I stumbled upon a blog post actually a theory if you will that asks the question, “Do people seek risk only to minimize losses? The author’s conclusion you may ask? Yes, people seek the tried and true solutionsÂ¦.they “play it safe when it comes to gains but “take risks to minimize losses, according to the author of the post. The author went on to explain a survey that he conducted around four options but starting with these two which would you choose? Option 1 take a guaranteed $75k gain or Option 2 take an 80% chance of getting $100K and a 20% chance of getting nothing? According to the survey results, three quarters of the time, people choose option 1.
The author goes on to describe the next question, which would you choose? Option 3 a guaranteed loss of $75k or option 4, an 80% chance of losing $100K and a 20% chance of losing nothing. Apparently 71% choose option 4, considered a riskier option than option 3. Also according to the article, “the upside must be at least 3x the guaranteed amount in order for most people to risk the sure thing. The whole notion of risk taking to minimize losses vs. maximize gains has some interesting ramifications. Let’s look at this in context of sourcing metals categories.
Consider these questions in context of risk or playing it safe when it comes to gains and taking risks to minimize losses:
- Which is the bigger driver for most organizations cost savings or cost avoidance?
- What is the buying behavior of companies when they perceive the price of a category will increase? (e.g. copper)
- What is the buying strategy when it appears a category will decline slowly in price? (e.g. steel)
- What is the buying strategy when the company knows it can not change its pricing for its customers?
- What is the buying strategy when the company can pass on price increases to its customers? Does that change the risk scenario?
- If a buying organization is measured year over year in terms of COGS to sales does that affect how the organization deploys its purchasing strategy?
- If a company has unknown or highly volatile demand, does that affect the buying strategy?
Clearly many individual purchasing scenarios drive the risk/reward decision-making process. From our vantage point, organizations go out of their way to minimize the risk of a loss but often walk away from any opportunity for a gain. Improvements in EPS or EBITDA become secondary to ensuring COGS as a percentage of sales don’t increase.
These survey results potentially call into question the strategic role of the purchasing organization. What do you think?