Leverage

Leverage refers to how much control we have over the outcome of a negotiation. Leverage comes in many forms, with the most powerful type of leverage coming from being the only provider of a resource in high demand.

For example, if you were the only person selling water in the middle of a desert, you would be the only provider of a resource in high demand. When thirsty travelers attempted to negotiate with you for the price of water, you would have all the leverage and could demand any price you wanted.

Limiting the power that comes from having overwhelming leverage is one of the main reasons for anti-competitive regulation, as competition acts to limit the amount of leverage one party has over another.

If in our example there were two water vendors in the middle of the desert, thirsty travelers would have a choice, and the vendors would have to compete with each other by offering ever-lower prices - that is, unless both vendors conspired to fix their prices and not go lower than the other - which is why there is also regulation to prevent price-fixing.

Though governments try to limit the leverage of large, powerful organizations, they also try to give leverage to individual inventors through the issuing of patents. The goal of a patent is to give leverage to the inventor by limiting the possibility of competition for the length of the patent, allowing them to profit from their invention, thus incentivizing people to innovate.

Leverage goes by another name: "Bargaining power," and like any power, it should be used responsibly. There can be a huge temptation to abuse having an overwhelming amount of leverage to take the other party for everything they're worth, but there should also be ethical considerations in deciding how much leverage to apply in any given situation.

Consider a scenario where you were the owner of an art restoration firm that was generally considered to be the best in the business. Now, imagine one of the world's largest museums were to approach you to restore a rare piece of art that was badly damaged, to the point where it was practically worthless - but would be priceless if it were fully restored.

If you were one of thousands of art restoration firms equally capable of doing the restoration, you would have very little leverage in negotiating a price, because if the museum didn't like the price you quoted, they would simply go to another firm. However, it just so happens that you are the only firm with the skills to correctly do this particular restoration to this particular piece of art, and as a result you have all of the leverage when negotiating a price with the museum. The question then is, how much of your overwhelming leverage should you utilize in negotiating a price?

In a free market economy, the fair market value of a good or service is whatever price the market can bear. Therefore, whatever you can charge the museum - that the museum is willing to pay - is considered the fair market value of the restoration. This means that if you used all of your leverage to get the highest price you could, when the museum pays for your restoration services, they have established the fair market price.

However, let's say that you chose not to follow the principle of fair market value in a free market economy, and instead of basing your price on the maximum the market could bear, you based it only on the cost to your firm of doing the restoration.

As your firm would have a fully stocked art studio, the main cost would be labor, for which you might have a standard rate of $100/hour. Based on your experience, the restoration should take around 100 hours, which results in $10,000 of labor costs. Using this cost-based pricing, you might then offer to restore a practically worthless piece of art to a priceless piece of art for $10,000.

Now, let's consider what would happen if instead of cost-based pricing, you used the leverage gained by being the only firm with the skill to correctly do this particular restoration to this particular piece of art to discover the highest price the market could bear.

By researching the price sold at auction of comparable artwork, you determine that the fully restored artwork could easily fetch $1 million. You further estimate that based on what the museum charges for admission, and how many people would come to see the artwork once it was restored, the museum could see as much as a $1 million uptick in ticket sales every year for the foreseeable future. This would mean that after your firm did the restoration, the museum would have gained an asset worth $1 million, as well as an extra $1 million per year.

As you happen to be a shrewd negotiator, you share these facts with the museum, and instead of charging them a cost-based price of $10,000, you quote them a price of $250,000 to do the restoration. As you are the only firm that can do the restoration, the museum agrees. By agreeing to pay your price, the museum has set the fair market price of doing the restoration at $250,000 - but they would have also happily paid $10,000 for the same work.

There is an adage that states, "If someone could pay less, they would," which acts as a reminder to never use the fact that people would always like to pay a lower price as justification to charge a lower price.

When negotiating, you will have to decide how best to utilize any leverage you have. You may choose not to use it, or to use it to its full extent. If you are negotiating for yourself, you are free to make whatever choice you like; but if you are negotiating on behalf of a business, remember that businesses have a fiduciary responsibility to shareholders to try to get the highest price the market can bear for their products and services, but even with businesses there is still the question of ethics.

In the case of the art restoration firm, the museum might choose to pay their price, try to negotiate them lower, or walk away and not get the art restored at all. In any of these cases, no real material harm was done to anyone. If, however, we consider essential goods, such as food, water, or medicine, then utilizing an overwhelming amount of leverage to get the highest price the market can bear is not only unethical, but also amoral.

Businesses have an understandable profit motive, as a business that does not make a profit will eventually no longer be in business. However, all of us exist in a society, and if businesses abuse their leverage to force people into paying the maximum price for essential goods, then eventually we may not have a society.