What is game theory, and why should it matter to your business?
Friday, November 13, 2020
With a global virus, social unrest and economic uncertainty, being a business owner is more challenging than ever. As our old systems crumble, it’s not easy to stay optimistic.
Benjamin Franklin once said, “Games lubricate the body and mind.” Maybe it’s time to start seeing business as a game; at least that’s what game theorists might suggest. Developed by mathematician John von Neumann in 1928, game theory, which could loosely be defined as the study of strategic decision-making, was originally associated with a branch of applied mathematics. Now, however, it has expanded to many other areas of study, including psychology, biology, and computer science.
In fact, the field is so popular that according to Investopedia, “since 1970, as many as 12 leading economists and scientists have been awarded the Nobel Prize in Economic Sciences for their contributions to game theory.”
So, what’s all the fuss about and how is it connected with business?
Game theory views decisions as interdependent, requiring all players to not only consider each other’s interests and decisions when creating a strategy, but to fully explore a number of potential scenarios. There are many different types of games, however, we won’t have room to explore them here. However, since strategy and business go hand-in-hand, it makes sense to use game theory when making decisions.
Considering the interests and possible decisions of competitors as well as customers and exploring possible scenarios would allow a business to create a strategy that leads to a better outcome. The challenge for business that even with all of that analysis is that some of it will still be based on assumption. This is why, in addition to a good strategy, it is essential to be nimble and account for the need to change strategy midstream and be willing to renegotiate.
Since businesses, like many games, are competitive, game theory could be used to develop new products, determine pricing, marketing tactics, etc. How? By anticipating how customers and competitors may react to a specific scenario (i.e., selling something familiar vs. selling something new, pricing high vs. pricing low, offering lots of free content vs. paying for ads), then creating a strategy based on this knowledge to better the chances of winning the game yourself.
To make it simple, let’s use game theory on a major business decision, using some simple steps.
1. Define the players. In business, this would include competitors and customers. You may want to focus on competitors and customers separately.
2. Make a list of possible choices available to each player. Consider first what your customers’ or competitors’ interests are.
3. Create a grid of different scenarios for each player based on their choices. This shows clearly what all of the possible decisions might be.
4. Determine the value of each choice. Analyze all of the different scenarios based on interests, risks and benefits.
5. Assess which strategy will offer the best outcome. Ideally, you’ll want the outcome to best serve you and your customers and keep your competition from threatening your business.
If you’d like to catch a quick glimpse of game theory in action, check out the scene from the movie, “A Beautiful Mind,” about Nobel Prize winner John Nash. He’s in a bar with his friends and, while looking at a beautiful woman, has an epiphany in which he describes his view of game theory in simple terms.
Finally, I’ll leave you with a quote from Einstein, “Games are the most elevated form of investigation.”
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