Game Theories in Procurement
How to systematically achieve maximum results in your negotiations
Based on its experience, the purchasing department often negotiates with potential suppliers using unknown and subjectively selected criteria.
If several equivalent suppliers are available for a contract to be awarded, the negotiations usually take place sequentially in bilateral meetings with individual suppliers. Here, the competition aspects are not transparent or are distorted. Furthermore, the supplier can only plan his bid strategy with some uncertainties.
The negotiating partners attempt to analyze the framework parameters of the initial situation as well as the other party’s own options for action, expectations and goals, to predict their behavior and to improve their own position through optimal activities. By effectively designing the framework conditions, purchasing can systematically steer the results of negotiations in the desired direction.
The consistent use of game theory considerations in binding purchasing auctions can significantly increase the results. In this context, purchasing defines clear rules for the course of negotiations and the subsequent awarding of contracts and communicates them openly. This enables suppliers to better plan their offers on the basis of the specifications and to compete directly with their competitors in the market. Purchasing now only acts in the role of a neutral arbitrator. In this way, buyers create a maximum competitive situation on the supplier side.
The game theory can also be applied to the course of procurement negotiations. In binding purchasing auctions, the buyer commits himself to precise, objective negotiation and awarding rules with regard to suppliers. These are defined by the auctioneer before the auction begins. Whether auctions can be successfully applied in purchasing depends essentially on two conditions:
- Existing competition in the procurement market (no seller’s market)
- The award volume should be both attractive in monetary terms for the market and strategically interesting for the bidders.
The success of an auction is not only dependent on the product or service and its volume, but also on the possibility of reducing the various comparison dimensions to only one component – the price.
Below is an overview of the best practice method for conducting purchasing negotiations with auctions.
The appropriate award design maximizes the result of purchasing and can lead to unexpected success due to competitive dynamics. There is no limit to the creativity of procurement in the negotiation and awarding design.
In addition to the decision for the appropriate auction design, transparency and trust is the key to success, since it is often the same people on the purchasing and supplier side who meet in recurring negotiations.
The perfect preparation is the absolute prerequisite for using game theory in auctions. It takes more time and ties up far more resources but is the decisive factor for success!
Game theory is a highly efficient method to make negotiations & auctions more successful. It belongs in every toolbox of the purchasing department to be able to use it in a targeted way.