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Game theory in procurement

Game theory in procurement
Game theory: the analysis of rational behavior in situations of strategic interaction.
Strategic interaction: the behavior of the other ‘player’ influences my ‘pay off’
The art of strategic decision making is acquired by experience
Game theory is a method to use experience systematically
 Players: people/companies/counties
o Who are rational and have at least 2 strategies
 Strategies: one action
o Or a set of actions
 Payoff
o Every possible outcome of the game results in a payoff for each player
 Rules
o Often implicit in the strategies and payoffs
Equilibrium: solution of a game
 no player has an incentive to deviate from their strategy
 question whether a player has an incentive to deviate from his strategy in order to reach a
better payoff
 Find the equilibrium by analyzing incentives of the players
Prisoner’s dilemma: is een begrip uit de speltheorie als voorbeeld van de relatieve voordelen van
samenwerken en niet samenwerken.
 Het spel kent twee spelers;
 Het spel is simultaan: beide spelers moeten tegelijkertijd beslissen;
 Het spel is non-coöperatief: er is geen contact tussen de spelers;
 Het spel levert een resultaat op dat niet het gunstigste is, beide spelers kunnen een beter
resultaat behalen.
Prisoner dilemma doorbreken/verzwakken d.m.v.:
 Sociale druk
 Communicatie en afspraken tussen partijen (afdwingbaar)
Repeated prisoner dilemma: wanneer een prisoner's dilemma-situatie herhaald wordt. Hierbij dient
men niet alleen rekening te houden met een enkel spel, maar ook met de strategie van spelers in
vervolgsituaties. Met name wanneer het aantal spelronden onbekend is, kan een coöperatieve
strategie lucratiever zijn.
Mechanism design sets rules on how players must behave in order to achieve a desired target. A
Mechanism is a set of rules/incentives to control player behavior.
 Bringing in other players/changing the game
 Changing the size of the pie (bundling)
o Across business (new+running business)
o Over time (multi-year contracts)
 Changing the actions of suppliers
o Enlarge time periods between negotiations
o Awarding process in which deviation is detectable
 Changing the pie at stake: asymmetric shares
o Asymmetric shares: 80%/20% is better than
Bargaining theory (onderhandelingstheorie)
 the branch of game theory dealing with the analysis of bargaining problems, through game
theoretic situations, where parties repeatedly make offers to each other which they either
accept or reject
 the theory itself is highly formal. However the insight gained through these models can be
used for concrete negotiation situations
 the ‘aim of the game’ is to put yourself in the other party’s shoes: how will the other party
react if he was to receive this offer?
Negotiation should start by enlarging the pie  increased by factors which are either of common
interest, or where the costs to one party are lower than the gains to the other.
Several factors determine the distribution of the pie:
 information
 focal points
 alternatives
 commitment
 competition
 timing
Own information
Never disclose own interests and targets without
Identify what information is valuable to others
Share information which places you in a better
Consider trading information
Other player information
Gather as much as you can
What do their actions reveal
Beware of ‘cheap talk’ and ‘exposure effect’
Evaluate whether information shared with you is
Incentivize others to share truthful info
Focal points in procurement
 clean sheet pricing
 price developments (of input factors)
 corporate savings target
 last/recent year pricing
 benchmark pricing
Application to target price:
 timing: who makes the first offer (first mover advantage)
 target price: justifiable target price might focus the negotiation towards a desirable outcome
 be aware of focal points set by the opposing party
BATNA: Best Alternatives To a Negotiated Agreement
Information about other party’s BATNA is strategic information.
Supplier’s strategy
 USP (innovation, brand name)
 Alternative business opportunities
 Alternative areas of business at same
 Leaving the market: exit strategy; if
you can’t win, you lose
Increase alternatives (competition)
 Qualify alternative suppliers
 Enable substitute technologies
 Consider exit strategy as option
 Make alternatives monetary
comparable and define walk away
Manage incentives
 Bundling of project awareness
 Multy-year contracts
Loss of alternatives/dependencies
 Awarding decision fixed before the
negotiation (stakeholder – and
customer requirement)
 Backwards compatibility required
 Preference for global footprint
 Beneficial abandonment of flexibility
 Credible commitment to a process and its outcomes provides certainty to the other party,
encouraging them to engage
 Commitment drives internal alignment and helps reach a unified position
 Non-compliance to commitment will severely damage reputation in future negotiations
 Credibility and reputation are built over time as actions are observed
How can commitment be achieved:
 Burning bridges
 Firm policy
 Long-term relationship
 Contracts
 Most-favoured-customer clause
 Delegation
 Licensing
3 key factors determine the expected negotiation results  weak bargaining position:
1. Weak competition: pre-selection of 2 suppliers
2. Weak selection: both suppliers win part of the business
3. Weak incentives: awarded shares are similarly attractive
3 key factors determine the expected negotiation results  strong bargaining positions:
1. Multiple, equally strong competitors: creation of competition and comparability despite
2. Transparent and case-specific selection process: committed and multi-lateral negotiation
3. Attractive business opportunity: maximum incentives to win the business
 Negotiating when cost drivers show favorable trends
 Are any of the companies under pressure of a deadline
 Are any of the negotiators under pressure of a deadline
 Is there any industry standard negotiation cycle
7 rules of bargaining theory:
1. Enlarge the pie
2. Acquire information
3. Provide incentives
4. Create commitment
5. Improve your BATNA
6. Increase competition
7. Negotiate at the right time
Open Auctions:
 Reverse Dutch auction: is een veiling waarbij een product op een te hoge prijs wordt ingezet,
waarna de prijs daalt totdat iemand akkoord gaat. Bijv. bloemenveiling. Onder meer
bloemenveilingen en visafslagen werken op deze wijze. De veiling gaat als volgt: de bieders
zitten bij elkaar en krijgen de partij van het product te zien die wordt geveild. Voor deze
partij wordt een prijs vastgesteld op de grote veilingklok. Deze prijs begint hoog waarna de
prijs daalt (wat te zien is op de klok). Die bieder die als eerste drukt (vroeger 'mijn' riep)
koopt de partij. De kunst is om niet te vroeg te drukken want dan betaal je te veel, maar druk
je te laat dan heeft een andere koper de partij al gekocht. Wanneer de prijs onder een
bepaalde waarde zakt wordt de klok stilgezet en komt er geen transactie tot stand. Men zegt
dan ook wel dat de partij is "doorgedraaid". Dit fungeert als een minimumprijs.
 An English auction is an open-outcry ascending dynamic auction. It proceeds as follows.
o The auctioneer opens the auction by announcing a suggested opening bid, a starting
price or reserve for the item on sale.
o Then, the auctioneer accepts increasingly higher bids from the floor, consisting of
buyers with an interest in the item. The auctioneer usually determines the minimum
increment of bids, often raising it when bidding goes high.
o The highest bidder at any given moment is considered to have the standing bid,
which can only be displaced by a higher bid from a competing buyer.
o If no competing bidder challenges the standing bid within a given time frame, the
standing bid becomes the winner, and the item is sold to the highest bidder at a
price equal to their bid.
o If no bidder accepts the starting price, the auctioneer either begins to lower the
starting price in increments, bidders are allowed to bid prices lower than the starting
price, or the item is not sold at all, according to the wishes of the seller or protocols
of the auction house
Often unclear rules: who has to do what in order
to get what?
Award of contract after the bidding process, i.e.
selection of suppliers according to price and
additional criteria whose importance is unknown
to suppliers prior to the bidding process
Well-defined rules which are communicated to
participating suppliers with reasonable notice
before the start of the auction
Award to contract including conditions (price,
share etc.) as a result of the auction process
The value of ownership evaluation
 Goal: Total Value of Ownership evaluation makes suppliers comparable via Comparison
 Advantages:
o Integration of TVO
o Achieving transparency to the in- and outside world
o Preserving continuity towards suppliers
o Creating incentives
o Increasing competition
o Prudent risk taking