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Applying game theory to procurement’s negotiations

Procurement and game theory

Negotiations can be a fraught process. Both supplier and buyer tend to look for an advantage over the other.

In truth, both should be looking to see if they can win together. To achieve this, procurement is increasingly looking towards different theories, most notably ‘Game theory’. In order to work, its principles need to be applied correctly.

 

Developed by John von Neumann and Oskar Morgenstern in the 1940s, game theory bases a predicted outcome on the interaction between two individuals’ decisions; the success of one individual’s chosen strategy or decision is dependent on the strategy or decision of the other individual and vice versa.

 

Although typically associated with political science and economics, there are occasions where the theory has been applied to successful negotiations within procurement. It demonstrates why two ‘rational’ individuals may not choose to cooperate effectively despite both knowing that to do so would be in their best interests.

 

Here are three tips for successful application of game theory to negotiations.

 

  1. Information and understanding

 

Game theory can help provide clarity to negotiations and ultimately help procurement achieve greater savings without the risk of alienating a supplier. How? It encourages procurement to better understand the thought process behind a supplier’s decision. Once a solution has been reached, the structure of game theory encourages procurement to look at the reasoning and then work backwards. Understanding a supplier’s mentality can inform future negotiations and potentially help build the relationship.

 

  1. Use common sense

 

It is not uncommon for negotiations to take the path where, although one particular outcome may be in both parties’ interests, one or both parties choose the outcome of greater self-interest. However, no one negotiation is the same and even though game theory suggests accepting a scenario that is mutually beneficial is the best course, that’s not to say that procurement should accept an offer that will bring less of an advantage to them or their business. Using common sense and applying this strategy only to appropriate situations will achieve better results.

 

  1. Prepare for the unknown

 

Even where the theory is applied, there is always an element of risk and uncertainty. Whether it be through market research or requests for information, proactively conducting research can help arm procurement with information useful in negotiations with stakeholders and suppliers.

 

If implemented well, game theory can add significant value to both the function and the business, according to TWS Partners’ Procurement redefined report, which states that the "innovative approach of applying game theoretical thinking to all aspects of procurement has a big impact – both in terms of results and with regards to the perception of the procurement function within an organisation". After all, by shaping and influencing interactions in negotiations, game theory can generate an almost instant return on investment which procurement can share with the business to demonstrate the value it brings to the wider organisation.

 

Applying these theories to procurement’s strategies has the potential to be a game-changer to both the function and the business, but, importantly, to suppliers as well.

 

This article is a piece of independent writing by a member of Procurement Leaders’ content team.

Sophie Dyer
Posted by Sophie Dyer

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