Suppose there are two partners involved on a project, how should the two of them split the costs? The answer is easy when the two of the same benefit. In that case, they should split the cost 50, 50. The question gets more interesting when the two partners don't give the same benefits. For example, what if one has twice the gain of the other? Does that mean she paid twice as much? I don't think so. But to convince you of that, it'll help to use an example. Let's call the two partners Aegean and Baltic and their two divisions of a SeaCorp. The potential benefits not including the cost of the project, but included A and B are 100 and 200. For example, they might be implementing a new payroll software program and that program save $1 an employee. If Aegean has 100 employees and Baltic has 200, then the benefits from the program would be twice as much for B compared to A. Or it could be that SeaCorp is creating a new ad campaign to build the company brand. The Baltic division is twice large or twice the profits of the Aegean and so expects to benefit twice as much from the campaign. The question is how should they split the cost of the project between the two parties? This is a negotiation question because each side would like to justify paying as little as possible. We know that Aegean will never pay more than 100 and Baltic will never agree to pay more than 200. Thus, if the project costs more than 300, there's no issue. The project isn't worth doing. The interesting case is when the cost is less than 300. The obvious answer is just to split the costs in proportion to the benefits. While that's a simple solution, I don't think it's a fair outcome. Let me offer a different and I think more principled approach. Here's my proposal about how to split the cost in three different cases. If the cost is 50, it gets divided up evenly, 25 and 25 between Aegean and Baltic. If the project costs 150, the split is 50 and 100. And if the cost is 250, then it's split 75 and 175. At first glance, you might think this is a bit ad hoc or maybe a lot ad hoc. It looks like we're dividing the cost evenly in the first case, proportionately in the second and who knows what in the third. As you might of guessed, there aren't three rules here. There's just one rule that unites all three. It's the Principal of the Divided Cloth, but the real key to the underlying logic is to look at the pie. Consider the first row where the total cost is 50. So what is the pie? I'll make this a multiple choice. Is it A, 300? B, 250? C, 100? D, 50? Or E, 0? If you add up the benefits, 100 to Aegean and 200 to Baltic, you get 300. But that's not the pie, since the cost must be paid. You might think then, that the pie is B, 250. The 300 total benefits net the 50 cost, but that isn't the pie either. Recall the definition of the pie, what the two parties can create by working together compared to what they can get on their own. 250 is one piece, what they can create by working together? But what can they create on their own? If they don’t reach an agreement, what will Aegean and Baltic do? Aegean will do the project on its own since it yields a net gain of 50, the 100 benefit minus the 50 cost. Similarly, Baltic will do the project on its own for a net gain of 150. The 200 (benefit) minus the 50 (cost). So without an agreement, Aegean and Baltic can jointly reap net benefits of 200. They can increase their gains from 200 working separately to 250 by working together. Thus, the value of an agreement is 50. That 50 is the pie. To get that extra 50, Aegean needs Baltic just as much as Baltic needs Aegean and that's why I think the 50 should be split evenly between the two of them. At the end of the day, Aegean gets a net benefit of 75, which implies Aegean pays 25. And Baltic gets a net benefit of 175, which implies Baltic pays 25. And check it out, that coincides with the first line of our table. Here's another way of looking at the first line. If Aegean and Baltic don't coordinate on the software package, they'll each have to buy their own copy. And they will, since each expects to receive more benefit from it than the cost of 50. The real difference between coordination and not is an extra software package. To avoid duplication and say 50, both sides are needed equally and that's why they should split the 50 equally. Time to try the second row of the table. What's the pie when the total cost is 150? At this point, you know the question to ask. How much net benefit can Aegean and Baltic to get by working together? They can gain 300 in benefits and the cost of the software is 150, leaving 150 net. Next question, how much benefit can they get on their own? If they don't reach an agreement, what will Aegean and Baltic do? The quick and wrong answer is that Aegean does the project on its own, spends 150 for something worth 100, leaving it to 50 in the hole. Aegean just wouldn't do the project in that case. Doing nothing is the better course. So, Aegean should get zero. Baltic on the other hand, can benefit two hundred at a cost of 150, netting it 50. It's worth while for Baltic to do the project on its own. Thus, the neck benefits look more like this. Without an agreement, Aegean and Baltic can jointly reap benefits of 50. They can increase their gains from 50 working solo to 150 by working together. Thus, the pie is 100. To get that extra hundred, Aegean needs Baltic just as much as Baltic needs Aegean. That's why, once again, I think they should split the 100 evenly. Aegean gets a net benefit of 50, which means it pays 50. And Baltic gets a net benefit of a 100, which means it pays 100. It just so happens in this case that the outcome is the same as proportional cost division, but that isn't how we got there. Indeed, the case of 150 cost is the only situation where things line up that way. Now, I think we're ready to tackle the third and final line of our table. What's the pie when the total cost is 250? If Aegean and Baltic work together, they can reap a collective gain of 50. The 300 benefit net of the 250 cost. What can they create on their own? If they don't reach an agreement, what will Aegean and Baltic do? Nothing. The cost is so high that neither Aegean or Baltic is willing to act on it's own thus the pie is 50. Aegean and Baltic can't get any benefit without joining forces and since Aegean and Baltic and equally to achieve this gain, I think it should be split 25, 25. If Aegean gets a net benefit of 25, this means it pays 75. And Baltic's net benefit of 25 implies that it pays 175, which is just as proposed on the bottom line of the table. My guess and my hope is that when you see the problem framed in this way, you'll come to the conclusion that this approach is more fair, more reasonable and simply divide in the cost in proportion to the benefits. The reason is proportional division doesn't account for what a party could get on its own. Proportional division doesn't look at the pie. Once you frame things in terms of the pie, the pie gets split evenly. That doesn't mean everything gets split evenly. The parties get to keep the portion they could get on their own. And that's why in the first row, Aegean ends up paying more than its proportional share. While in the third, it pay less. As you might have guessed, the three solutions here are the same as what comes out of the principle of the divided cloth. Let's look at the first row. With collective benefits of 300 and a cost of 50, the cloth to be divided up between the two parties is 250. Neither side can ask for more than its total benefit from the project. Thus, Aegean can claim a 100 and in so doing, it concedes 150 to Baltic. Baltic can claim 200, conceding 50 to Aegean. There's 50 in dispute, which gets divided up evenly between Aegean and Baltic, leaving Aegean with a total benefit of 75 and Baltic with 175. In the second row, the cost is 150. So the cost to be divided up shrinks to 300 minus 150 or 150. Baltic's claim of 200 means it's conceding nothing to Aegean, while Aegean claim of 100 implies its conceding 50 to Baltic. The full 100 of Aegean claim is in dispute and that is divided up evenly between Aegean and Baltic. This picture helps us appreciate. A key insight from the Principle of the Divided Cloth. If the total pie is 150, you don't get more credit for claiming 200 than for claiming 150. In other words, once you have a claim on the entire pie, that's it. You don't get anymore for claiming two or even three times the pie. Thus, the Baltic claim of 200 effectively gets reduced to 150 the size of the cloth. At this point, I hope the third row is now clear. The length of the cloth is only 50 and both Aegean and Baltic are claiming the whole thing. Since their claims, 100 and 200 are both more than 50. Since the entire cloth is in dispute, it gets split evenly, 25 and 25. To my eye, the solution is more intuitive when framed using the perspective of the pie. I think it's clear to think about what the two sides can achieve together versus what they can achieve on their own. That said, it's remarkable that this approach was anticipated some 2,000 years ago in the Principle of the Divided Cloth. There are two lessons I'd like you to take away from this session. The first is that using the perspective of the pie will you justify a solution that's different from proportional division. And that sense, I've doubled your options. Of course, if a proportional division works better for you, you don't have to bring it up. But if the other side has seen this video, you might have some trouble arguing against it. The 2nd point is that the negotiation problems don't come to you all framed and tied up in a bow. People don't come and say, here's the pie. A lot of hard work in negotiation is taking the facts from the ground and converting them into a framework, where you can understand what the pie really is.
