In the business world, you should always seek advice when buying or selling. The most commonly used approaches are the "selling by auction" or the "selling through negotiation". In Malta, both approaches are frequently used but perhaps not everyone is aware of the distinction between the two or when it is better to use one approach in preference of the other.
What is the difference between the process of selling by auction and selling through negotiation? Essentially, an auction is a public sale in which a "asset" is generally sold to the highest bidder subject to the successful bidder meeting certain pre-defined criteria whereas a sale by negotiation in normally a private process with one interested party at a time and which allows the buyer and seller to explore common interests, generate options, and identify ways in which to create an outcome that delivers maximum value to all concerned.
At Business School students are sometimes told the story of the two interested buyers who want to buy an orange. If the orange is sold by auction there can only be one winner and that will be the one with the highest bid. If, on the other hand, the orange is sold through negotiation, it could transpire, after a healthy dose of discussions and an exchange of information between the seller and the interested parties, that one of the buyers is content with just the juice, since s/he wants to make orange juice, whereas the other interested party, is happy with the rind, since s/he wants to make marmalade. It is a rather simplistic example but one which helps to explain the difference between the two methods of selling. In this particular case, the selling through negotiation proves to be better for all parties especially the seller.
Believe it or not, there is such a thing as "Auction Theory". I wouldn't necessarily recommend that you read up about it but suffice it to point out four important factors that need to be taken into consideration when selling by auction. First, there is such a thing as an optimal number of interested bidders.
The general wisdom is that after about 15 bidders, auction theory estimates, the value of having an extra bidder becomes negligible. I know what you thinking: surely the greater the number of bidders the more likely you are to get a high price in an auction. But all else being equal, the value of each incremental bidder goes down as the total number of bidders goes up.
My advice would be that between five to eight bidders is the ideal number since trying to handle more can be very time-consuming and cumbersome. Second, if the universe of potential buyers is small an auction will not result in the best result for the seller since by selling through negotiation and talking directly with the interested parties you might get a better deal. The attempted sale of Malta Shipyards springs to mind.
Third, you have to be sure that an auction will attract the buyers you want to attract through an auction. Again I think the example of Malta Shipyards shows us that in this particular case and given the economic climate it might have been wiser to opt for a sale through negotiation.
Fourth, Auction Theory predicts that the final price in an auction will be the second highest valuation plus a little bit more. So if the two highest bids are similar to each other, all well and good, but if there is a big gap between the top two bids the probability is that the seller is leaving money on the table. I am obviously generalising and simplifying. It isn't always so clear cut. If however you are interested in reading up about the subject, may I suggest the research work of Guhan Subramanian.
As a general rule of thumb when selling an asset the seller needs to consider the specifics of the asset; it is one thing if you are selling a property but quite another if you are selling an advertising agency for instance. The seller, therefore, needs to take into consideration how complex the asset being sold is. Thus an advertising agency is probably valuable because of the human capital, their internal and external relationships and the client base. I think a negotiated sale would be far more appropriate and capable of capturing the real value of the business than by selling by auction.
The seller also needs to bear in mind that an auction is good at quantifying everything in price (which accountants tend to prefer) but sometimes and depending on the asset, you can come up with a deal which is win-win and creates value for all parties and price would have only been one of many other factors taken into consideration.
Just rewind back to the orange example, in which one buyer wanted the orange juice whereas the other wanted the rind. An auction would have just sold the orange to the highest bidder- a win-lose scenario with price being the deciding factor. Lastly, if you are an organisation like for example Mita, don't always lean in favour of buying services through auction since this factors out the importance of relationships, reliability and reputation. I say this because an auction, by definition, reduces everything to price and sometimes, and in some businesses, long-term relationships are far more important. Toyota of Japan has a successful habit of choosing suppliers not because they are the cheapest but because the chosen suppliers have the right attributes to be trusted and build a long-term stable relationship with, which in difficult times can be very valuable.
So before selling or buying, next time, think about the characteristics of the asset and the context in which it is being sold before taking your decision. Think first!
Mr Fenech is managing director at Fenci Consulting Ltd.
www.fenci.eu