Ban Consultants A firm and its supplier are going to negotiate a deal every quarter. Since the supplier's cost is $10 million per quarter and the value to the firm is $14 million per quarter, there is $4 million per quarter to split between the two

Question

However, they can hire a negotiation consultant for a quarter for $500,000 . If neither hires the consultant, each expects to get half of the $4 million pot. If only one hires the consultant, it expects to get three-fourths of the pot minus the consultant costs. If they both hire consultants, they cancel each other out and they expect to get half the pot minus the consulting costs. They expect to repeat this process every quarter for the foreseeable future. Can they agree to ban the consultants?

Answer 1

Each quarter, they play a prisoner's dilemma game in which they each hire consultants that turn out to cancel each other out and so only add to their costs. But since they repeat the game indefinitely, they can condition their strategy today on what their counter-party did last quarter. In particular, they can agree to not hire outside consultants if the other party does not. However, if one party hires a consultant this quarter, the other party will commit to hiring a consultant this quarter. Now, both players have to consider not only the short-term gain from hiring a consultant, but also the longer-term loss from having to negotiate across the table from a negotiation consultant in the future. The latter will usually outweigh the former and so they keep to the agreement.