sea corp

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Suppose there are two partners
involved on a project,

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how should the two of
them split the costs?

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The answer is easy when
the two of the same benefit.

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In that case,
they should split the cost 50, 50.

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The question gets more interesting when
the two partners don't give the same

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benefits.

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For example, what if one has
twice the gain of the other?

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Does that mean she paid twice as much?

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I don't think so.

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But to convince you of that,
it'll help to use an example.

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Let's call the two partners Aegean and
Baltic and

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their two divisions of a SeaCorp.

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The potential benefits not including
the cost of the project, but

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included A and B are 100 and 200.

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For example, they might be implementing
a new payroll software program and

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that program save $1 an employee.

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If Aegean has 100 employees and
Baltic has 200,

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then the benefits from the program would
be twice as much for B compared to A.

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Or it could be that SeaCorp is
creating a new ad campaign to build

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the company brand.

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The Baltic division is twice large or
twice the profits of the Aegean and so

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expects to benefit twice
as much from the campaign.

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The question is how should they split
the cost of the project between the two

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parties?

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This is a negotiation question because
each side would like to justify

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paying as little as possible.

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We know that Aegean will
never pay more than 100 and

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Baltic will never agree
to pay more than 200.

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Thus, if the project costs more than 300,
there's no issue.

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The project isn't worth doing.

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The interesting case is when
the cost is less than 300.

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The obvious answer is just to split
the costs in proportion to the benefits.

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While that's a simple solution,
I don't think it's a fair outcome.

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Let me offer a different and
I think more principled approach.

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Here's my proposal about how to split
the cost in three different cases.

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If the cost is 50,
it gets divided up evenly, 25 and

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25 between Aegean and Baltic.

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If the project costs 150,
the split is 50 and 100.

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And if the cost is 250,
then it's split 75 and 175.

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At first glance, you might think this
is a bit ad hoc or maybe a lot ad hoc.

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It looks like we're dividing
the cost evenly in the first case,

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proportionately in the second and
who knows what in the third.

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As you might of guessed,
there aren't three rules here.

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There's just one rule
that unites all three.

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It's the Principal of the Divided Cloth,
but

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the real key to the underlying
logic is to look at the pie.

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Consider the first row
where the total cost is 50.

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So what is the pie?

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I'll make this a multiple choice.

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Is it A, 300?

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B, 250?

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C, 100?

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D, 50?

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Or E, 0?

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If you add up the benefits, 100 to
Aegean and 200 to Baltic, you get 300.

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But that's not the pie,
since the cost must be paid.

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You might think then,
that the pie is B, 250.

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The 300 total benefits net the 50 cost,
but that isn't the pie either.

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Recall the definition of the pie,
what the two parties can create by

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working together compared to
what they can get on their own.

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250 is one piece,
what they can create by working together?

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But what can they create on their own?

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If they don’t reach an agreement,
what will Aegean and Baltic do?

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Aegean will do the project on its own
since it yields a net gain of 50,

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the 100 benefit minus the 50 cost.

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Similarly, Baltic will do the project
on its own for a net gain of 150.

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The 200 (benefit) minus the 50 (cost).

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So without an agreement, Aegean and Baltic
can jointly reap net benefits of 200.

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They can increase their gains from 200
working separately to 250 by working

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together.

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Thus, the value of an agreement is 50.

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That 50 is the pie.

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To get that extra 50, Aegean needs Baltic
just as much as Baltic needs Aegean and

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that's why I think the 50 should be
split evenly between the two of them.

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At the end of the day,
Aegean gets a net benefit of 75,

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which implies Aegean pays 25.

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And Baltic gets a net benefit of 175,
which implies Baltic pays 25.

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And check it out, that coincides
with the first line of our table.

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Here's another way of
looking at the first line.

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If Aegean and Baltic don't
coordinate on the software package,

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they'll each have to buy their own copy.

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And they will,

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since each expects to receive more
benefit from it than the cost of 50.

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The real difference between coordination
and not is an extra software package.

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To avoid duplication and say 50,
both sides are needed equally and

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that's why they should
split the 50 equally.

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Time to try the second row of the table.

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What's the pie when the total cost is 150?

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At this point,
you know the question to ask.

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How much net benefit can Aegean and
Baltic to get by working together?

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They can gain 300 in benefits and the cost
of the software is 150, leaving 150 net.

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Next question, how much benefit
can they get on their own?

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If they don't reach an agreement,
what will Aegean and Baltic do?

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The quick and wrong answer is
that Aegean does the project on

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its own, spends 150 for something worth
100, leaving it to 50 in the hole.

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Aegean just wouldn't do
the project in that case.

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Doing nothing is the better course.

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So, Aegean should get zero.

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Baltic on the other hand, can benefit two
hundred at a cost of 150, netting it 50.

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It's worth while for
Baltic to do the project on its own.

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Thus, the neck benefits
look more like this.

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Without an agreement, Aegean and
Baltic can jointly reap benefits of 50.

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They can increase their gains from 50
working solo to 150 by working together.

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Thus, the pie is 100.

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To get that extra hundred,

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Aegean needs Baltic just as
much as Baltic needs Aegean.

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That's why, once again,
I think they should split the 100 evenly.

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Aegean gets a net benefit of 50,
which means it pays 50.

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And Baltic gets a net benefit of a 100,
which means it pays 100.

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It just so happens in this case that the
outcome is the same as proportional cost

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division, but that isn't how we got there.

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Indeed, the case of 150 cost is the only
situation where things line up that way.

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Now, I think we're ready to tackle
the third and final line of our table.

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What's the pie when the total cost is 250?

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If Aegean and Baltic work together,
they can reap a collective gain of 50.

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The 300 benefit net of the 250 cost.

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What can they create on their own?

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If they don't reach an agreement,
what will Aegean and Baltic do?

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Nothing.

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The cost is so high that neither Aegean or

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Baltic is willing to act on
it's own thus the pie is 50.

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Aegean and Baltic can't get any
benefit without joining forces and

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since Aegean and Baltic and
equally to achieve this gain,

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I think it should be split 25, 25.

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If Aegean gets a net benefit of 25,
this means it pays 75.

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And Baltic's net benefit of
25 implies that it pays 175,

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which is just as proposed on
the bottom line of the table.

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My guess and my hope is that when you
see the problem framed in this way,

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you'll come to the conclusion that this
approach is more fair, more reasonable and

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simply divide in the cost in
proportion to the benefits.

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The reason is proportional
division doesn't account for

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what a party could get on its own.

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Proportional division
doesn't look at the pie.

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Once you frame things in terms of the pie,
the pie gets split evenly.

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That doesn't mean everything
gets split evenly.

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The parties get to keep the portion
they could get on their own.

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And that's why in the first row,

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Aegean ends up paying more
than its proportional share.

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While in the third, it pay less.

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As you might have guessed,
the three solutions here

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are the same as what comes out of
the principle of the divided cloth.

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Let's look at the first row.

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With collective benefits of 300 and
a cost of 50,

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the cloth to be divided up
between the two parties is 250.

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Neither side can ask for more than
its total benefit from the project.

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Thus, Aegean can claim a 100 and in so
doing, it concedes 150 to Baltic.

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Baltic can claim 200,
conceding 50 to Aegean.

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There's 50 in dispute, which gets divided
up evenly between Aegean and Baltic,

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leaving Aegean with a total
benefit of 75 and Baltic with 175.

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In the second row, the cost is 150.

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So the cost to be divided up
shrinks to 300 minus 150 or 150.

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Baltic's claim of 200 means it's
conceding nothing to Aegean,

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while Aegean claim of 100 implies
its conceding 50 to Baltic.

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The full 100 of Aegean
claim is in dispute and

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that is divided up evenly
between Aegean and Baltic.

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This picture helps us appreciate.

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A key insight from the Principle
of the Divided Cloth.

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If the total pie is 150,
you don't get more credit for

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claiming 200 than for claiming 150.

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In other words, once you have a claim
on the entire pie, that's it.

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You don't get anymore for claiming two or
even three times the pie.

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Thus, the Baltic claim of 200 effectively
gets reduced to 150 the size of the cloth.

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At this point,
I hope the third row is now clear.

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The length of the cloth is only 50 and
both Aegean and

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Baltic are claiming the whole thing.

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Since their claims, 100 and
200 are both more than 50.

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Since the entire cloth is in dispute,
it gets split evenly, 25 and 25.

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To my eye,

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the solution is more intuitive when
framed using the perspective of the pie.

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I think it's clear to think about what
the two sides can achieve together

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versus what they can achieve on their own.

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That said, it's remarkable that
this approach was anticipated

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some 2,000 years ago in
the Principle of the Divided Cloth.

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There are two lessons I'd like you
to take away from this session.

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The first is that using
the perspective of the pie will

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you justify a solution that's
different from proportional division.

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And that sense, I've doubled your options.

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Of course, if a proportional
division works better for

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you, you don't have to bring it up.

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But if the other side has seen this video,

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you might have some trouble
arguing against it.

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The 2nd point is that the negotiation
problems don't come to you all framed and

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tied up in a bow.

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People don't come and say, here's the pie.

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A lot of hard work in negotiation is
taking the facts from the ground and

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converting them into a framework, where
you can understand what the pie really is.