Learning by Playing: More Supply Chain Games

In January 2011 I published an article called “Playing for Real: Supply Chain Games”. As I said in the original article, supply chain games are a great way to develop new staff’s instincts about coordination, competition, and the cause-effects of rule mechanisms on behavior.  In early 2012 I added the two additional games shown below for training supply chain instincts. One game looks at how strong supply chain governance is different in reputational and transactional relationships. The other game simulates a price war, which is always fun.

REPUTATION VS. GOVERNANCE

The importance of supply chain governance is not often discussed. In my experience, supply chains tend towards arrangements with a strong organization who enforces compliance to a specific coordination paradigm onto the other supply chain members. The alternative to having governance managed by one strong organization is a network of peers who use, among other things, reputation and bi-lateral agreements to achieve coordination. This supply chain game is about experiencing the benefits and drawbacks of the two approaches.

THE GAME SETUP:

  • Divide your players into four groups of equal size.
  • Two groups act as one supply chain, and the other two groups act as another supply chain.
  • For each supply chain, assign:

o A supplier

o A retailer

  • Make sure you have two decks of playing cards to use in the game
  • Ask all players to put in some money, about what they might spend on lunch.

THE GAME PLAY:

  • Set the two supply chains apart from each other
  • One supply chain is called “Reputation”, the other “Governance”
  • Give each supply chain a deck of cards, with all the cards given to the “Supplier”

EACH ROUND, THE FOLLOWING HAPPENS:

  • For the “Reputation” supply chain:

o The Retailer and the Supplier agree on a value between 1-10

o The Supplier chooses a card and passes it to the “Retailer”

o The Supplier records the value agreed and the Retailer records the value on the card minus the value agreed, with face cards (king, queen, jack) worth nothing.

o Example: the supplier and retail agree on a value of “5″, the supplier than hands over a card with the number “6″, and so the supplier gets 5 points and the retailer gets 1 (because they agreed to give the supplier 5, got a card value of 6, and 6-5 = 1).

  • For the “Governance” supply chain:

o The Retailer offers a specific split of the card value, such as 50%. They cannot negotiate about this, just make an offer.

o If the supplier agrees, they pass a card to the retailer

o The card’s value is split as agreed and the retailer and supplier record their scores

  • Play for 10 rounds
  • The top-scoring group gets 75% of the money, and the second place group get’s the other 25%… note that its possible that only one half of a supply chain wins, such as the retail group from the governance supply chain taking 1st place and the supplier from the reputation supply chain coming 2nd.

DISCUSSION:

Before playing the game, could you imagine how each group will strategize? First, look carefully at the way winners are rewarded. The first and second best group will get some money. This means that a group doesn’t just try to be best, they may also settle for second best in order to earn some money. And in both supply chains, cooperation between the supplier and retailer is needed in order to make any points at all.

Second, in the “reputation” supply chain, the supplier can only be controlled by a retailer who assumes they will be cheated. For the supplier, any number agreed to above zero gives them a chance to trick the retailer. But if they trick the retailer too early, the retailer will stop agreeing to high amounts and the overall scores for both of them will be low. In the “reputation” supply chain the supplier can always have a higher ending score than the retailer, but must demonstrate they are trustworthy in order to get any points at all.

Third, for the “governed” supply chain there is no chance for trickery. Instead, there is either cooperation or nothing. The retailer has the power to set the terms of the cooperation, and in doing so the main risk is that they do not offer an equitable enough division of points to tempt the supplier.

After playing the game, discuss what behaviors emerged and what management strategies appeared during game-play. Because we’re talking about people making their own decisions, there is no way to know in advance how the groups and supply chains will actually behave. But here are some points that often arise:

  • The governed supply chain is, by design, capable of delivering higher total points. By eliminating the ability to act independently at the harm of the rest of the supply chain, it’s expected that the supplier always tries to give the maximum point value possible to the retailer. As long as a supplier agrees on a split of points, regardless of the split value, they will always be better off by passing their highest-value card.
  • What can go wrong with the governed supply chain is that the supplier realizes they will never be able to come in first, only second. This demotivates the supplier and may turn them callous towards the retailer, especially if the retailer offers something too far from a 50%-50% split.
  • The two points above are very much a reflection of real supply chains. A strongly governed supply chain is both more effective overall and also less interesting for the minor players. The supplier may benefit in terms of volume from a highly governed and organized supply chain, but they do not often see a real incentive to act proactively in the relationship. It’s always about compliance, not cooperation.
  • For the reputation supply chain it should be obvious how much energy goes in to trying to predict, influence, and track a counter-parties behavior. Even if the reputation supply chain does well, they tend to do well only through extra labor compared to the governed supply chain. This is absolutely an accurate reflection of real supply chain dynamics. Reputationally-managed supply chains take constant vigilance and counter-party management.
  • It’s very unlikely that the reputation supply chain has as high of a total score as the governed supply chain. At the start of the game, it may take a few rounds to establish trust, during which time the retailer doesn’t want to offer high points. Then, towards the end of the game, the supplier has an incentive to try to cheat the retailer. This also should cause the number of points offered by the retailer to go down. On the last round, the retailer should be offering zero points, and the supplier should fully cheat if they get the chance.
  • The two points above reflect business realities when managing a supply chain in which no single party can enforce governance. Lack of enforcement directly translates in to opportunity to benefit from defecting.
  • If anyone thinks that the last-round of the reputation supply chain is unrealistic, go and see what happens when a supply chain includes a company that is going out of business. Right as a company goes bankrupt or closes an operation, there is tremendous incentives for all their partners (and employees) to cheat them. And that temptation becomes reality unless (and even despite) strong supply chain manager actions.

THE PRICE WAR

In the USA, the UK, EU, and Australia there tends to be a view that price wars are always negative. The price war history in the US, for example, shows some great services and products which were turned into commodities by poorly planned or executed price wars. Once the consumer sees that prices have gone down, they are very resistant to returning to high prices again. But other markets, most notably China, have a tradition of calculated and effective price wars. The game below allows the players to experience the dynamics of a price war, including the pain and risk of an escalation.

The price war game is a little more complicated than the others I’ve introduced; it also takes longer to play. But there is a richness to it that is worth the trouble. Through the game we get an idea of why so many price wars are (1) self-destructive to the entire market, (2) destroy the one who started the war in the first place, (3) force some but not all customers out, resulting in low overall profits without decisive market share control, (4) even when finally won by one party, leave the winner too weak to make short term benefits. In real life this often results in an upstart coming and taking over from the weakened winner, when they would not have survived the price war itself.

DOCUMENTS FOR THE TEAMS AND PROCTOR:

Supply Chain Games Workbook

THE GAME SETUP:

  • Divide your players into four teams of equal size.
  • There should also be a proctor, who administers the game.
  • This is a purely competitive game: all teams are fighting for themselves
  • Assume the teams all produce a generic object, like air freshener for a car. The consumers have no brand loyalty and will switch to the lowest cost provider if possible.
  • Demand is a little elastic: lower prices causes greater demand
  • There is also a production economy of scale: the more volume a company produces the lower its per-unit costs will be.
  • Ask all players to put in some money, about what they might spend on lunch. This helps make the game feel more real and to sharpen the players’ decision making focus.
  • A demand and variable cost document should be given to each team, so they can plan their strategy. They should also get a copy of the tracking sheet.
  • Each team starts with $1,000 as their cash reserves.

THE GAME PLAY:

  • Give each team a chance to study the variable cost and variable demand numbers. They should have a plan ready so the game is not chaotic, and also so the game rounds can run faster. A plan means that they know what production and pricing response they will use given the other teams behaviors.
  • Once the rounds begin, try to keep the round limited to two minutes. If the groups fail to keep pace, they are skipped for that round and make no sales. Agility is a real value in business; fast mediocre decisions sometimes are better than a slow and calculated one.
  • Each round, the following happens:

o Using their cash reserves, the teams decide how many units to produce. They should do this privately without the other teams listening.

o The units produced are added to their inventory, and the costs removed from their cash reserve. The teams then tell the proctor the cash reserve and inventory level they have.

o The teams set a price point, and announce it to the other teams at the same time (i.e. not allowing the last team to announce their price the chance to revise based on the others). A good way to do this is to have the teams write their price points on a paper and hold up the paper for the proctor to see.

o If two teams use the same price point, they split the effective demand at that price.

o The proctor uses the price points to calculate units sold per team. This is done automatically in the provided Excel workbooks. At this point, all teams can see all the information of everyone: inventory, cash reserves, price point, etc.

o Finally, the teams convert the units sold to cash reserves, and deduct those units from their inventory. This is the last step of the round.

  • Play for 20 rounds
  • If at any point a team runs out of cash reserves, they are removed. They cannot make further actions. They are bankrupt.
  • At the end of the 20 rounds, the cash reserves per team are summed and each team is given a percentage of the real cash-pot based on their team’s fake cash. Example: if one team has $125, and the other three teams each have $25, then the first team gets 62% of the real cash collected from the beginning of the game.

DISCUSSION:

Before playing the game, could you imagine how each team will strategize? No team can afford to wait long: even producing zero units will lead to bankruptcy in round 8. Generally each team will want to price the lowest of the teams, but also high in absolute value. But the higher the absolute value of the price point, the more it hurts the losers. For example, being last in prices 20, 21, 22, and 23 gives $368 revenue. Being last in prices 40, 41, 42, and 43 gives zero revenue. Pricing below 18 is always costing more than the revenue it brings in: it is loss-leading. But a team might price very low to forbid the others from getting revenue.

 

After playing the game, discuss what behaviors emerged and what pricing strategies appeared during game-play. Here are some points to consider:

  • Strategically, it makes sense to try to force out other players early. Every time a player is forced out, the average price point tends to rise.
  • The best outcome for any team is to force out the other three, and then raise prices to the maximum and earn great profits.
  • Because price wars drain cash reserves, even a winning team might not be able to earn a lot of revenue because they can’t finance their own production.
  • Price wars can go wrong very easily. Sometimes the game results in everyone going bankrupt. Sometimes a player who starts the price war ends up going bankrupt before their target victims.
  • Not only can price wars go wrong and self-destruct on the people who use them, sometimes they are simply unwinnable. Notice that if two players are forced out, the other two can usually survive by keeping their price points close to their manufacturing costs. The result is overall low market value (i.e. both players don’t make much revenue), but that neither player can force the other one to go bankrupt.
  • Price wars also tend to emerge even when no player thinks it’s a good strategy. This is because many products are in a “winner take all” or “winner takes most” market. When the cost of being seen as over-priced is large, businesses tend to drive each other towards the lowest tolerable level. This exact dynamic happens in the grocery industry, where margins are razor thin mostly because of price-wars.
  • In the end, price wars are a delicate balance between:

o Cash reserves, since a player with cash reserves can always keep prices low and bleed the other teams to death.

o Market share… if the market would keep buying the same amount regardless of price it would never make sense to lower prices. We lower prices to take market share and therefore place pressure on the competitor’s cash reserves.

o Increasing economies of scale. As the teams sell more units they can afford to produce more units, and the production of more units per turn makes the average unit more profitable.

 

In the real world, the estimate of your competitors cost per unit is incredibly important to a price war. If you have this information (and substantial cash reserves) you can cut prices to a point where only one competitor is unable to be profitable. All the other competitors will match your price easily because they still make a profit. This uses the weight of the entire market against one company. That company is likely to exit the market. Then, you repeat the process for the next least-economical company. Through this process the average price point falls over time and at each step one and only one company is truly bleeding. This is important because if all companies are bleeding, the price war cannot be sustained for long. Through a cycle of these kinds of price cuts a market can be compressed to one or two competitors out of many. Then the last round is of course very bloody and, as we noted above, perhaps even indecisive.

 

Finally, a note on the supply chain implications of price wars. Pricing is an important component of supply chains, which is often disregarded outside of university marketing departments. Price wars in reality require cooperation along the supply chain, because the consumer’s price point represents the entire revenue for the supply chain: all other transactions are just to distribute the consumer’s money. The supply chain is also expected to contribute to the ability to flex upwards as market share grows (if you’re winning the price war) and to shrink costs downwards (if you are losing the price war). Finally, the whole process of achieving better economies of scale and per-unit costs is usually tied to supply chain operations. If the company plans to conduct a price war, and avoid bleeding to death in the process, they often include an explicit need to lower per-unit costs as volumes grow. Supply chain managers who do not realize their pivotal role in a real price war eventually figure it out… after painful realizations that it’s not just “sales and marketing” who must execute on the price war strategy.

 

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