"It's a Win-Win": Deploying Game Theory to crack Sustainability

Game Theory has given us the cliché of the "Win-Win", but when combined with advanced software, Game Theory may just be the key to balancing sustainability with economic value.

Everyone responds better to the Carrot rather than the stick. But buyers still expect suppliers to jump through hoops in responding to tenders: uploading ISO certifications, filing out long questionnaires, paying for third party audits. This may have been acceptable when buyers could always "swipe left" to find an alternative supplier: however in these supply constrained times a more creative approach is needed. This is where elements of Game Theory can be combined with advanced sourcing software to discover new solutions that benefit both sides.

Although I studied Game Theory as part of my Maths Degree, I never really understood how those abstruse equations could relate to anything relevant to business today. Then I attended the London Sustx Sustainability Summit, and heard about the uses of Game Theory by TWS Partners to help buyers express to sellers how much they valued sustainability (e.g. their own internal price of carbon), and then allow sellers to offer different solutions.

If people have the right incentives they will show the right behaviour

At FreeMarkets, a company acquired by Ariba in 2004, we developed a capability called Alternative Bidding. Tuomas Sandholm (founder of CombineNet) calls this Expressive Bidding. He explains

This allows the buyer to leave the item specification partially open, so the suppliers can pick values for the item attributes -- such as material, grade, and delivery options -- in a way that matches their production efficiencies. In other words, the methods yields better matching of supply and demand because they are expressed in more detail. The savings do not come from lowering supplier margins, but from reducing economic inefficiency.

And this is the precise meaning of a win-win situation, a mutually beneficial outcome for both parties.

Here's a simple example that I came across in the old FreeMarkets days. When acquiring resin from Indonesia, both the buyer and the seller had freight contracts in place, so what is the optimal way to pay for freight? Should the seller quote include freight and Duty (DDP - Delivered Duty Paid) or net of all delivery costs (EX-Works). Our software allowed the supplier to submit multiple offers, such as €1.53/kg EXW or €2.20/kg DDP. As quoted above, this allows both traders to find a "win-win". The buyer could have done something similar with Refining (99% purity, or 99.9% purity) and Packaging (drums or Rail cars): the buyer wants 99.9% purity in drums, but it is not clear who should do the final purification and packaging.

So what does this have to do with Sustainability? Procurement teams are discovering that an optimal bid is not just price, quality and delivery: they are increasingly valuing sustainability.

This is where the insight from TWS comes in. Take Greenhouse emissions: many companies have already published their internal price of carbon: Microsoft's was $15/metric ton in 2020, and likely to increase. Now we can apply Alternative Bidding. Imagine you are a small supplier selling to a corporation who have shared their internal price of $15/TN. You yourself have two different offerings:

• A "Green" offering, where you have paid more to source from green suppliers, and where you manufacture with low energy production facilities. You price at $25 / Unit
• A "Grey" offering, where you used regular suppliers and standard production. You price this offering at $17 / Unit. (Dirty is cheaper, right?)

Now the Buyer can choose the optimal solution based on their internal price of carbon. Just as with the Transportation example, there is no "right" answer, carbon is reduced in the most economically efficient way.

To be successful you need:

• A Strategy that maps to your Sustainability Goal, including sharing of your Carbon Price. This will likely need Senior Management buy-in as you will probably be no longer buying "the cheapest"
• The requirement that Suppliers reveal the Carbon content of their (multiple) bids. Small suppliers will need to be educated on how to do this.
• Software that supports Alternative Bidding, critical to get scale, and to take advantage of other market mechanisms such a Reverse Auctions.

At SAP, our flagship products SAP Ariba Sourcing (the successor product to FreeMarkets) supports Alternative Bidding and additionally our partner Keelvar can be used for more complex optimisation scenarios.

So Game Theory is not just obscure equations, dimly remembered. It can now be used by today's Sourcing Software to allow both buyers and sellers to collaborate on solving the toughest sustainability challenges.