Using Game Theory to Drive Procurement Negotiations
Imagine you’re buying that latest phone from a dealer.
The dealer has a fixed price at which he wishes to sell the phone and cannot drop the price further without making a loss. The dealer drives negotiations based on the fact that you’re interested in making the purchase, and if he could sell the phone to another customer, he might get a price beyond the break-even point and earn a better profit. While you negotiate the price based on the fact that the dealer wants to sell the phone and there’s a profit margin wherein you can bring down the phone’s price.
In such everyday situations, utilising Game Theory in rational decision-making can help individuals unfold better outcomes. By definition, Game Theory is a study of strategy and decision-making used in initiating negotiations or settling conflicts between different parties. In negotiations, Game Theory is implemented under the assumption that the parties involved acknowledge the information and reach equilibrium at a common ground.
The “Game” is often referred to as an interaction between the involved parties who consciously know the boundaries and rules of the “Game”. Some of the best-known games include Prisoner’s Dilemma, chicken, stag hunt, and trust, among others.
Practising Game Theory in Procurement
Traditionally, the procurement process involved issuing a Request for Proposal (RFP), post-which bidders respond with their best offer to close the contract together. Depending upon the buyer’s specific requirements related to sourcing, the buyer enables parallel negotiations with multiple vendors based on pre-defined scoring and evaluation. With the lack of competitive dynamics and systematic evaluation to structure the auction, buyers and suppliers remain unaware of the best possible prices that can benefit both parties.
Whilst Game Theory is the scientific modelling of interactions, it can be utilised extensively to revamp traditional negotiation methodologies to steer toward a preferable outcome. In today’s procurement scenario, structured, rule-based negotiations can increase results and savings notably. From a strategic point of view, Game Theory based negotiations can increase the competitive dynamics and transparency between suppliers and businesses.
In procurement, buyers can enable open auctions, where suppliers can see competitors’ bids, or closed auctions, where participating suppliers are unaware of the bids and qualify by giving the lowest price possible. With these techniques, buyers can navigate participants towards the desired direction while giving suppliers the opportunity to undercut their bids. These eAuctions facilitate transparency and openness for all suppliers and ensure monetary as well as non-monetary goals.
Benefits of Implementing Game Theory
1. Better Communication
Game Theory’s systematic and mathematical approach gives both parties an opportunity to analyze the negotiation and reach agreements on common ground reasonably. The strategies can also be traced back, studied, and reused for any negotiations in the future.
2. Improved Savings
Buyers can reap a better return on investment for their sourced goods/services by having transparency on the best possible price from the vendor’s side. They can also explore new avenues of savings by retaining competitive tension between vendors and adjusting the price to achieve optimal outcomes.
3. Streamlined Negotiations
While negotiation is a mix of competition and cooperation, Game Theory can be a promising strategy to drive negotiations. Carefully identifying the required prices, quantities, and qualities, while evaluating bids from participating suppliers can eliminate elements of uncertainty and risk.
4. Strong Supplier Relationships
The intent of implementing the Game Theory is to have a win-win situation for both parties and not detriment one’s business. With transparency about commodity/services pricing, powering procurement solutions with Game Theory can tactically select the best bid out of the potential supplier pool without them losing the margins.
Conclusion
Game Theory-based negotiations come with multiple benefits, however, they cannot be applied in every situation. The assumption of making rational decisions is backed by significant computing power and historical data, which enables AI to automate the bidding process. Present-day legacy procurement systems don’t structure data in the desired format and have become redundant with unclean data.
New-age procurement software like Procol is designed to clean data coming from multiple sources and use it to drive efficient negotiations. Our solution suite enables frictionless exchange between buyers and suppliers throughout the entire source-to-contract process. Want to know how we’ve eAuctioned spends worth INR 7500 Cr+ through our platform? Schedule a demo now.