Nivi: Do you want to talk about Pareto optimal?
Naval: Pareto optimal is another concept from game theory, along with Pareto superior.
Pareto superior means something is better in some ways while being equal or better in other ways. It’s not worse in any way. This is an important concept when you’re negotiating. If you can make a solution Pareto superior to where it was before, you will always do that.
Pareto optimal solutions require a trade-off to improve any criterion
Pareto optimal is when the solution is the best it can possibly be and you can’t change it without making it worse in at least one dimension. There is a hard trade-off from this point forward.
These are important concepts to understand when you’re involved in a big negotiation.
Negotiations are won by whoever cares less
I generally say, though: “Negotiations are won by whoever cares less.” Negotiation is about not wanting it too badly. If you want something too badly, the other person can extract more value from you.
If someone is taking advantage of you in a negotiation, your best option is to turn it from a short-term game into a long-term game. Try to make it a repeat game. Try to bring reputation into the negotiation. Try to include other people who may want to play games with this person in the future.
An example of a high-cost, low-information single-move game is having your house renovated.
Contractors are notorious for overbooking, ripping people off, and being unaccountable. I’m sure contractors have their own side to it: “The homeowner has unreasonable demands.” “We found problems.” “The homeowner doesn’t want to pay for it.” “They don’t understand; they’re low-information buyers.”
It’s an expensive transaction. Historically it’s been very hard to find good contractors; and the contractor has little information on the homeowner.
Convert single-move games to multi-move games
So you try to go through friends. You try to find people with good reputations. You’re converting an expensive single-move game with a high probability of cheating on both sides into a multi-move game.
One way to do that is to say: “Actually, I need two different projects done. The first project we’ll do together, and based on that I’ll decide if we do the second project.”
Another way is to say: “I’m going to do this project with you, and I have three friends who want projects done who are waiting to see the outcome of this project.”
Another way is to write a Yelp or Thumbtack review—especially if the contractor operates within a community and wants to protect their reputation in that community.
These are all ways to turn a single-move game into a longer term game and get past a position of poor negotiating leverage and poor information.