The Application of Game theory in Supply Chain Management

The Application of Game theory in Supply Chain Management

Supply chain managers should prioritize gaining knowledge in game theory to empower their teams with the skills needed to drive innovation and optimisation. By equipping their team members with this expertise, supply chains can better analyse and navigate complex strategic interactions in increasingly interconnected supply chains.

How and why is Game theory applied?

Game theory in supply chain management refers to the application of mathematical models and strategic frameworks to analyse and predict the behaviour of supply chain participants when their decisions influence one another. It helps model competitive and cooperative behaviours to optimise decisions, and therefore can be a powerful tool to optimise strategic interactions among various stakeholders, such as manufacturers, suppliers and retailers. Various aspects and applications of game theory in supply chains in addressing challenges such as competition, coordination, cooperation, pricing, risk management, efficiencies and sustainability are highlighted next.

Game theory applications include dynamic competition models, cooperative game strategies for joint profit maximisation, and Stackelberg games for hierarchical decision-making. Game theory also addresses sustainability by modelling interactions that consider environmental impacts. Overall, it provides a robust framework for understanding and improving complex supply chain dynamics.

Competitive interactions

One primary application of game theory in supply chains is modelling competition between stakeholders. Supply chains often consist of multiple entities competing for market share, resources and profitability. Game theory provides tools to analyse these competitive interactions, helping businesses devise strategies to enhance their market positions.

For example, dynamic competition models are particularly useful in understanding competition over time. These models help to demonstrate how supply chains adjust their strategies based on competitors’ actions and market conditions, ultimately influencing pricing, production, and inventory decisions. By anticipating competitors’ moves, businesses can better position themselves to gain a competitive edge.

Game theory has also been applied to understand supplier competition within supply chains. This dynamic game approach models interactions between suppliers vying for contracts with manufacturers. The analysis improves the understanding of competitive dynamics by revealing how suppliers’ strategic decisions, such as pricing and capacity investments, significantly impact their performance.

Cooperative Interactions

While competition is prevalent, cooperation among supply chain stakeholders can lead to mutually beneficial outcomes. Here, game theory offers frameworks to analyse and facilitate such cooperation, promoting coordination and collaboration.

It is well-known that supply chain partners can achieve better overall performance by sharing information and aligning incentives. Here, cooperative game theory is applied to inform decisions on forming coalitions and distributing joint profits among participants. For example, cooperative games can help identify fair profit-sharing schemes and foster long-term partnerships. Game theory has also been applied to cooperation between logistics service providers and customs authorities. By modelling their interactions as a game, various strategies can be identified for improving compliance, coordination and efficiency in customs procedures. This cooperation is crucial for reducing delays and costs in international supply chains.

Pricing strategies

A third area of application is pricing in influencing demand, profitability, and competitive positioning. Game theory provides insights into optimal pricing strategies by modelling interactions between supply chain participants.

For example, a game theory-based pricing strategy can be applied to uncertain demand situations. This model demonstrates how suppliers and retailers can adjust prices dynamically based on market conditions and competitors’ actions. By incorporating uncertainty into the framework, businesses can make informed pricing decisions in balancing competitiveness with profitability.

Stackelberg games, a subset of game theory, are particularly relevant for hierarchical supply chains with leaders and followers, e.g. a two-echelon supply chain game model that considers carbon emissions can be developed. In this model, the manufacturer (leader) sets the wholesale price, while the retailer (follower) determines the retail price. This hierarchical decision-making process helps optimise pricing strategies across different supply chain tiers, promoting sustainability and profitability.

Risk management

Supply chains are exposed to various risks, including demand fluctuations, supply disruptions and geopolitical uncertainties. Game theory offers tools to manage these risks by modelling strategic interactions and identifying robust strategies.

For instance, risk-sharing agreements, such as joint investments in safety stocks and shared contingency plans, can be modelled as cooperative games so that various mitigation strategies and actions can be demonstrated. With this structured approach to balancing risks and rewards, game theory helps in fostering collaborative risk mitigation.

Additionally, in competitive environments, game theory helps identify optimal risk management practices so that businesses can anticipate rivals’ actions and adjust their strategies accordingly.

Environmental sustainability

Environmental sustainability is a critical concern for modern supply chains. Here, game theory provides a framework to analyse and promote environmentally sustainable practices.

For example, carbon emissions can be incorporated into a Stackelberg game model, which can demonstrate how supply chains can optimise their pricing and production decisions to reduce carbon footprints while maintaining profitability. A further example is where supply chain partners can use cooperative games to share the costs and benefits of green technologies. Competitive game models, on the other hand, can help identify market-based incentives for adopting sustainable practices. In so doing, game theory facilitates the transition to greener supply chains, balancing environmental and economic objectives.

Opportunity!

Therefore, supply chain managers should leverage game theory by equipping their brightest minds with this knowledge, as it provides immense opportunities to innovate, optimise, and solve problems in supply chain management. By combining strategic thinking, technological acumen and collaboration skills, they can significantly influence how modern supply chains operate, ensuring resilience, sustainability, and profitability in an increasingly interconnected world.

To sum up, game theory offers a powerful toolkit for analysing and optimising strategic interactions within supply chains. As supply chains become increasingly complex and interconnected, the application of game theory will continue to play a crucial role in enhancing performance.

References

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Leng, M., & Parlar, M. (2010). Game theoretic applications in supply chain management: A review. *INFORMS Journal on Computing*, 22(1), pp. 1-22.

Li, Y., & Kouvelis, P. (2019). Supplier competition in supply chains: A dynamic game approach. *Production and Operations Management*, 28(1), pp. 35-51.

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Yang, Y., & Yu, Y. (2017). Game theory-based risk management in supply chain. *Journal of Cleaner Production*, 164, pp. 1373-1384.

Zhao, X., & Chen, Y. (2020). A Stackelberg game model for a two-echelon supply chain considering carbon emissions. *International Journal of Production Economics*, 229, p. 107772.