Similarly, a buyer can negotiate with sellers independently. If they have comparable financial strength and cost structures for a commoditized product, the lowest price each is willing to quote will be the same, at a minimal profit margin. If the bids are not converging, the buyer’s tactic is to continue the negotiation by revising the floor price progressively. If they converge, this indicates the prisoner’s dilemma has played out. This is helpful in price discovery with ever changing supply market scenarios and price structures, especially in the indirect space where not many are indexed and easy to track.

Game theory works best in “oligopolistic” situations which applies to most Indirect categories with ongoing supplier rationalization programs. Equal bids might result from collusion among sellers. Certain commodities can become cartelized because of changes in industry structure. Suppose the market for copier paper shrinks (because of excessive price squeezing) and marginal manufacturers exit. Fewer players mean greater alignment of interests and easier opportunity to collude.

One way to spot a possible cartel is to shuffle the “lots” of an sourcing events and check for consistency in bidding. Where bidders know one another’s prices, the bids will most likely move in tandem. Is there a way to break a cartel? Changing the price structure might work. For example for contingent labor, one round of an auction sets bidding for a management fee; another asks for a minimum hourly commitment at a set price. Such tactics might throw the alignment among the cartel members out of kilter, helping the buyer triangulate the price structure of the service. This tactic is also useful in understanding margin structures in categories.

A buyer who is unfamiliar with the category is at a disadvantage without proper understanding of game theoretic techniques. Even simple payoff matrices or “What If” scenarios are hugely helpful in designing negotiation scripts in multi-round negotiations. A typical spend distribution might have 20-30% of categories that clearly benefit from applying the theory.

Game theory principles can improve sourcing rigor and potentially get 100-200 basis points more in a negotiation cycle over traditional techniques without much effort. Even an efficient sourcing operation can raise its game and achieve rapid payback. An academic concept is finding increasing buyer acclaim for its effectiveness. A forthcoming paper from Genpact will show how.