When any business looks to reduce costs, input prices are typically regarded as one of the most rigid, difficult to change elements, because of their heavy reliance on external factors.
With procurement increasingly finding itself subjected to these factors, and with suppliers increasingly being the source of innovation and technology solutions to businesses, the supply base is finding itself in the driving seat steering procurement teams during negotiations.
Game theory – the scientific modelling of interactions between different parties in competitive situations – can be applied to the function to help it reduce costs, leverage company performance and value, and boost competitive advantage. It provides a way for procurement to strategically influence market dynamics and put itself back in the driving seat with suppliers.
There are four main building blocks to implement game theory correctly and to the function’s advantage.
One of the most common challenges in negotiations is establishing internal and external commitments to the terms procurement sets out. A loose negotiation structure makes the process lengthy, inefficient and vulnerable to renegotiations.
By applying game theory, the function is in a better position to bind all involved parties to a pre-agreed commitment, helping to steer negotiations through pre-assessed routes. This limits the likelihood of the team ending up ‘haggling’ with internal stakeholders and suppliers.
Procurement must of course be at the heart of the supplier selection process but when applying game theory, it is beneficial to combine the expertise of all internal stakeholders. This cross-functional collaboration can bring together benefits from across the organisation, while still giving procurement the ultimate power over the decision-making process.
Implement advanced strategic tools to better influence and shape the markets the business operates in. These tools enable procurement to shape the competitive landscape as a price shaper rather than a price taker, and elevate competition between suppliers. In turn, this helps procurement extract the maximum possible value both commercially and with regards to contract terms.
Game theory, as the science of decision making, creates the need for role assignment and outcomes enumeration. Procurement teams should implement a more structured process, meaning that conflict of interest and moral hazards are both eliminated thanks to internal alignments that are set and committed to at an early stage.
In today’s fast-evolving economy where suppliers are rising in terms of size and diversification, it’s imperative procurement takes on a more structured methodology. But this type of methodology can only work if these four building blocks are implemented correctly.
Read part one of this blog series here
Members can read more about negotiation excellence in Procurement Leaders Guide to: Negotiation
Dr Sebastian Moritz is director and Nafa Ben Haddej is strategy consultant from TWS Partners, a market leader in the application of game theory and market design in business
This contributed article has been written by a guest writer at the invitation of Procurement Leaders. Procurement Leaders received no payment directly connected with the publishing of this content.