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Europe Forum preview: How behavioural economics could change your procurement function

paul craven

Procurement Leaders Europe Forum returns to Amsterdam in October for two days of discussion around how new trends and technologies will shape the function in the years to come and to the way in which procurement can develop value-generating relationships with suppliers.

 

Those procurement executives who want to stay ahead of the competition should not miss out.

 

Ahead of speaking at the Forum, behavioural economist Paul Craven shares some of his tips on creating win-win relationships with key external suppliers.

 

Procurement Leaders (PL): What is behavioural economics and how did you become interested in it?

 

Paul Craven (PC): I worked in the financial markets for almost 30 years and one of the things I noticed was that the industry commonly accepts the ‘traditional’ economic way of thinking that humans make rational decisions based on what they regard as conscious, analytical logic as well as immediate economic self-interest. In practice, however, decisions to invest in currencies or other markets are often reached from a more emotional, instinctive or unconscious perspective.

 

What was missing in the traditional theory was behavioural economics. Behavioural economics shows us how real people make real decisions in the real world.

 

We as humans like to think we make rational decisions, based on moving from steps A to B to C to D. But this is not always the case. Humans make mental shortcuts and often miss out steps due to their unconscious biases and heuristics. We then try to make sense of our decisions, falling back on confirmation bias. As Robert Heinlein put it, “Man is not a rational animal, he is a rationalising animal”.

 

These biases are often based on good evolutionary reasons – as an example, human beings naturally take comfort in ‘the safety of numbers’ but in modern business, those who perform best are often those who fight the herd instinct and dare to be different.

 

PL: What can procurement executives learn from behavioural economics?

 

PC: In the business world, whether working in procurement or in finance, there is no escaping the fact we ultimately care about revenues and profits, so we naturally strive to maximise the bottom line. But to do so can result in us becoming too focused on the short-term, transactional wins, meaning we can often forget the important, nonfinancial things at play.

 

There is a famous saying that ‘not everything that counts can be counted, and not everything that can be counted counts’.

 

Rather than simply looking for short-term transactional gains, procurement benefits more from building long-term relationships. This is where behavioural economics comes in. The question is: what really matters to human beings?

 

Understanding this is key to longer term success for the business.

 

In real life, getting the best price on one occasion is usually less important than securing loyalty long term. A chance to build a strong relationship is more important than today’s price. Whereas if procurement is always asking simply for the lowest possible price without regard for the relationship, then the supplier will have no incentive to deliver any more than the minimum goods or services it has contracted to the buying company. Losing sight of the relationship between supplier and buyer could create more damage in the long term than saving a few more pennies could.

 

PL: How can behavioural economics be applied to negotiations?

 

PC: Numbers, facts and figures are of paramount importance, but humans don’t necessarily respond these alone. These are the logical ways to persuade someone in a negotiation but they are not the only factors. Credibility and trustworthiness can be just as important and, to cement the best deals, the best persuaders and influencers appeal to the heart as well as the head. There is also an element of reciprocity here; most people respond in kind, and this is as true in business as in life.

 

Another example relates to pricing given people’s desire to compare things to make sense of the narrative. For example, a buyer considering two different options based on price will frequently make a decision based on cost, often favouring the cheaper option. By offering a third choice, it is far easier for a seller to highlight the true value of their preferred option.

 

PL: What should leaders in procurement be doing to avoid behavioural patterns such as groupthink and biases?

 

PC: Social psychology teaches us that there are both individual biases and group biases. One type of bias is ‘conformity’ as members of working groups will often fall into groupthink – and accept a consensus without truly debating the issues. This is where it is important to have a ‘devil’s advocate’ in any decision-making body, someone who is prepared to challenge conventional thinking.

 

Leaders can do a number of things to steer their teams away from groupthink. In meetings, for example, the leader should not give his or her own view at the beginning as this will influence the views of their team before other opinions are aired; instead, it is important to let others share their ideas first.

 

PL: In light of the recent unpredictable geopolitical events, how should businesses prepare for the future?

 

PC: In 2016, businesses and investors spent a lot of time worrying – about China’s economy, about the UK leaving the European Union, about Donald Trump – but the fact is it is difficult to predict how these things will pan out and what impact they will have on markets and businesses. In the end, most stock markets actually finished the year substantially higher.

 

The lesson is surely that business leaders need not waste time pretending to be experts in geopolitics and obsessing over macroeconomic trends. If you are a procurement specialist, focus on your area of expertise, and don’t be distracted by the newspaper headlines. While scenario analysis is a useful exercise to consider business options, pinpoint macroeconomic or geopolitical predictions are usually a waste of time. To quote Eisenhower, “in preparing for battle, I have always found that plans are useless but planning is indispensable.”

 

Find out more about the Europe Forum and to book your place here

 

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