How to use game theory to reduce your carbon emissions

posted by Sponsored by TWS Partners
16 June 2022

This piece of content is sponsored by TWS Partners

There is mounting pressure for organisations to remove CO2 from their operations and encourage their entire supply chain to do the same.

Procurement professionals are increasingly aware of game theory but often unaware of how or when to apply it. 

At a recent event for procurement leaders, hosted in London by Supply Management Insider and game theory experts TWS Partners, delegates heard how in addition to being used in negotiations the methodology has broad application across all kinds of business activity.

Dr Sebastian Moritz, managing partner at TWS, described it as a means of “steering the behaviour and decisions of another party so we take them along with us”. In this instance, that joint mission is to deliver carbon reduction.

“Most companies have pledged to go green, some have even publicly announced net zero commitments, the problem is how you get there,” he said.

Companies have already been looking at ways to cut or curb carbon from their direct operations and energy use – the scope one and scope two emissions. However, scope three emissions, as set by the Greenhouse Gas Protocol, typically account for around 60-80% of the total and therefore represent the greatest opportunity for impact. These are the emissions that come from the production of to the use and disposal of goods in the supply chain and put procurement in a prime position to help realise CO2 reductions.

Moritz said using game theory to cut CO2 was not only about the rules put in place to influence suppliers who are part of a sourcing exercise, but how you design the process before you approach the market to bring about the best result. “We’re using game theory here to incentivise, steer and manage the behaviour of the supply base.”

Moritz said three steps were required to apply game theory to reducing CO2 emissions:

1. Carbon footprinting or accounting: understanding how much carbon is currently produced by each supplier as they make a good or service. This acts as a baseline from which to demonstrate improvement, identify hotspots and tackle problem areas using carbon roadmaps. It allows what’s measured to be managed.

2. Introducing carbon TVO (total value of ownership) and incentives. This means engaging and incentivising suppliers by including CO2 as one of the parts of a TVO assessment used in tenders and framework competitions.

3. Carbon pricing: establishing a company-wide dynamic pricing scheme that helps to identify the best internal and external decarbonisation measures. If for instance, it is more economically advantageous for one department to reduce carbon than another, that second department could effectively ‘pay’ the first for reducing some of their total on their behalf. Effectively it makes carbon a new kind of currency exchange.

“Most people struggle with the first step, the measurement,” said Moritz. “After the carbon footprinting and accounting, it’s about providing a consistent framework for buyers to incentivise the supply chain to invest in your organisation and others to reduce the use of carbon and ensure they live up to their promises.”

Establishing a baseline

Cutting carbon emissions should be a win-win for companies, who are all under mounting pressure from governments, investors, consumers and employees to make changes.

Successful companies realise that action on climate change is critical to their success. These organisations reap the rewards of increased revenue, reduced overall costs, stakeholder engagement and lower risks – but they do have to be prepared to make upfront investment in change and seek out better solutions.

Christian Heinrich is managing director of tech start-up Carbmee which works with organisations to help with the first of the three steps – measuring and therefore managing the carbon emissions across their value chains. He said: “If you can’t drill down into the carbon in your supply chain you will never be able to improve anything.”

As he highlighted at the event, inaccurate information that takes numerous staff hours to compile and collate via supplier questionnaires is both impractical and often useless because it is frequently out of date, inaccurate or incomplete. A scalable solution is required to provide reliable, baseline data that can generate supplier specific footprints. “The path to net zero starts with measuring your carbon footprint and identifying hotspots,” he said. 

“No one can become carbon neutral overnight,” he added. “The first step is to get all suppliers under management, then identify your hotspots in direct materials, focus on the main drivers and make strategies with them.

“Since the biggest proportion of scope three emissions come from the procurement of goods and services and logistics, it puts procurement in the driving seat to lead the charge to reduce them.”

Developing a framework for change

Sanyalax Morrison, strategic procurement director at National Highways, which looks after England's motorways and major roads, explained how her organisation is working towards its aim of achieving net zero carbon emissions from its maintenance and construction operations by 2040.

Her three-step plan, which has already progressed in a number of areas, includes:

1. A holistic carbon reduction framework for the strategic procurement division, which has four key elements: carbon accounting and target setting; communicating carbon must-have requirements that suppliers must fulfil in the future; a carbon supplier assessment process that incorporates CO2 into the supplier selection process, with incentives to reduce it; and contractual commitments.

2. Category-specific carbon roadmaps developed cross functionally that link the net zero plan to future procurement activities.

3. Incentive schemes. An implementation plan for upcoming tenders covers measuring and accounting, technologies, supplier proposals and supplier commitment.

For instance, she said, close partners who commit to reductions might not necessarily be able to charge more, but they could gain competitive advantage. “If they can move more quickly or are willing to invest more in research and development to make improvements, we can give them more work. It’s about making a commitment to each other,” she said.

She said National Highways will provide better visibility of its pipeline so its supply chain can see the long-term investment and, in return, suppliers can use this to innovate better technology or material to help the organisation to deliver its target.

“We need to work in collaboration with our supply chain to tackle carbon challenges,” she added. “To deliver net zero we need a framework so that we are all incentivised together – our staff and suppliers, we know we can’t do it alone. We’re still learning, every day but we have an ambition. Everyone has aims, but what they need is a plan, we’re developing that right now.”

She said the organisation has been clear with all stakeholders and a centralised carbon team ensures it is capturing all activity across the organisation. Suppliers have also been warned that they must make improvements to win future business. “But we’ve also used a carrot,” she added, “for those willing to come on this journey with us, we want to build a collaborative roadmap together.”

National Highways is considering whether alternative materials might bring about improvements without affecting its number one imperative – safety. It is leveraging relationships to make changes where it is not a direct or key customer and working alongside partners, the Department for Transport, Network Rail and HS2.

Presenting use cases for incentives schemes already in operation, Dr Christian Paul from TWS said sourcing exercises could be managed in such a way to ensure suppliers were incentivised not to over-promise. He also said commitments can be given a monetary equivalent, with penalties to pay back some of the money if they are not achieved. 

“Game theory provides the framework to set the right incentives needed to effectively reduce emissions,” he said. “It ensures the right trade-off between quality, cost and carbon so that the next tonne is saved where it costs less and is most efficient. And if you put the importance and monetary impact of carbon reduction at the forefront of suppliers’ minds – you give it teeth. Financial consequences ensure it’s not just a tick-box exercise.”

Abhinay Muthoo, professor of economics at the University of Warwick, said organisations needed to ensure that the new rules of the game were hardwired into the statutes of how an organisation works. “It’s about behaviour change,” he said, and people must “rethink the time horizons”.

“This is something that could take 10, 20, 30 years – with the impact seen long after you may have left as procurement director – so you need to be thinking and operating differently and you need to start now.”

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