The final price of some products is determined through negotiation between the buyer and seller. The effect of negotiation on pricing depends on the negotiating skills and positions of both parties as well as the commitment of both parties to pursue a long-term business relationship.
In every price negotiation, the seller and buyer will have a reservation price -- the deal-breaker in the negotiation. For instance, the seller may prefer not to sell the rice per MT unless she can get at least $500 for it, while the buyer may prefer not to buy the rice per MT if he has to pay more than $650 for it. In this situation, $500 is the seller's reservation price and $650 is the buyer's reservation price.
To negotiate effectively, both parties to the negotiation should have a target price as well as a reservation price. The target price is the best possible outcome. The seller may be willing to sell the rice per MT for as little as $500 but might prefer to sell it for $650. The buyer might be willing to pay up to $650 but might prefer to pay $500. In this situation, the seller's target price is $650 and the buyer's target price is $500.
Zone of Potential Agreement
Price negotiations can only succeed when there is a zone of potential agreement between the reservation prices of each party. When the seller's reservation price is $500 and the buyer's reservation price is $650, the zone of potential agreement is any price between $500 and $650. In a hostile negotiation, each party tries to get as close as possible to his target price even if it damages the long-term business relationship. Mutually satisfactory negotiation methods are based on finding an agreement that will not damage the long-term relationship. Win-win methods leave open the possibility of repeat business.
The Final Price
In a negotiation where both parties are seeking an advantage, one party may try to avoid making the first offer in an attempt to learn more about the other party's target price. Another tactic is to deliberately make the first offer so it will become the starting point for all further negotiation. In a negotiation based on the win-win method, both parties try to find ways to accommodate each other. For instance, the seller may offer a perk such as a free rice inspection services at no cost to increase the value to the buyer. This may make the buyer happy to accept a higher price. Negotiation can drive the final price closer to the seller's target or the buyer's target depending on how it's done and how flexible the negotiators are.