In our personal life we have learnt, when planning, to take into account the potential action of others. It is very possible for example that all the trains will be full, no tickets will be available for a football match or that the friend you are planning to go with has a full calendar and is unable to go on the weekend you would have wanted to go on. We instinctively understand that we need to negotiate and reach a result for the common good.
In business life, the situation is very much different. In many cases negotiating with for example your competitor is strictly forbidden. One can not agree for example on pricing with competitors. This would be regarded as a cartel. In other words ”fixing the market”. It is illegal and absolutely forbidden. These situations resemble situations we meet in competitive games. For example when playing soccer and tacking a penalty kick, you would not go and tell the goalie which side you will be kicking.
Competitive game theory deals with decisions made simultaneously and gives tools to think about these situations in a structured and rational way.
The critic to game theory is that most people can not apply structured thinking in practice and that even in very simple situations the analytic process becomes very difficult. A second critic to game theory is that humans are not always driven by self interest and that humans behave altruistically in some cases. Over ten Nobel prizes have been awarded to discoveries based on game theory. Thus having made a note of its limitations and critic, I still find it an interesting and necessary subject to both teach and learn.
The most practical way to dive into game theory is the art of negotiation. Thomas Schelling (https://en.wikipedia.org/wiki/Thomas_Schelling) received his Nobel price for applying game theory into negotiation situations and for using a game theoretic view to prevent a nuclear war and disaster.
Start with a simple negotiation.A good tactic is that both parties have two options. For example a student might be thinking about dropping out from school. The student has two options (stay at school or drop out). The parent might be thinking of buying a car to the student (the parent has two options buy a car or not buy). The negotiation process would be very quick and I am sure an agreement would be reached quickly and the parents would buy a car if the student does not drop out. This is the type of negotiation we conduct daily without giving it much thought (except in this case buying a car is expensive and we would really think about it!) Go through the video´s on this chapter and learn how to break down this situation and analyze it from a game theoretic perspective.
In competitive game theory,the parties are not allowed to discuss or agree. Hence they need to base their actions on what they anticipate the other would do. Game theory helps you go through this logical thinking process. Have a look at the following video´s to get an idea of how the rational thinking process and the related matrixes work. In the quizzes you can test your skills and you can also restructure the parent student negotiation and see what would happen if they were not allowed to negotiate (this is also a good way to see what could be negotiated).
Modern businesses and markets are very intertwined and also form networks and ecosystems. Understanding these interdependencies i.e. game theory is a structured way to look at the interdependencies in modern businesses.
Competitive games is one branch of game theory. The other is collaborative games. To get a glimpse of collaborative games please search for the video Shapley value and sharing a taxi ride. I will not go into collaborative games on this course, but please keep in mind that companies also do co-operate. A great example of co-operation is standardisation. Because of standardisation our mobile phones work in almost all of the countries in the world. Also standardisation makes international trade and the related payment methods possible (please look into incoterms).
The following video´s are constructed from the five rules introduced in the book The Art of Strategy (Dixit & Nalebuff 2008)
The Art of Strategy, Dixit Nalebuff
Rule 1: Think forward reason backwards
Rule 2 Solving for a dominant strategy
Rule 2b The prisoners dilemma and the challenge in playing a dominant strategy
Rule 3, Elimintae Dominated strategies
Rule 4 Search for mutual best responses
Rule 5 Mixed Strategies
How to get a salary increase
Here is one way to apply game theory, but please be careful. It is not easy to apply. You will find the video by searching YouTube ”how to get a salary increase” I have had students come back to me and saying that they applied the teachings of the video with success. I am happy for them, but be warned: game theory is not that easy in practice. One of the key challenges is have you really modelled the situation perfectly enough.
And here you have a 46 minute video by the Author of the book Avinash Dixit
Literature
Dixit, Avenish K.; Nalebuff Barry J, The Art of Strategy – A Game Theorist’s Guide to Success in Business and Life 2008
Dodge Robert V. Schellings Game Theory – How to Make Decisions, Oxford University Press 2012
Watson Joel, Strategy, An Introduction to Game Theory, Sheridan Books, Third Edition 2013
The Digital Landscape 