Using game theory can have a profound impact on procurement negotiations, but there are rules you must follow.
Game theory, the scientific modelling of interactions between different parties with conflicting objectives, can boost the success of negotiations, interactions in which both procurement and sales are pursuing their own interests. Game-theory-optimised negotiations can help avoid some of the problems associations with sales tactics, such as initially inflated pricing and time-consuming negotiations.
With procured goods and services defining up to two-thirds of a company’s costs, strategic thinking in procurement can make a huge difference. We have worked on more than 2,000 sourcing projects using game theory. Here are the key 10 success factors we have noticed.
1. No stalking horses
Never take suppliers who are not accepted by stakeholders into a game-theory-based negotiation. You’ll risk your own reputation as a buyer in the market if such a supplier wins and you didn’t nominate them.
2. Price is not the only factor
In every sourcing decision there are a number of relevant factors, of which price is just one. This means, before any negotiation takes place, procurement must work with all stakeholders to incorporate these factors into the sourcing decision.
3. Don’t stop with a qualitative assessment
Although most companies use qualitative measures such as scorings, it is not sufficient. Having two suppliers with different scores and prices means it is virtually impossible to say which one is the better choice for the business.
4. Only the bottom line counts
The most holistic view procurement can take is to ask what the impact of stakeholder concerns or preferences would be on the company’s bottom line. This should become your measure for the impact of softer factors.
5. No excuse, quantify it
Each concern and preference can be quantified. Whatever a stakeholder brings forward, turn it into a monetary value. It’s possible and, with experience and training, you can quantify factors like risks, ability to innovate and strategic preferences.
6. Stay committed
Only by establishing and committing to these agreed monetary values throughout the entire sourcing process can you avoid curve balls being thrown in by stakeholders jeopardising procurement’s credibility.
7. Document your commitment
A formal commitment (supplier set & sign off of the monetary assessment), is the best way to stop suppliers from approaching stakeholders outside of the process and to stay disciplined internally.
8. Horses for courses
Game theory teaches us one thing: small changes to the negotiation design can have a dramatic impact on the outcome. Never use a suboptimal negotiation design as you will leave money on the table.
9. Don’t hurt yourself
Using game-theoretically optimised negotiations can be extremely powerful, but an ill-defined negotiation design can have disastrous effects.
10. Walk the talk
If a supplier has won in a fair competition, nominate them as it was your commitment.
Dr Sebastian Moritz is director of TWS Partners
Supply Management and TWS Partners are hosting a half day workshop on the application of game theory to procurement, on 16 October in London. To register your interest, click here.