Game Theory and Procurement: Strategic Decisions Through the Kraljic Matrix
In procurement, buyers are constantly faced with a variety of strategic decisions. Should you negotiate harder for lower prices, cooperate to build long-term partnerships, or optimize processes for efficiency? More importantly, how do you decide based on the risk and impact of the item being procured?
While traditional procurement approaches often focus on linear strategies like negotiation or optimization, Game Theory offers a more dynamic framework for decision-making. This post will explore how Game Theory principles apply to different procurement strategies, helping buyers optimize their actions across risk and impact scenarios.
While traditional procurement approaches often focus on linear strategies like negotiation or optimization, Game Theory offers a more dynamic framework for decision-making. This post will explore how Game Theory principles apply to different procurement strategies, helping buyers optimize their actions across risk and impact scenarios.
Buyer Actions and Game Theory
Procurement decisions can be viewed as a series of strategic games in which both the buyer and the supplier have competing (and sometimes aligned) objectives.The critical buyer actions— negotiate, cooperate, optimize, or terminate—all have varying payoffs based on how suppliers are likely to respond.
Let’s apply Game Theory to analyze these actions and explore how different strategies play out across procurement scenarios.
We proposed a set of scores applied to each buyer's action when the business impact is high or low, and so is the supply risk. The sum of scores from the right-side table forms the resulting left-side table, which we may use to define procurement strategies.
For example, when you negotiate in the Leverage quadrant, your payoff is the sum of your "Negotiate" scores for high business impact and low supply risk, i.e., 3+1=4.
However, there may be better moves than negotiating in Bottleneck scenarios. The supplier holds the leverage here due to high supply risk and limited alternatives. Cooperating isn't the best strategy, as the supplier knows its powers and insists on a preferential position. The buyer may need to optimize then.
In the Strategic quadrant, cooperation yields the highest payoffs for both buyer and supplier (score 5 for the buyer). Both parties benefit from a long-term partnership with consistent supply and innovation.
Optimization is a Pareto-efficient strategy in leverage and strategic procurement. In these cases, process improvements and supplier performance programs provide long-term value for both sides. The payoff for optimizing in these scenarios is high (score 5 for Strategic and 4 for Leverage).
In Bottleneck procurement, optimizing yields lower payoffs (score 1) because the focus is on securing supply rather than improving efficiency. Suppliers in bottleneck situations often have little room to optimize, so efforts in this area may not be reciprocated.
In Strategic procurement, terminating a supplier could have disastrous consequences (score -5) as the buyer would lose access to critical goods or services. The buyer and supplier benefit more from continuing the relationship than acting independently.
In Non-Critical procurement, termination carries minimal risk (score 0) because alternative suppliers are readily available. Game Theory suggests that the buyer can act alone without risking significant negative consequences.
Negotiate: Zero-Sum or Non-Zero-Sum?
In procurement, negotiation is often treated as a zero-sum game—one party’s gain is the other party’s loss. However, in many cases, negotiation can be non-zero-sum, where both parties can achieve some benefit, especially if they have aligned long-term goals.Game Theory applied to Kraljic Matrix.
In Leverage scenarios where the buyer holds most of the power, negotiation works like a dominant strategy for the buyer. The supplier has limited alternatives, and the buyer can drive down costs or secure better terms with little risk. The payoff for negotiating in these cases is high (score 4), as the buyer can extract significant value.However, there may be better moves than negotiating in Bottleneck scenarios. The supplier holds the leverage here due to high supply risk and limited alternatives. Cooperating isn't the best strategy, as the supplier knows its powers and insists on a preferential position. The buyer may need to optimize then.
Cooperate: The Prisoner’s Dilemma in Procurement
Cooperation between buyers and suppliers can be analyzed through the Prisoner’s Dilemma, where both parties must decide whether to cooperate or act in self-interest. Cooperation tends to provide higher mutual payoffs, but only if both parties are willing to work together.In the Strategic quadrant, cooperation yields the highest payoffs for both buyer and supplier (score 5 for the buyer). Both parties benefit from a long-term partnership with consistent supply and innovation.
In contrast, in Non-Critical procurement, cooperation offers little value (score 2) because the stakes are low. Each party may act more independently since neither faces significant consequences from a lack of collaboration.
Optimize: Pareto Efficiency in Procurement
Optimization in procurement focuses on improving efficiency, minimizing waste, and maximizing output. Game Theory’s concept of Pareto Efficiency applies here—an outcome where no party can strengthen its position without making the other worse off.
Optimization is a Pareto-efficient strategy in leverage and strategic procurement. In these cases, process improvements and supplier performance programs provide long-term value for both sides. The payoff for optimizing in these scenarios is high (score 5 for Strategic and 4 for Leverage).
In Bottleneck procurement, optimizing yields lower payoffs (score 1) because the focus is on securing supply rather than improving efficiency. Suppliers in bottleneck situations often have little room to optimize, so efforts in this area may not be reciprocated.
Terminate: Risk and the Stag Hunt Game
Terminating a supplier relationship is a high-risk move that can be understood through the Stag Hunt Game, where players must decide whether to cooperate or act alone. The risks of termination are incredibly high in Strategic and Bottleneck scenarios, where supply continuity is critical.In Strategic procurement, terminating a supplier could have disastrous consequences (score -5) as the buyer would lose access to critical goods or services. The buyer and supplier benefit more from continuing the relationship than acting independently.
In Non-Critical procurement, termination carries minimal risk (score 0) because alternative suppliers are readily available. Game Theory suggests that the buyer can act alone without risking significant negative consequences.
Applying Game Theory to Procurement
Game Theory offers procurement professionals another way to analyze their strategic options in the context of the Kraljic souring matrix.By understanding the payoffs for Negotiating, Cooperating, Optimizing, and Terminating based on risk and impact, buyers can choose the optimal strategy for each procurement scenario (i.e., Kraljic quadrant.)
It is not necessarily the best solution, but it is an intuitive and logical way to determine your Kraljic-inspired strategies, at least for those who struggle to remember typical solutions by heart.
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