Ice Cream, Deal Making, The Law Of Diminishing Marginal Utility And Why It Matters To Real Estate Deal Makers

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We wanted to achieve two goals today: (a) to Ruminate about the negotiation process; and (b) to achieve record “shortness” [for Ruminations, that is]. When you reach the end, let us know “How’m I doing?” [see, Edward Irving “Ed” Koch].

The most essential economic concept affecting business negotiation is (or should be) what economists call “The Law of Diminishing Marginal Utility.” You and I love ice cream. You have a lot and I have none. But, I have money (or something else you’d like).

What is marginal utility? With apologies to Samuelson, Marshall, Krugman, Tirole, and others, we’re going to stick with our ice cream theme. Think how refreshingly delicious an ice cream cone would be on the hottest day of the hottest summer on record. “Ahhh… .” It’s so good, I think I’ll have a second. That was pretty good too. Not as good as the first bite of the first cone, but pretty good. To each individual, there comes a point where “enough is enough” [see, Streisand and Summers, No More Tears]. Yes, you would have paid a handsome premium for that first ice cream cone, but virtually nothing for the third, fourth or whatever is beyond your personal cut-off point.

There was a lot of “utility” in the first cone, but each successive cone was of diminishing utility. That’s “The Law of Diminishing Marginal Utility.” Call the Royal Swedish Academy of Sciences.

Now, this is a Retail Real Estate Law blog (that tramples across a lot of general commercial real estate issues). So, what does all of this have to do with the price of ice cream in Iceland? Here’s what –

Someone has a quantum of money (or other generally desirable and exchangeable thing) beyond what makes her or him as happy as her or his first or second or tenth dollar. Someone else has enough real property to make that person happy; what is “excess” beyond that quantum just doesn’t make that person as happy “keeping it” rather than exchanging that “excess” real property for money. We’ll state that a different way because we know that what immediately preceded this sentence won’t make sense to everyone.

One party has “extra” money beyond what it needs. That excess, depending on the numbers, is just like the ice cream. Each extra dollar gives less pleasure than the earlier ones. Another party has enough real property for itself to make it pretty happy and the “extra” real property isn’t really as rewarding, again depending on how much there is. Yes, there is a point where the last dollar one receives just isn’t worth the trouble of getting. That doesn’t happen all at once. There is a sliding scale – the dollar before that was more worthwhile, and so forth. The same is true for real property. If someone is sitting on a lot of it, just having it in inventory isn’t a good feeling.

So, when people make a deal, they exchange things – in our case, money for property. It could be purchase money or it could be rent. It could be sold and gone forever or it could be lease it and get it back. Each party has to decide what quantum of marginally less useful money or property it wants to give up to get what the other side has.

Do you want to hear it simple-like? Be willing to give up that last ice cream cone in return for something that will bring you more enjoyment. That could be a tenant or it could be a leased space. It’s not principle, it’s only money. And, you aren’t enjoying that last dollar to the same extent as you enjoyed the first one.

If you have a property that’s “sucking wind,” you should be more willing to “deal.” That’s because it doesn’t have the same utility as it would have if you really liked holding onto it any longer. Similarly, when you have money to the extent that you really aren’t getting as much benefit out it as you did from your first dollar, let it go.

Do you want an example? Why fight over a thousand dollars if the money really doesn’t give you that same old pleasure as it used to? If you want to make a deal, there’s nothing wrong with standing on principle, so long as the principle you are standing on is the “bottom line.” If you want the property, pay the expense – pay the $1,000. If you want to get rid of (or lease) the property, don’t hold out for the $1,000 on principle. One side wants the property more than they want the money, and the other side wants the money more than they want the property. How can that be? It’s the Law of Diminishing Marginal Utility. While $1,000 is an absolute sum, at any point in time it means more to one person than the other. The same is true with real property. If this weren’t true, there would be no sales or leases (or loans).

Too weird today? Let us know.

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Comments

  1. Randall Gunn says:

    Thank you, thank you, thank you. I once worked for a major grocer. I was the deal make and attorney. The grocer was ground leasing a site a a shopping center. The grocer was going to be spending over $5 million in capital investment.I was dealing with an in house attorney. That attorney took umbrage to working off of the grocer’s base documents. The result, redline and demands to change something in EVERY sentence of a 30 page lease..

    After a month of negotiations with little progress, I blew up. I told the attorney that most of the time his type of actions were done to justify a fee. Since he was in house, it was to justify his existence and employment. This brought the deal makers within the landlord to step in and complete the process.

    On the other side, I have represented small tenants. Local tenants. They only do 3 year leases. I tell them that it does not make sense to argue over the third nuance and condition of condemnation issues.

    PS: I could give the city name for the landlord and let people guess but, that might not make me that endearing to the landlord.

  2. Sometimes less is more. Fewer words does not necessarily mean you are painting an incomplete picture (think a picture is worth a 1,000 words). The negotiation process is an art form, some have it and some don’t – and for what its worth in my experience the less experience someone has the more negotiations are involved, which is usually accompanied by a bad attitude/lack of professionalism.

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