Game Theory!

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Game Theory! / 099, 28 Oct 2023

Last week, we had explored some facets of decision making, specifically the blend of emotion and logic that goes into all major decisions. While that dealt with decision making at a personal level, today we look at decision making in management at a larger (organisation) level, using the popular and fascinating concept of Game Theory. This was made popular by the book Theory of Games and Economic Behaviour (1944) by John von Neumann and Oskar Morgenstern. It was further developed by John Nash who developed a concept for mixed strategies in what came to be called the ‘Nash Equilibrium’. It was further developed by many other equally eminent persons, initially economists, and later by many others, into an established wide-ranging concept useful for decision making in business management, especially for Strategy.

Game theory has little to do with games, though. It is the analysis of rational behaviour in interactive decision making involving multiple players. It is useful for dealing with competitive situations where a decision choice depends critically on the decision choices of other players. Like in a game of chess, before we make a move, we try and anticipate the next possible move our opponent will make. And if you are a grandmaster, you would probably be able to calculate all permutations and combinations of remaining moves in a game. Similarly in business, game theory can be used to make better decisions with lesser mistakes by the process of anticipating market impact and behaviours that could result from our choices. Let us explore some key concepts of Game Theory using a few examples:

Outcomes and Payoffs: If you are one among many other players in a commoditised business, and you take a decision to drop prices. One outcome could be gaining more customers and market share, leading to a positive payoff. Another outcome could be triggering off a price war that could lead to a negative payoff in terms of margin erosion.

Rationality: All players in Game Theory are considered to be rational, i.e., they are aware of their strengths, limitations, and they think through these before acting. It is assumed that all players are human, subject to emotional pulls based on their own value systems. For example, in deciding on a key transfer, a manager may analyse which of the candidates would be likely to be happier in the new location / role.

Sequential or Simultaneous events: Sequential events are easier to analyse, where one player has to make a move (like chess) before the other can. But Management usually has Simultaneous events occurring (economy, technology, labour, supply chain, etc.) which complicates the analysis. We have to build multiple “what-if” scenarios to arrive at a few best possible decisions in plural, and then – based on best judgement and situations – pick one.

At the end of the day, the best possible outcome in the given circumstances, considering constraints, opportunities and risks, will be the best outcome of a decision using Game Theory concepts. To quote management guru Michael Porter, “the essence of strategy is choosing a unique and valuable position rooted in systems of activities that are much more difficult to match”. In today’s VUCA world, where clarity is scarce, this essence of strategy could be our most important learning from Game Theory.

I hope you enjoyed reading this one, and as always, I request you to share your thoughts and experiences in the comments section. Let us build a conversation around this topic!

Warm regards, Krishnakumar.

Image courtesy:

Chess Clinic by Tony Walsh ( appadvice.com )

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Reference Sources:

Game Theory EXPLAINED with EXAMPLES | B2U | Business-to-you.com

Game theory - Wikipedia

Game theory - Strategies, Equilibrium, Payoffs | Britannica

https://www.researchgate.net/publication/265746332_Decision_Making_Using_Game_Theory_An_Introduction_for_Managers

Making game theory work for managers | McKinsey

How Management and Game Theory Understand Strategy | California Management Review ( berkeley.edu )