Dr Sebastian Moritz, Director of TWS Partners, explains the four main building blocks of game theoretically optimised sourcing decisions and processes which should be used by Procurement to survive in today’s changing world.
When any business looks to reduce costs, input prices are typically regarded as one of the most rigid and hard to change elements due to their heavy dependence on exogenous factors. This view is leading to companies gradually losing the edge in optimising input costs, as suppliers are becoming the major providers of innovation and technology specialised solutions.
Procurement departments are being pushed into positions where they are operating mainly as attached service providers who are being led by pronounced preferences of internal stakeholder and suppliers. This in turn is strengthening suppliers’ ability to steer companies to the direction of their terms, and it is time for change.
Procurement needs to be transposed to the core of any business in order to create an inter-department approach capable of coordinating the sourcing needs strategically. Game theory – the scientific modelling of interactions between different parties in competitive situations – enables Procurement departments to thrive as entrepreneurial value drivers capable of significantly reducing costs, increasing overall company performance and value, and competitive advantage.
How to change Procurement’s role
Using game theory techniques, Procurement is able to strategically influence the market dynamics and competitive forces in negotiations to its advantage. This is achieved by looking into four key building blocks:
1. Negotiation excellence and commitment
One of the most common challenges in Procurement negotiations is the difficulty to establish internal and external commitments to the negotiation process. A loose structure makes the process lengthy, inefficient and open to re-negotiations, and prone to cost increases post supplier nomination.
By applying game-theoretical thinking, Procurement teams are able to bind all involved parties to a pre-agreed commitment, ensuring that negotiation is steered through pre-assessed, and more importantly, only intended routes. This allows for expected outcomes and improved commercial terms rather than ‘haggling’ with internal stakeholders and suppliers in a conventional manner.
2. Cross functionalities
Procurement must be at the heart of the supplier-selection process. Using economic reasoning, it is possible to strategically combine the expertise of all internal stakeholders. This cross-functional process enables companies to speak with one voice with its suppliers and builds on the inputs of different concerned parties.
For example, in the automotive industry, engineers, quality managers, logistics experts and representatives from commercial functions are all invited to the creation of a holistic value-centred metric evaluation. They work alongside the other contributing departments on prioritising the factors that may critically impact the commercial value of a product. But they not only do this in a qualitative manner. They assess the monetary impact of each and every factor named by a stakeholder – therefore shifting the focus from price to value.
The methodology allows Procurement to oversee the totality of each decision’s impact on a company’s bottom line – the most holistic perspective anyone can take in a business. A true CEO perspective!
3. Advanced strategy and market design – play the game, or change the game!
Advanced strategic thinking brought by game theory allows Procurement to influence and shape the markets companies operate in. It ensures that Procurement becomes the driver of a working competitive landscape rather than accepting the ‘rules of the game’ set by other players in the market.
This also allows Procurement to foster and leverage competition between suppliers and thus drives better results for the whole organisation in all dimensions – commercial and non-commercial. Utilising such an approach, Procurement can incentivise suppliers. For example, to invest more into R&D and innovation, to deliver better quality, more reliable supply chains and market leading commercial terms.
4. Process and organisation
Applying game theory to Procurement ensures a much more structured process where cross functionality is facilitated by a well-designed process. Shortcomings of conventional sourcing approaches are eliminated thanks to the internal alignments that are set and committed to at an early stage, ensuring the company runs its sourcing processes and decisions faster and more efficiently. This sees Procurement evolving, in the perception of other departments, from a reactive service provider to a forward-thinking value driver in organisations.
In today’s fast-evolving economy where suppliers are gaining significant size and diversification, it is imperative to rely on a smarter Procurement methodology. Game theory is that methodology. It is progressively expanding among Procurement professionals, with 90% of them confirming that the methodology has significantly contributed to their success*, ranging from automotive, aerospace and high-tech to manufacturing-driven companies.
To understand more and to learn how to implement game theory in your organisation today, read the white paper “Procurement Redefined”, the survey “The power of game theory is in your hands” or contact TWS Partners on +44 (0)203 5804276.
About TWS Partners
TWS Partners is the market leader for the business applications of game theory and market design. With more than 60 game theory and industrial economics consultants, the company has already successfully implemented over 2,000 projects on Procurement savings from a total spending of over €200 billion. TWS Partners is continuously engaged in embedding its methodologies into the clients’ organization and processes.
*TWS Partners and CIPS 2017 survey, ‘The power of game theory is in your hands.’