Bargaining power

Several formulations of bargaining power have been devised. A popular one from 1951 and due to American economist Neil W. Chamberlain is:[1]

We may define bargaining power (of A, let us say) as being the cost to B of disagreeing on A's terms relative to the costs of agreeing on A's terms ... Stated in another way, a (relatively) high cost to B of disagreement with A means that A's bargaining power is strong. A (relatively) high cost of agreement means that A's bargaining power is weak. Such statements in themselves, however, reveal nothing of the strength or weakness of A relative to B, since B might similarly possess a strong or weak bargaining power. But if the cost to B of disagreeing on A's terms are greater than the cost of agreeing on A's terms, while the cost to A of disagreeing on B's terms is less than the cost of agreeing on B's terms, then A's bargaining power is greater than that of B. More generally, only if the difference to B between the costs of disagreement and agreement on A's terms is proportionately greater than the difference to A between the costs of disagreement and agreement on B's terms can it be said that A's bargaining power is greater than that of B.

In another formulation, bargaining power is expressed as a ratio of a party's ability to influence the other participant, to the costs of not reaching an agreement to that party:

BP_A(Bargaining Power of A) = (Benefits and Costs that can be inflicted upon B)/(A's cost of not agreeing)

BP_B(Bargaining Power of B) = (Benefits and Costs that can be inflicted upon A)/(B's cost of not agreeing)

If BP_A is greater than BP_B, then A has greater Bargaining Power than B, and the resulting agreement will tend to favor A. The reverse is expected if B has greater bargaining power instead.

These formulations and more complex models with more precisely defined variables are used to predict the probability of observing a certain outcome from a range of outcomes based on the parties' characteristics and behavior before and after the negotiation. One potential application is in patent infringement lawsuits, when the jury must determine for the patent holder and the potential licensee a mutually agreeable royalty for use of the patent holder's proprietary technology. One economist suggests a methodology to calculate the royalty whereby the total surplus of the transaction (or, the gains from trade generated when the patent holder successfully licenses its technology to the licensee) is calculated first, then split among the negotiating parties based on, in part, their relative bargaining power.[2] The model explains that a patent holder with more bargaining power—for example, a patent holder that licenses its patents on an exclusive basis or that owns a commercially successful technology—would capture a larger share of the total surplus than the licensee, and vice versa, as well as shows how that insight could guide a court's determination of a reasonable royalty in a patent infringement lawsuit.

Buying power is a specific type of bargaining power relating to a purchaser and a supplier. For example, a retailer may be able to dictate price to a small supplier if it has a large market share and or can bulk buy.[3]

In modern economic theory, the bargaining outcome between two parties is often modeled by the Nash Bargaining solution.[4][5] An example is if party A and party B can collaborate in order to generate a surplus of 100. If the parties fail to reach an agreement, party A gets a payoff X and party B gets a payoff Y. If X+Y<100, reaching an agreement yields a larger total surplus. According to the generalized Nash bargaining solution, party A gets X+π(100-X-Y) and party B gets Y+(1-π)(100-X-Y), where 0 < π < 1. There are different ways to derive π. For example, Rubinstein (1982) has shown that in a bargaining game with alternating offers, π is close to 1 when party A is much more patient than party B, while π is equal to ½ if both parties are equally patient.[6] In this case, party A's payoff is increasing in π as well as in X, and so both parameters reflect different aspects of party A's power. To clearly distinguish between the two parameters, some authors such as Schmitz (2013) refer to π as party A's bargaining power and to X as party A's bargaining position.[7] A prominent application is the property rights approach to the theory of the firm. In this application, π is often exogenously fixed to ½, while X and Y are determined by investments of the two parties.[8]

• Bargaining
• Collective buying power
• Inequality of bargaining power
• Intra-household bargaining
• Porter five forces analysis
• Purchasing power