Game Theory


TWS PartnersWith in-house production decreasing in most industries, supply chains are becoming increasingly integrated and complex and companies are ever more reliant on suppliers’ flexibility and supplier-driven product innovation. Game theory can be a “game changer” to help manage this complexity and to move the role of Procurement from a tactical to a highly strategic role.

 

The application of game theory dramatically improves the outcome from all decision-making Procurement scenarios including complex, cross-functional sourcing activities, annual price negotiations, make-or-buy decisions, or outsourcing projects. Read more about TWS Partners.

What is Game Theory?

Do you order a starter, too, or stick with only a main dish?

Game theory is the scientific modelling of interactions between different parties each pursuing their own interests. The parties interact and choose their action in view of what the other parties might think and do. Economists call this game theory and they think about such interaction as a ‘ply-by-ply’ game, where each player is trying to find an optimum strategy.

Research on game theory is a very active branch of economics which has won several Nobel Prizes. The application of game theory in business is twofold.


Winning the game

Firstly, game theory is a method for understanding the ‘rules’ of an interaction and for finding the best strategy in that setting.

Imagine you are considering two pieces of jewellery on a market stall. The seller asks you which one you prefer. If you reveal your true preference, will he quote you a higher price for that piece than he otherwise would have? Should you bluff and say you prefer the other, only switching at the last moment? What if the seller accepts that strategy and believes that you will be bluffing? What if he thinks that you think that he thinks you are bluffing?

Should you start with a very high asking price for your house to anchor the negotiation in that price range? Or do you let the other side make the first offer? How do you react to a counter-offer with an expiry date?

If your company is bidding for a contract, what can you do to differentiate your bid without being dragged into an all-out price competition? Would you take a different approach if you were pitching to a repeat customer?

Game theory characterises such settings and describes each action and response as the moves of a game. Game theory experts then work their way ‘backwards’ from winning positions to the start of the game and analyse how good outcomes can be achieved and bad ones avoided. They develop ‘dominant’ strategies, whose outcomes are independent of how the other parties act. They also look for ‘fixpoints’ or ‘equilibria’, where the different participants’ actions lead to stable and satisfactory outcomes.

Game theory finds the best strategy for you, given a specific ‘playing field’.


Inventing a new game

Secondly, game theory is a method for structuring interactions so that the participating parties are steered towards a desirable outcome.

When an employer and a union cannot find an agreement, both parties suffer. Can they resolve their negotiation deadlock without the damages from industrial action? How can they determine whether and where a compromise is possible, without weakening their respective bargaining positions?

If teachers are rewarded based on the grades of their students, are they encouraged to become better at teaching or tempted to hand out good grades for poor work? Is a better incentive scheme possible?

A government wants to assign grant money so that it is put to best use. How can they know how much to assign, if all suitors are overestimating their needs? Ideally, the receivers should return unused funds for reallocation at the end of the year, rather than squandering them just before the deadline. Is there a mechanism that reveals the truth and rewards frugal management?

Game theory tells you which environment you have to create so that everyone will be doing the right thing. By choosing which information to reveal, when and to whom, and by establishing how you react to certain actions and offers, you are changing the rules of an interaction. This, in turn, sets the incentives for everyone else. Your ‘rules’ can make the other parties reveal their true intentions, encourage cooperation, and steer the interaction towards the best result.

Game theory helps to design a playing field where everyone is working towards the best outcome.

If you are splitting the bill, order a starter, too – or change the rules of the game!


Game theory for procurement

In procurement the design aspect of game theory is particularly effective, as the buyer typically sets the rules for the negotiation process and the clauses that govern the contractual relationships after supplier nomination.

Each procurement negotiation and contractual relationship can be described in the game theory framework. Game theory then yields answers for key questions in strategic procurement, such as:

  • How do you set the best rules for the negotiation game or sourcing activities in general?
  • How can you ensure the rules are accepted and adhered to by all participants?
  • How do you incentivise suppliers to provider better value?
  • How can the resulting outcome be sustainably enforced and adapted to changing circumstances?

TWS Partners have successfully implemented over 2,000 projects across a vast range of categories and industries, working with market leading organisations in Europe and internationally within the Automotive and Transportation, High-Tech and Telco, Pharmaceutical, Chemicals and Consumer Goods industries, with a total spend of more than 200 billion Euros.

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Related concepts

Negotiations in Procurement

You can motivate suppliers to offer their best price by starting the relationship as a conversation, not a competition (den Butter and Linse)

Find out more

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You can motivate suppliers to offer their best price by starting the relationship as a conversation, not a competition (den Butter and Linse)

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Insights

How to use Game Theory and rule-based processes to get an edge in procurement negotiations

Procurement negotiations are renowned for being a battle of wills and a show of steely determination, more akin to a game of poker than a business transaction. With the application of game theory, the scientific framework which analyses interactions between different parties, Procurement can ensure they hold all the cards and turn this game of chance into a scientific, proven and reliable process.

Find out more

White paper

Game theory is a game changer for procurement

The world is changing. In-house production is decreasing, reliance on external suppliers for innovation is increasing, and supply chains are becoming ever more complex. To compete in this changing world, the role of Procurement must also change - but how? One answer is game theory.

Find out more

White paper

Survey

Application of game theory in procurement survey

By conducting this global survey, CIPS and TWS Partners aim to investigate the current level of awareness for the topic and degree of application across CIPS members and their organizations worldwide. The survey is closed now, results will be available soon.

 

Survey

About TWS Partners

TWS Partners – the game theory experts

TWS Partners

TWS Partners is the only company globally which exclusively specialises in using game theory to improve business performance. In Procurement, game theory helps in the analysis of complex sourcing decisions and can be used to achieve significantly better results and to significantly strengthen the role of Procurement teams.

The level of interest from CIPS members in game theory was confirmed following the 2016 CIPS Annual Conference presentation were TWS Partners and Jaguar Land Rover gave a joint key note speech on the commercial application of game theory and the transformation of Jaguar Land Rover’s Procurement function.

Founded in 2001 in Munich as a spin-off from industry and research, TWS Partners implement methodologies based on Nobel Prize-winning research to support large and complex sourcing projects and negotiations. The TWS Partners’ team consists of more than 60 consultants, many with PhDs in Economics and Game Theory and links to leading universities in Europe and the UK.

TWS Partners has already successfully implemented over 2,000 projects, working with market leading organisations in Europe and internationally within the Automotive and Transportation, High-Tech and Telco, Pharmaceutical, Chemicals and Consumer Goods industries, with a total spend of more than £170 billion.  

 

TWS Agility Check

The TWS Agility Check is a practical and scientific analysis tool which can be tailored to a company’s own needs. It comprises the Agility Benchmark and Agility Pilots. The Agility Benchmark involves workshops to deliver a 360 degree analysis of the Procurement function, identifying areas for improvement in comparison with other agile organisations. Agility Pilots are test projects in your “live” environment, to give a reality check with direct added value, given that our projects generate ROI right from the start. Arrange a TWS Agility Check.

 

Procurement redefined

Game theory offers more than a simple blueprint for sourcing projects - it teaches a whole new way of thinking that enables Procurement teams to systematically achieve above average results. The methodology implicitly means that each and every solution must be case specific and tailored to the situation.

It sees businesses learning and evolving on a project-by-project basis, with each success building momentum and driving change throughout the entire company.

The results achieved create trust and then enthusiasm in the Procurement department and other participating functions. This leads to a brand new level of cross-functional collaboration – all initiated by the Procurement department and TWS Partners.

To find out more about game theory, read TWS Partners’ white paper Procurement Redefined.

To get in touch with TWS Partners and enquire about how game theory can revolutionise your organisation, contact us