Increasingly, companies are utilizing the science of Game Theory to understand competition and formulate strategy. I was first exposed to Game Theory in a Political Science course where two teams (representing the US and the Soviet Union) had to negotiate a simulated arms control treaty. Later on, I have used similar tools to help Companies deal with a variety of mission-critical strategic issues.
Within a business context, Game Theory utilizes “strategy games” to analyze organizational and individual behavior within highly competitive markets or situations. These games consist of well-defined mathematical scenarios encompassing a set of players (individuals or firms), a set of strategies available to those players, and a payoff specification for each combination of strategies. One famous example of a strategy game, familiar to first year psychology students, is the four quadrant Prisoner’s Dilemma.
Typically, multiple games are played to incorporate the different competitors and potential strategies. Strategy games focus on delivering: 1) a recommended set of strategic incentives or threats to guide competitive behavior to a desirable outcome, and; 2) an analysis of how a series of possible strategic moves can predict various competitive outcomes. Different types of games can be utilized depending on the number of players, the amount of cooperation expected and the timing constraints.
Game Theory is ideal for strategy formulation and decision making within complex and risky business environments:
Ideal Markets:
- Duopolies (e.g., Microsoft vs Google)
- Oligopolies (e.g., Oil & Gas, Cars, Airlines)
Special situations:
- Auctions (e.g., sealed project bids)
- Bargaining activities (e.g., union vs management, price negotiations)
- Social network formation (e.g., viral marketing effectiveness)
Game Theory methodologies are not without their shortcomings, which should be thoroughly understood before proceeding. Most often, experienced consultants should be called upon to lead senior executives through the games.
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