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.
- 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.
- 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.
- 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.
While the word innovation means different things to different organizations, companies are unanimous in agreement that, today, innovation needs to become the bedrock of the business – whether it’s a new piece of technology, a more efficient way of doing things, or simply a new approach that tackles an age-old problem.
Businesses are increasingly turning to suppliers to provide the tools to make new innovations a reality and, although several different functions interact with suppliers, it is procurement that is typically responsible for bringing them on board and integrating them into the business.
According to research from Procurement Leaders, on average, two-thirds of a company’s revenue are spent with suppliers. With such a significant proportion of cash being invested into suppliers, it makes sense to make the most of this investment by forming closer, more collaborative, working relationships with them. After all, if the end game is achieving innovation across every area of the business, the old adage ‘two heads are better than one’ means that collaboration between procurement and suppliers will help drive efficiencies and lead to better outcomes for all.
22% of CPOs intend to direct more resources towards supplier relationship management (SRM) in 2017, according to Procurement Leaders’ most recent Trend Report, highlighting the importance that CPOs are placing on improving the relationships their functions have with suppliers.
A fully engaged supply base is vital to a procurement function. It can help deliver new products that help grab market share from competitors, improve manufacturing processes or drive sustainable performance.Read More »
A good negotiator needs not just a repertoire of strategies, tactics and techniques, but also the experience to know when and how to deploy them.
One strategy – the concession strategy – lies at the heart of every negotiation as it determines how you can manage the way a negotiation plays out. Yet the concept and the actual reality of putting it into practice seem to be difficult to match up.
It is a moveable feast of what we can and cannot accept, combined with how we manage what we need to negotiate, and a planned means, that helps us reach the end goal in a way that maximises our success. In my experience, the concession strategy is the least planned-for and most-avoided component of negotiation preparation.
As a procurement leader, it is important to ask the following questions: What do I know about our suppliers? What should I know that I don’t?
Most businesses can tell you anything you want to know about their cust
omers. Not only do companies know who their customers are, organisations also know their clients’ wants and needs, purchasing patterns, risks and priorities, contract terms and committed service levels. Businesses are expected to know what a customer pays versus what they are supposed to pay, as well as which type of customer will pay more for specific items and those that will pay less. To put it simply, they understand the detailed financial implications of a change in any customer relationship.