Leveraging 'Game Theory' in Strategic Sourcing

Sourcing managers who understand game theory gain deeper insights into the interests and objectives of participants


  1. One size doesn’t fit all: Classify categories where there is low market leverage – One way of doing this is to have a list of parameters that qualify “leverage” such as Brand Reputation, the impact your business has on the supplier’s growth, past stickiness of your suppliers, your current vendor churn, current Supplier Management Systems and also a comparative price benchmarking with some of your competitors. Typically for categories that you don’t have high leverage with the vendor base you can design a sourcing script that aggregates all “What If” scenarios before going to the negotiation table
  2. Change the game after each round: More often than not smart suppliers can see through the pattern of your negotiation hence manipulate their pricing structures accordingly. It’s important to change the negotiation script at each stage. For example for a Contingent Labor category if the first round is all about margin structures the next round could be about deconstructing the cost of operations in a specific project and the third could be changing the parameters and scope of the project itself. Before initiating a game buyers must also be well aware of their total costs, risks and trade-offs
  3. Optimize on a few factors: not all at the same time – When sourcing organizations arrive at a negotiation table trying to optimize on all fronts, they fail to create a mutual supplier win-win. For each category it’s important to extract value over a sustained period of time rather than putting in all boundary conditions all at once. This leads to poor supplier relationships and is difficult to sustain leverage over time. If the first wave was Unit Price reduction the following rounds could Payment Terms or Minimum Order quantities. For game theory to play out evenly in a balanced two-sided manner it’s important to have some occasional hooks – in the prisoner dilemma context, adequate incentives that compel one of them to confess.

4. Structuring and timing e-Auctions carefully: Lot of companies use Auctions as the most effective and first line of defense for speedy realization of value. While the whole auction concept is largely predicated on tapping on “competitive” behavior and psychology, timing it well and structuring it will care could yield close to 7-14% of savings in a specific category. New auction formats like the Dutch and Brazilian auctions cover a broader product spectrum for online allocation especially for a category like Utilities. For multiple lot rounds putting small lots first over big lots is a smart idea as the converse many times makes the supplier lose focus on the small lots after the big lots are allocated. Buyers need to know their markets well in order to predict auction outcomes well in advance. This also means that Buyers should develop enterprise reverse auction strategies on which individual buyers can then base their tactics for each category. They should also clearly establish, communicate and adhere to the Business Rules diligently

  1. Robust Supplier management/development programs: One of the critical success factors of game theory is the buyers understanding of the supplier psyche. This comes once you know your supplier base and their cost structure well to then influence their decision making, Supplier Management programs that go beyond just risk assessment at the time of on-boarding really help. Tools such as Achilles, Hiperos, and Sci-Quest help sourcing teams to manage supplier evaluation and ongoing development in a more fact-based manner. Firms also need to ensure that they create a structure that helps both parties learn from each successive sourcing event

Even an efficient sourcing operation can raise its game and achieve rapid payback. An academic concept is finding increasing buyer acclaim for its effectiveness. Buyers need to learn how to apply the theory to bidding matrices and spend profile by category. Category playbooks or commodity dossiers should incorporate game theory principles to bolster strategic sourcing rigor. By learning these practices, buyers will find they can benefit in a wide range of negotiations.

Raj Bhattacharya is Vice President and Global Source to Pay Transformation Leader at Genpact. He is based in Hyderabad, India.

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