money
Living away from India has definitely spoilt me. For 150 Indian rupees, you can get 7 liters of milk, or 2 Big Macs (called Chicken Maharaja here) or a month of mobile talk time, or a 25 km cab trip from airport to home. Whereas for 5SGD in Singapore, I can only get 1 Big Mac or 2 cartons of milk or a 4 km cab ride from the nearest food court to home or just a small cafe latte at starbucks.

Hence, it's easier for me to part with a 100 than my mom to part with her 50, for a scarf which has a higher perceived value to me.

Uncertainty and Rational Behavior of the Seller
Economics teaches us, a rational individual will maximize his utility given certain constraints. For the seller, his utility is proportional to his profit function.
Say, he procured 100 scarves from a craftsman for 50 rupees each. Let's assume his transportation cost was 500, his other fixed costs add up to 15 more for each scarf. For him to earn profit, he must sell all of them at an average price above 70.

His range of negotiable price would be as high as he can quote to, and as low as 50 (variable cost), keeping in mind, he can sum a neat profit in the end.

But why quote 500 then, when it is a whooping 614% profit? I guess, a couple of reasons for it. Firstly, his nett investment on the 100 scarves is 7000 INR. When he starts selling, he is a bit unsure on how many he will sell. Assuming, before me, he managed to sell only one. He safely estimates if he can sell off 20 at a premium, and remaining 80 at a loss, he can still pocket a good profit.
If we do the math 7000/20= 350

Now even if he sells the remaining at 20 each, he gets 1600 which is a 23% profit.
Interestingly, he starts his quote at 500 and not 350, knowing that his customers would always bargain and try to pitch a lower price. Also, as he starts selling more scarves with profit, his confidence of recovering his investment increases, and he is more forthcoming to bargaining. Thus if you buy later, you might end up with a better price but as a tradeoff you have lesser colors to chose from, since all the better ones have already been bought with a slight premium.

Conclusion
The starting quoted price (500 in this case) is also a function of the economic condition of the society. In a relatively poor society like in India, sellers will often try to cheat the more affluent customers who find it hard to guage the true value of the commodity. It is also a lot easier for the seller to price discriminate based on the appearance and personality of each buyer. Were all buyers alike, it would have made the Seller's job a lot harder.

Also, merchants are often required to bribe their local authorities and mobs to do a hassle free trade. This corruption increases their fixed cost. And now add to it the customer's higher percieved value of the good and their lower percieved value of money. This results in merchants often quoting a lot more to rich or new buyers. Foreigners are privy to such unfair experience. 

Based on the above discussion, there is a reason why my mom is more successful in this ancient art of haggling. So words of wisdom, the next time you shop, don't forget to bring your mom along. Happy shopping!

Photo courtesy:
http://summerandsushant.blogspot.com/2010/10/about-shopping-bargaining-in-india.html