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Basic Haggling Theory: Negotiating Lower Prices (a.k.a. making more money)

April 19th, 2010 Leave a comment Go to comments

You’re at a garage sale. What happens differently when you make an offer of $30 on an item the seller would have otherwise sold to you for $20? Well, nothing, except you’ve given up $10 you would have otherwise had. The money went into the seller’s pocket instead of yours. Haggling is making sure that money ends up in your pocket instead of someone else’s. Simply put, people have beliefs and perceptions that affect their offers in a haggling situation. When they are known to you, you can adjust your haggling strategy such that you to capture a bigger share of the trade surplus, and in turn make greater profits off of your items.

Everyone has had some experience with the idea of haggling: fighting down the price of a car, making combo-deals at the flea market (ok, maybe not everyone), or even negotiating some extra benefits or higher salary from a prospective employer. Surely enough, there is a fine science behind how haggling works, a subfield of economics that could be termed “bargaining.” Before diving in to haggling strategies, it’s useful to look at the basic theory behind bargaining in a buyer/seller situation.

Every seller in a transaction has a minimum price they would like to be paid under which they would prefer to keep an item, and every buyer has a maximum price they would be willing to pay for that item. (This is hard to measure, but usually an approximation is good enough for us). This value for buyers is generally higher than it is for sellers (otherwise nothing would ever be exchanged!) The difference between the buyer’s max price (or “valuation”) and the seller’s minimum price (also “valuation”) is defined as the “gain from trade.” It’s a benefit to everyone, because items are being moved from people who would get more utility (e.g. pleasure, comfort) from an item than the person who originally had it, and the person who originally had it gets liquid cash to spend on other things that make him/her happier.

So really, when you haggle over a price, what you’re really doing is playing a sort of game whose outcome is how that gain from trade gets divided up between you and someone else. If you push a seller to sell something to you at their absolute minimum price, then what you’ve done is captured 100% of the gains from trade – the best you could have possibly done given the seller you are dealing with.

Of course, you will never actually observe a seller’s true valuation. In fact, most people conducting a garage sale don’t even have a strict minimum price in mind – they just shoot from the hip, so they don’t quite know their valuations either. With experience, you will come to find that there are a variety of circumstances that you can exploit to get yourself a better price from the seller.

 The Importance of the Seller’s Beliefs and Perceptions

Unfortunately, the valuation story does not completely define the reality of haggling. Sellers’ minimum prices vary throughout the day – for example, I’ve noticed, and it fits with intuition, that larger items sell for lower prices later on in the day, as the probability of another buyer showing interest in a large item showing up diminishes in the seller’s mind. The alternative for the seller is to keep the item you’re interested in and possibly be stuck with it in their garage again (or be forced to throw it away, etc.)

You, too, are constrained by your alternatives. Imagine that you went to a sale and immediately signaled that you would not walk away without buying item x. This would tend to get you charged higher prices. It’s folk knowledge that you should act disinterested in front of a seller to get you a lower price – it’s part of the “poker face” of haggling. And what’s a poker face’s primary function? To conceal private information that can be used by the other party to raise their own payoff by lowering yours. In haggling, that important piece of private information is known as your outside option.

Your outside option is essentially what happens when you walk away from a transaction without exchanging anything. Both buyers and sellers have outside options: for buyers, it’s going home empty-handed or perhaps buying the item somewhere else; for sellers, it’s keeping the item under consideration or selling the item to someone else. So you can see how if a seller knows a buyer’s outside option is harsh (e.g. the wife will have his ass if he doesn’t bring home a food processor TODAY), he knows that he can charge the buyer a higher price. Likewise, if a buyer knows that if a seller doesn’t really care about an item (i.e. it’s just been sitting in his garage for years and he doesn’t know much about it), he’s more likely to get a lower price for that item.

Combining Valuation and Outside Option to Make an Offer

Your basic strategy is to compile what information you have about the seller and assess their outside option, as well as their valuation. First, you can start with the immediately observable: What does their house look like? How do they look (e.g. how are they dressed)? How organized is the sale? What combination of items are on display? Then, you can also glean what you can from communicating with the seller: how long has the sale been going on? when do they plan to finish? What’s their story behind item [x]? How much do they quote you up front when you ask about item x, y, or z?

You also should note what the seller observes about you: what car did you drive up in? how are you dressed? have you been polite, or have you engaged in a conversation with the seller? how interested do you look in the item? were you obviously lingering around with your cell phone looking up item values? These questions tell the seller about your valuation and outside option. Over time, you will learn to manage this image to create the most favorable circumstances for yourself.

By knowing the answers to these questions and how to interpret them, you will know not to make an offer too high that will get accepted, which you will regret after the fact. In my experience, this is the #1 way to lose money in haggling. Less important, though still relevant, you will also know not to make an offer so low that you generate resentment that ultimately costs you a higher price on the same item or even other items.

As you may have guessed, as a seller yourself, you will apply this information to your benefit, but only in reverse. The concepts apply in almost any situation with negotiation and when internalized can save you a lot of money over your lifetime. In my next article on haggling, I will offer concrete and practical tips for negotiating prices, such as managing your image, offering to buy items in bundles, and more.

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  1. Jennifer
    May 6th, 2010 at 12:26 | #1

    I have always struggled with haggling because for some reason I put myself in the sellers showes (like I imagine I am the seller and because “I” would want to get the most money for my item) I am trying to get out of that mindset. I need to do what’s best for me not the other person. It seems like most people would do whats best for them. Probably because I grew up without much money I am used to not having it. I learned alot from this article. Thank you.

  2. admin
    May 6th, 2010 at 13:33 | #2

    Jennifer,

    As insensitive as I might sound in crass discussion of financial issues, I sometimes have personal trouble with the same issue. It’s normal to feel as if your actions are predatory. However, you must remember that you’re not the mafia – the price you end up paying still requires the other person’s consent and if they consent to a low price, so be it. You’re not breaking anyone’s legs.

    Your business is primarily based on information that you have that others don’t, and there is a cost to attaining that information. You can’t really put yourself in the seller’s shoes, as they didn’t incur the cost to attain that information.

    Be respectful and empathetic, as it’s good for your own psyche, but don’t be afraid to go for the prices needed to make your business worthwhile for you.

    Thanks for your comment, and good hunting!

    -Chris

  1. June 9th, 2010 at 13:34 | #1