Archive: August, 2018

Nudge not fudge

A friend of yours, Kate, recently started a new job as a team leader in the head office of a global organisation. She used to work for a small business where she was responsible for all aspects of procurement from negotiating prices to implementing contracts. In her new role as team leader, she will be responsible for placing purchase requisitions and expediting orders. Although this is only a small part of the role she used to have, the value of transactions will be much higher and she’ll have to liaise with lots of different stakeholders.

In the first week of her new job she had a meeting with William from Procurement who explained that the procurement policy states that preferred suppliers should always be used and if suppliers submit an invoice without referring to a purchase order number then it will be returned unpaid. Kate’s team are running low on stationery and there is an urgent requirement for a new online brochure so when she gets back to her desk she logs on to the procurement system to create her first purchase requisitions. She finds the details for 3 preferred suppliers for stationery and a long list of market agencies. The marketing agency she used in her last job is not on the list but she knows that they will be able to deliver quickly. Should she follow William’s advice and contact some of agencies on list or ask the supplier she knows to start work and sort out the purchase requisition later?

William is what behavioural economist like Richard Thaler call a choice architect. William is responsible for organising the context in which people make decisions. By selecting preferred suppliers, he is limiting Kate’s choice. A nudge is any aspect of the choice architecture that alters people’s behaviour in a predictable way. If William had highlighted one of the 3 stationery suppliers he would nudge Kate into selecting that supplier over the other 2.

William is also a choice architect for marketing agencies, however, the situation is different. By providing too many options and insufficient information he has made it difficult for Kate to make a choice. The procurement policy states that preferred suppliers should be used but it’s very difficult to select the best one to do the work. William has fudged the choice architecture which may lead Kate to use a supplier not on the list. Asking a new supplier to start work without a purchase order means that there will be no due diligence, no contract, a problem with payment and an increase the total number of suppliers which will compound the problem further. How can William nudge Kate into making a better choice? He has 4 options:

1. Select preferred suppliers. William could ask each agency to respond to a request for a proposal (RFP) and select the best ones to become preferred suppliers

2. Select one supplier to be the default preferred supplier. If Kate doesn’t select any supplier then the purchase order would be sent to the default supplier automatically. This supplier would either do the work in-house or outsource it. William could ask the larger agencies offering a range of services to respond to a RFP

3. Provide a brief description of each agency and the type of work they specialise in. William could gather the information by asking each agency to respond to a request for information (RFI)

4. Remove agencies with low levels of activity. William should decide the threshold which may be based on spend, number of purchase orders or number of internal customers

Option “1: Select preferred suppliers” is the best choice architecture for Kate and William. Kate is given clear guidance and has the comfort that she is getting the best commercial arrangement. William is able to achieve his savings target and manage the relationships with the preferred suppliers.

Option “2: Select a default supplier” will have many detractors. Marketing professionals will argue that big agencies do not always offer the best solution for all requirements and procurement professionals will say that better pricing can be achieved from regular competition. Whilst both of these arguments are correct, option 2 is better than the current situation because it prevents Kate from succumbing to status quo bias and engaging the agency she used in her last job. William can monitor the spend with the default supplier and re-negotiate a better deal if spend increases.

Options “3: Provide a brief description” and “4: Remove agencies” will help Kate make a decision. Kate will be able to short-list suppliers based on the description and removing agencies will address the just maximise choices strategy. Unfortunately, neither will help William achieve his savings target or protect the organisation commercially, however, it may be enough to stop Kate from creating a new supplier.

By recognising his role as a choice architect, William creates an opportunity to influence Kate’s behaviour and achieve a better outcome for procurement. William may not have enough time to ask all the marketing agencies to respond to a RFP but there a number of other options which will nudge Kate into making a better choice. Hopefully this example illustrates how behavioural economics can help procurement and where a nudge is better than a fudge.