Making game theory work for managers

In times of uncertainty, game theory should come to the forefront as a strategic tool, for it offers perspectives on how players might act under various circumstances, as well as other kinds of valuable information for making decisions. Yet many managers are wary of game theory, suspecting that it’s more theoretical than practical. When they do employ this discipline, it’s often misused to provide a single, overly precise answer to complex problems.

Our work on European passenger rail deregulation and other business issues shows that game theory can provide timely guidance to managers as they tackle difficult and, sometimes, unprecedented situations. The key is to use the discipline to develop a range of outcomes based on decisions by reasonable actors and to present the advantages and disadvantages of each option. Our model shifts game theory from a tool that generates a specific answer to a technique for giving informed support to managerial decisions.

Several factors in today’s economic environment should propel game theory to a prominent place in corporate strategy. The global downturn and uncertain recovery, of course, have prompted radical shifts in demand, industrial capacity, and market prices. Some companies, emboldened by the crisis, have tried to steal market share. New global competitors from emerging economies, particularly China and India, are disturbing the established industrial order. They use new technologies and business models and even have novel corporate objectives, often with longer-term horizons for achieving success.

These uncertainties can paralyze corporate decision making or, perhaps worse, compel managers to base their actions on gut feelings and little else. Game theory can revitalize and contribute clear information to decision making—but only if its users choose a set of inputs detailed enough to make the exercise practical and analyze a range of probable scenarios.

Decades old—and misunderstood

Game theory as a management tool has been around for more than 50 years. Today, most university business students are introduced to the idea through the classic “prisoner’s dilemma.” This and similar exercises have instilled the idea that game theory generates a single solution representing the best outcome for reasonable players.

In academic settings, game theory focuses on logically deriving predictions of behavior that are rational for all players and seem likely to occur. It does so by seeking some form of equilibrium, or balance, based on a specific set of assumptions: the prisoners aren’t aware of each other’s actions, can give only one answer, and so on.

But the real world is messier than the neat environment of the prisoner’s dilemma, and game theory loses some traction when faced with practical, dynamically evolving business problems. Companies using this approach often fail to strike the right balance between simplifying a problem to make it manageable and retaining enough complexity to make it relevant. In addition, decision makers often get a single proposed solution without understanding clearly the assumptions that went into its formulation. This problem is especially troublesome because solutions that seek a universal equilibrium among players in a sequence are sensitive to the initial conditions presented and to the assumptions used in deriving an answer.

We have developed a model that addresses these objections. Instead of predicting a single outcome, with all factors balanced, the model first generates a narrow set of strategic options that can be adjusted to account for changes in various assumptions. Instead of solving an individual game, the model automatically involves a sequence of several games, allowing players to adjust their actions after each of them, and finds the best path for different combinations of factors. As one result, it supports executive decisions realistically by presenting managers with the advantages and disadvantages of the strategic options that remain at each stage of the progression. In a second step, the model finds the “best robust option,” considering its upside potential and downside risks under all likely scenarios, assumptions, and sensitivities as time elapses. This approach is different from attempts to look for equilibrium in an artificially simplified world.

Let’s say, for example, that two companies in the global machinery market face an attacker from China planning to open its own multipurpose factory. Depending on myriad assumptions about cost structures, customer demand, market growth, and other factors, the best strategy in one scenario could be for the incumbents to cut prices. In a second scenario, using slightly different assumptions, it could be best to wait until the entrant acts and then to secure the greatest value by reacting appropriately.

Traditional game theory delivers the best answers and equilibriums, which could be completely different for each scenario. Then it tries to predict the most likely scenario. But you can’t analyze uncertainty away, and the traditional approach actually offers management a series of “snapshots,” not a recommendation based on the overall picture. Our model, in contrast, examines how assumptions and actions might change and looks at possible gains and losses for each player in a dynamic world. In the example of the machinery companies, the best robust option could be to leave room for the entrant in a particular niche, where the incumbents are weakest and there’s little risk that the entrant could expand into other segments.

Our model seeks to balance simplicity and relevance by considering a likely set of actions and their effect on important metrics such as demand and profit. Experience and an understanding of the various actors’ sensitivities to different situations guide the analysis. By considering only the most relevant factors, the model manages complexity and, at the same time, creates transparency around important break points for the key drivers. One such break point could be how strongly the market must react to an attacker’s move before an incumbent’s best strategy shifts from coexistence to counterattack.

The best way to understand the model is to examine it in action.

Game theory and European rail

After years of debate and delay, the deregulation of passenger railways in the European Union appears to be gaining momentum. Cross-border passenger service is to be fully open to competition from January 2010. Some member states, including Germany, Italy, Sweden, and the United Kingdom, have taken the initiative and begun opening domestic long-distance passenger rail service to competition, as well.

The experience of other deregulated industries provides rail operators with some lessons, such as the futility of price wars, which generally destroy an industry’s profitability. But the unique characteristics of rail make it exceptionally difficult to predict how competition will alter the playing field. In passenger rail service, for instance, network effects are prevalent, as routes connecting passengers to numerous cities and towns tend to be highly interdependent.

Certainly, new entrants will try to skim off some of the most profitable point-to-point routes. Despite significant upfront capital expenditures, these challengers will probably try to use lower operating costs to undercut the incumbents’ fares. Beyond that, it remains to be seen how and where the attackers will attack and how incumbents will defend themselves.

Besides mutually destructive price wars, what options do the incumbents have? Should they rewrite their schedules to compete with the attackers’ timetables head-to-head? Would it make sense for them to emphasize their superior service or to compete on price by stripping away frills? Should they concede some minor routes to the new entrants in hopes of limiting the damage or fight for every passenger?

To address these questions, the model we developed uses game theory to understand the dynamics of the emerging competition in long-haul passenger rail routes. It breaks down the complex competitive dynamics into a set of sequential games in which an attacker makes a move and an incumbent responds.

From the perspective of the attackers, the range of options available can be distilled into four main choices. The attackers could imitate the incumbents by providing similar or identical service. They could go on the offensive with a more attractive service—for instance, one that is cheaper or more frequent. They could specialize by offering a niche service, probably only at peak hours, that isn’t intended to compete with the incumbents across the schedule. Finally, they could differentiate by providing a clearly distinctive service, such as a low-cost offer focused on leisure travelers, with suitable timetables and less expensive, slower rolling stock.

Likewise, the range of responses available to incumbents on each route under challenge can be broken down to their essence: to ignore the attackers by not reacting at all; to counterattack by contesting the entry through changes in price, frequency of service, and schedules; to coexist by ceding some routes and learning to share them; or to exit a route by stopping service on it.

These initial steps in setting up a game theory model are straightforward. The crucial element is to create a list that is both exhaustive and manageable. But the world is dynamic, and the payoffs for each player depend heavily on the details. Four factors, which must also be included in the rail model, can significantly affect the outcome.

Total changes in demand. What will happen to demand with each move by an attacker and response by an incumbent? When offered a broader, more comprehensive choice of rail links, passengers could change their behavior—for instance, travelling by train instead of car or plane.

Cost differences. New players typically have significantly lower operating costs than incumbents, which, however, generally enjoy economies of scale. But a higher degree of complexity and public-service obligations, such as maintaining uneconomical routes, often negate this advantage.

Network advantages. Incumbents almost always have a network advantage, since attackers rarely replicate an incumbent’s entire system. (Many routes, intrinsically unprofitable by themselves, are valuable only as feeders to the larger network.) Passengers generally prefer seamless connections—a preference that plays to the incumbents’ strengths, especially to and from points beyond the major routes.

Price sensitivity. Attackers typically charge lower fares, and the degree of difference needed for passengers to switch lines or modes of transport (from cars to trains, for instance) is critical to the outcome.

In the common approach to game theory, analysts look at dozens of permutations of actions and reactions, choosing those they feel are consistent and mutually balanced, as well as most likely to occur. Then they make assumptions about these or other factors. The result is a solution, with one particular set of assumptions, derived from all the interests of all the players. The solution could, for instance, be to fight the new entrant tooth and nail on all fronts.

But in looking at the problem, we found several conditions in which the players’ interests could be seen as consistent and mutually balanced. Just as interesting, the results were sensitive to our initial assumptions: in other words, when we slightly modified an assumption about, say, changes in demand, the results would be very different. From this perspective, our model resembles a business simulator, allowing executives to get a clear understanding of the likely evolution of competition under differing conditions. It helps companies to generate the best option as the moves of competitors become clear.

The outcome of the rail analysis

What did the model say about European passenger rail?

Consider, first, one set of conditions. In this scenario, the incumbent operates a fairly large network and has enjoyed monopoly advantages—in particular, relatively high profits. But because of the monopoly legacy, the incumbent suffers from operational inefficiencies and a sizeable cost base. Overall demand is elastic: customers are likely to travel more by rail if service improves and quite likely to accept low-price offers. A new company with a substantially lower cost base considers cherry-picking a few of the more attractive routes by offering improved service.

This model suggests that although the attacker enjoys lower costs and seems to have a favorable starting position, it will probably take only a sliver of market share, and that thanks largely to a general increase in rail use. The incumbent will remain dominant. Seeing the likely outcome of the attacker’s specialized or niche entry, the incumbent’s executives should conclude that a strategy of tolerance would be best. Only a small share of the market is at stake, and the incumbent could lose much more if it engaged in a costly battle for this sliver—for instance, by waging a destructive price war or using other expensive tactics. If the attacker is more aggressive, the incumbent’s best answer would be to fight back with tactics including aggressive price competition, targeted marketing activities, and more frequent and better service on the routes under attack. Note, however, that this would substantially lower profits for both players.

To cover the full range of possibilities, the model can manipulate each variable. Under certain circumstances (if the demand reaction is muted, the incumbent’s cost disadvantage high, and its network advantage small) entrants have the inside track and could probably take control of the market. When circumstances favor the incumbent a little more (because its network advantage is stronger or its cost disadvantage smaller) it will probably have strong incentives to lower prices preemptively to prevent a possible attacker’s entry. If conditions are more ambiguous, the incumbent may have to settle for coexistence, although it can probably retain market leadership. The attacker’s share of the industry’s profits would vary significantly, depending mainly on the incumbent’s network advantage (Exhibit 1).

Three scenarios

Image_Three scenarios_1

When we run the European passenger rail model through an array of different situations, a critical factor appears to be the way demand reacts to liberalization. Will the new offerings seduce travelers to take trains rather than cars or jetliners, or will overall demand remain stagnant, leaving rail companies to battle for an unchanged pool of customers (Exhibit 2)?

The influence of pricing

Image_The inuence of pricing_2

If the attacker’s entry doesn’t stimulate demand, two operators cannot profitably share most routes: high fixed costs make many of them natural monopolies supporting only a certain level of capacity. A weak incumbent—for instance, one with major cost disadvantages or few network benefits—could be squeezed out by an agile attacker. A strong incumbent could cut fares before the attacker committed itself to any investment, dissuading it from making the challenge. In the end, the competitors will face a winner-takes-all situation, with only one left in the market.

When rail demand can be stimulated, players will probably coexist profitably. But the model suggests that even when the attacker enjoys the best conditions, the incumbent is likely to retain market leadership. Reasonable attackers will have an incentive to enter only on a small scale that the incumbent can usually tolerate. More aggressive moves from either side would trigger ruinous price wars or service expansions, destroying the industry’s overall profitability.

Finally, at each moment, incumbents almost always have one best robust option that conserves much more of their profits than any other course. Quite often, deviating from that option reduces the entire industry’s profits significantly. But unlike a solution based on traditional game theory—a solution optimal only for a single precisely defined future—our model generates an answer that represents the best compromise between risks and opportunities across all likely futures. Unlike the answers suggested by traditional game theory, this one does not require all competitors to behave according to a narrowly defined rational equilibrium at each moment. The transparency of our approach helps executives understand the break points of a strategy: how much reality must differ from its assumptions before a new strategy is needed.

Although we focus here on European passenger rail, our model shows how game theory can be applied to many complex environments and produce results informing many strategic decisions. We’ve applied the model to other problems, with similarly enlightening results. In health care, for example, we examined the dynamics of the commoditization of certain drugs—in particular, after Asian manufacturers offered higher-quality versions of them. We also looked at the strategic options of companies in the chemical industry in the wake of recent overcapacity and reduced demand. Game theory is a powerful framework that enables managers to analyze systematically the ties among interactions between actors in a market and to develop appropriate competitive strategies. But it’s helpful only if executives expect a tool that helps them make informed decisions based on a range of market actions by each player, not a single answer that solves the whole riddle.

Hagen Lindstädt is the head of the Institute for Management at Karlsruhe University, and Jürgen Müller is a principal in McKinsey’s Stockholm office.

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The Oxford Handbook of Strategy: A Strategy Overview and Competitive Strategy

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The Oxford Handbook of Strategy: A Strategy Overview and Competitive Strategy

29 Game Theory In Strategy

John Powell is Professor of Strategy at Southampton University. Before taking a Ph.D. at Cranfield University and subsequently starting his academic career, he held a number of board-level positions in the defence industry, and bases his research (in the modelling and management of major inter-company conflicts) on those experiences and his active consultancy. He holds HM the Queen's Gold Medal for academic excellence and the President's Medal for the OR Society of UK.

  • Published: 02 September 2009
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The contribution of game theory to the understanding of economic and other social processes during the latter half of the twentieth century has been immense. This article concentrates on an understanding of the relevance of certain key types of game to strategy. For example, it examines the relevance of iterated games to the reputation-building process in an industry. Stylized games like Chicken and Rendezvous , where participants are, respectively, in irremediable opposition and in complete (but defective) cooperation, mirror many strategic processes and inform our thinking about pre-commitment and norms of expectation, respectively. Examination of situations where equilibrium among the participants is achieved by adopting an evolutionary stable strategy ( Hawks and Doves ) shapes our thinking about the level of analysis of our strategic intent. Lastly, the latest methods of representing specific conflict–cooperation relationships between companies are discussed in order to show that game theory is capable of doing more than discussing strategic situations in general, and can, in fact, be used for specific action planning.

29.1 Introduction

The contribution of game theory to our understanding of economic and other social processes during the latter half of the twentieth century has been immense and even a superficial survey of the associated literature is a task beyond the limits of this chapter. Instead, we shall concentrate on an understanding of the relevance of certain key types of game to strategy For example, we will examine the relevance of iterated games to the reputation-building process in an industry Stylized games like Chicken and Rendezvous , where participants are, respectively, in irremediable opposition and in complete (but defective) cooperation, mirror many strategic processes and inform our thinking about pre-commitment and norms of expectation, respectively. Examination of situations where equilibrium among the participants is achieved by adopting an evolutionary stable strategy ( Hawks and Doves ) shapes our thinking about the level of analysis of our strategic intent. Lastly, the latest methods of representing specific conflict/cooperation relationships between companies are discussed in order to show that game theory is capable of doing more than discussing strategic situations in general, and can, in fact, be used for specific action planning.

29.2 The Development of Game Theory

29.2.1 the games we play.

Man has played games for many thousands of years. Bronze Age graves, for example, have been found containing a simple pebble-moving game related to the modern-day African game of mancala . Generally speaking, these pastimes involve direct (if stylized) confrontation between the participants: what one player wins the other loses. The games we consider here, however, are neither so trivial in their effect nor so unidimensionally confrontational. Like the relations between companies, where a competitor in one situation can be a partner in another, real-life games are an intimate mixture of cooperation and conflict.

The essential concept of a game in the sense we understand it here is that two or more players are struggling over a limited (but not necessarily fixed) resource. The struggle is to win resources by achieving a cooperative agreement and/or by application of some sort of force. An example might be two companies seeking to agree over the work-share of an important project. Coercion is undoubtedly present, but there is nevertheless a sincerity of intent, since, if they do not agree a work-share, they are unlikely to be able to implement the project. A second example of this hybrid cooperative/competitive behaviour is the struggle for a number of companies to control market share. To the extent that the market is fixed in size, they are undoubtedly in direct opposition one with the other. To the extent, however, that they can cooperate (even tacitly and implicitly) to increase the total size of the market, say by introducing a new technology or de facto standard desired by the customer, they are in cooperation.

The early work on game theory was carried out by von Neumann and Morgenstern ( 1944 ) The scope of its attention is interesting. It deals with both parlour games, such as poker, and with more ‘businesslike’ games such as bargaining and the formation of coalitions in negotiation. Many of the contemporary themes of game theory as a part of economics can be traced back to this important work, but as we look back today on the scope of game theory, it has a breathtaking reach which it would have been difficult to predict at its birth.

Game theory probably reached its apotheosis, at least in public perception, in the 1960s, when, led by the work of Thomas Schelling ( 1960 ) and the RAND corporation, it was seen as enormously influential in the formation of the grand nuclear strategy of the Cold War. The essential idea of ‘strategic’ thinking, in the strict sense of seeking a ‘self-consciously interactive’ solution (Ghemawat 1997 : 8) stems from this era. The concept of zero-sum games, where the resources fought for by the participants are fixed, achieved common usage as a proxy for the mutually assured destructive intent of the nuclear stand-off. Game theory's role as a means of understanding military and global political conflict still continues, but we shall concentrate on the more general economic and social applications.

The strongest line of development from von Neumann and Morgenstern's seminal work has been in the application of game theory to strictly economic problems, to the extent that in 1994 the Nobel Prize in Economic Science went to three game theoreticians, Nash, Harsanyi, and Selten. The work of these three, together with that of Shapley reflects the enormous progress made by economics in addressing general technical questions of game theory, but thousands of other papers reflect the search by economists for specificity and accuracy in their models. The spread of these models is very wide indeed, extensive work being carried out into, for example, negotiation and bargaining, voting power, sequential games (where moves are carried out in turn), infinite games, multi-person duels, the role of information, collective action in bargaining, and many other topics of a similar nature. To most strategic managers, however, these topics are largely inaccessible, since they are voiced in a mathematical language that only specialists can appreciate. Nevertheless, it would be an error to dismiss them as irrelevant to strategy, since the work underpins all of the more directed material accessible to the strategist.

A second line of development has been the application of game theory to more general social studies, exemplified by the work of Brams ( 1994 ) and Binmore ( 1994 ). Here we see a treatment less mathematical and dealing with such diverse topics as reputation, threat, deterrence, and altruism. Axelrod's ( 1984 ) study of cooperation among trading entities in a computer environment also falls within this category. An associated area of study is the application of game theory to biological evolutionary studies, one aspect of which is discussed below (in the game Hawks and Doves ) when we examine the tactics and behaviour of birds in winning food in order to throw light on the extent to which we should see strategy as a reactive response to a series of specific situations or as a structure for the adaptation of policy. To use more familiar terminology, should we see our core competences as a bundle of skills allowing us to react successfully to a series of market situations or as a capacity at a higher level of analysis allowing us to adapt our strategies, or, indeed, our concept of what constitutes a strategy in response to the policy environment in the industry?

A third line of development has been in the generation of situation-specific models. Most of the economic and social models are, because of their purpose, archetypal in nature—they provide stereotypes of behaviour, which allows us to understand the essential structure of negotiations, for example—but, because of their need for generality, they do not often possess the specific detail needed for a particular management problem. This does not, of course, render them impotent. It is merely that their intent is descriptive rather than normative. Into this former category of specific models falls the work of Fraser and Hipel ( 1984 ), Howard ( 1971 , 1998 ), and others (Bennett 1980 , 1986 ; Powell 1999 ).

29.2.2 Classification of Games

It is useful to have some sort of method for classifying strategic games. One instinctively feels that there are inherent structural differences between:

a number of competitors each simultaneously trying to decide on their investment strategies for product/market development; and

two companies seeking to agree over work-share for one of a series of large projects.

In the first case information is very definitely not shared among the participants. Play is simultaneous, in that there is no natural ordering sequence of investment decisions for the group of competitors and the participants cannot (either by legislation or self-interest) have mutually binding agreements.

In the second case the players are part of a sequence of binding agreements, since they hope to cooperate in the future as well as on this particular project. They also have a much greater degree of sincere communication between them than in the first case. These considerations and others below form a sound basis for classifying games.

Are moves in the game sequential or simultaneous? There is a distinct difference in thinking style between that required when you move and then the opponent moves, knowing what you have done, and when both players make their tactical choices simultaneously (or, more precisely, without prior knowledge of the other's choice). In the first case, the situation requires you to think ‘What will my opponent do in reaction to my move? ’ In the second, simultaneous, case you each have to decide what the opponent is going to do right now, but recognizing that each of you, in calculating your current move, will be taking into account that the other is predicting his opponent's (i.e. your) move.

An example of the importance of sequential games is that of deciding whether first mover advantage can be realized when a number of firms attempt to enter a new market. On one argument, if a firm can defend aggressively the initial position (or indeed has a reputation for having defended a position aggressively in the past), there will be first mover advantage. Scale economies grow as initial market share is lifted by the initial rapid growth of an immature market and the first mover takes the rent on his or her entrepreneurial foresight. On other occasions, where the technical basis for the initial entry cannot be defended, the second mover has the advantage, since it may well be less costly to retro-engineer a product than to have invented and innovated it.

A particularly rich case study of a sequential game covering the battle between BSB and Sky Television over the UK satellite TV market in the early 1990s can be found in Ghemawat ( 1997 ).

  To what extent are the players competing or cooperating? In some games the participants are struggling over a fixed asset and one player's gain is the other's loss. Such a situation (known as zero-sum) necessarily leads to a degree of aggression not present where the contested resource is expandable through co-operation. This cooperation is not necessarily overt or even, on occasions, obvious to the participants. Take the case of companies selling competing project support software, say, a risk management tool. The market for these expensive software packages is limited by the major projects which are available for bidding, and so in some respects these companies compete in a zero-sum fashion and will be optimizing their moves so as to bring down the other as much as to enhance their own position, since these objectives amount to the same thing.

On further examination, however, the single project confrontation is seen to be part of a larger more cooperative game, since there is a component of one company's action which helps the other, since any market development activity helps all software manufacturers by raising the generalized perceived need among clients.

To see that such behaviour is truly strategic in nature, one should observe the advantage gained by large telecommunications companies such as BT who embraced enthusiastically the European PTT standard setting of the late 1980s, thereby gaining a considerable entry barrier in the subsequent battle for European telecommunications business. If you set the standard, you may well ‘leak’ some technical information to competitors, but collectively the early standard setters are better fitted to defend the technical position that they have collectively created. The latecomer has to invest to compensate.

Is the game a one-off or will the players meet again? Whether or not the game is repeated bears enormously on the strategy for its solution. In situations where a one-off agreement has to be made, the temperature can become very high indeed. Any takeover, for example, where the negotiators do not expect to gain any position in the new company, say because they will be retiring on their share options, is likely to be more aggressive than one where the direct initial confrontation is attenuated by knowledge that ‘we all have to rub along’ in the new company. Behaviour of participants is, therefore, altered if they expect to have to use concepts like trust or reputation in their future business dealings. On the other hand, if, as in the stock markets of the 1980s, the concept of dog eat dog applies, there is no future value in dealing other than aggressively with another participant.

There is another reason why repeated trading with the same participants alters behaviour, and it bears strongly on our strategic behaviour. If we have traded with a company before, we have a better chance not only of predicting their behaviour but of gaining insight into their competences. It could be argued that avoiding trading with the same companies is a way of protecting the tacit skills of the firm. Certainly the reverse is true. It is a well-known tactic on the part of certain very large companies to carry out due diligence 1 on a target company a number of times. In a sense they are in bad faith on the first occasions. Even though they intend to make an offer eventually, they are using two separate mechanisms of influence—first, they are gaining a better view of the target's competences and hence a more accurate valuation. Secondly, they know that the behaviour of the target is altered because they, too, dare not assume that this is a single, one-off engagement between the management teams.

Do the players have the same information? There are some parlour games, such as chess, where players possess the same information, but in business this is a rare situation indeed. Generally speaking, business people see information as one of the assets with which they manipulate situations towards their advantage. Hirschleifer and Riley's ( 1992 ) comprehensive book on the subject deals with many aspects of asymmetry of information in economic and business situations, mostly from a game theoretic viewpoint. We might, for example, seek to withhold from a potential strategic partner the true value which we place on the relationship in order to obtain favourable terms for alliance. We wish to release information to our advantage but to withhold information which acts against our interest, and so do others with whom we deal.

Our deceit, however, is so natural and understandable that partners will be very sceptical of our utterances and will tend to rely only on those actions or commitments that are real. In particular, two phenomena known as screening and signalling model this need for us to judge others on deeds rather than words.

Signalling is the act of a player who has more information than another and who wishes to convince the other players that he is not bluffing in claiming this valuable knowledge. In order to be convincing, the first player must carry out an act which can only be interpreted as being in his interest if the claim to knowledge is, in fact, correct. Let us imagine that we are trying to convince predators that we are determined to protect our position. One component of an entry barrier is well understood to be the willingness of an incumbent to react aggressively to intrusion, say by prompt and aggressive court action to protect a patent. We could make loud noises in the press, but this could be interpretable as bluff. Instead, we recruit expensive patent lawyers, saying in effect, ‘Look, we are going to react aggressively to any attack on our patent. If we were bluffing, it would not be worth our while having this high paid help, but because we are going to defend our position it makes sense for us to make the commitment.’ Screening , used in the sense of testing or filtering, is the demand by a less-informed participant that the other make an objective commitment that cannot be interpreted as bluff.

Can the rules of the game be changed? Most business games involve an establishment of the rules prior to some actual play, and if those rules are not in our favour, self-evidently we will be put at a disadvantage. Strategically, therefore, it is important to take part in the pre-game that sets those rules. Many takeover battles in restricted markets have a pre-game component where the Mergers and Monopolies Commission is asked by one contender or another to rule on whether a bid would be allowed. Usually the issue is whether an acquisition by the potential buyer would create an inappropriate domination of the market. There are many examples of this, including the break-up of the Ferranti companies in the mid-1990s and the hostile bid by Royal Bank of Scotland for NatWest bank in December 1999. In some cases (and Ferranti is a good example), winning or losing the pre-game is tantamount to winning or losing the game itself because if a takeover were allowed in principle, the subsequent bidding war would be a foregone conclusion because of the superior financial strength and commitment of one of the parties.

The European PTT standard setting discussed briefly above can also be seen as a pre-game.

Are cooperative agreements binding? There is a convention in game theory that situations where the parties are able to enter into enforceable agreements to take joint action are called cooperative games whereas those where the parties cannot enter into an enforceable agreement are called non-cooperative games. This is rather misleading, since it seems to imply that no cooperation can result without binding agreements. This is not the case. It is perfectly possible for parties to agree on joint action in the non-cooperative case, so long as it remains in their individual and separate interests to act in the agreed (but non-enforceable) fashion. One might think that the majority of business situations are, in this sense, cooperative ones, but very often agreements with very powerful bodies such as governments are so unbalanced that they become in effect non-cooperative games. A small company carrying out consultancy work for a foreign government might think that the government will be bound by normal rules of commercial contracting. This is not the case necessarily, and the government may be forced by the actions of its own legislature to renege on a contract signed. Any assumption that a game is cooperative should be carefully audited; we are far better seeking stable solutions which maintain agreements through beneficial self-interest rather than relying on externally stabilizing influences. An example of this is two firms setting out on a strategic relationship, say to share markets or bundle deliverables. Of course, they will establish a legal agreement between them, but the real stability in the relationship is produced by early establishment of jointly beneficial business, so that they each see a benefit in making the relationship work.

29.3 Strategic Action: Cooperation and Conflict

29.3.1 general versus specific.

Game theory's relevance to strategy does, of course, depend on what one means by strategy. The approach taken here is that the remit of strategy is not merely the long-term, wide span of control of the affairs of companies, but also includes the management of short-term events, often involving relatively limited resources, on which the future of the firm can, nevertheless, turn. Certainly game theory has a role to play at this level of analysis, providing generalized descriptive advice which allows us to make sense of the actions of others in an aggregated sense. Rather than model the behaviour or hypothesize about the motivations of specific competitors, we discuss them as archetypes. Thus, in the examples already given, the concept of pre-games can inform our general thinking about how we approach any attempted takeover, namely as a multi-stage engagement.

Not all strategy is of that aggregated type, however. Just as in warfare, where strategy is generally seen to involve the wide sweep of whole armies over continents, there are occasions when a small band of determined men 2 can turn a war. Similarly, in business strategy there will be occasions where an isolated relatively small-scale event (the failure to take over a company, the establishment of a PTT standard) can turn the future for a company. It is unwise to concentrate exclusively upon the generally applicable strategic theory at the expense of the specific interaction which may prove to be of critical importance. It is wise to distinguish between the small and the unimportant.

The difficult thing, naturally, is to determine which specific events are the most important. In the main part, such insight marks out the strategic mind from the more mundane and is a matter of subjective capacity, but the interaction between scenario planning, a ubiquitous approach to future sensemaking, and discrete space games, discussed below, presents some prospect of assisting us in this task. Here we see a game theoretical modelling approach to specifics being placed within a more subjective, global view of the future, so that the former provides the necessary detail to produce management action plans while the latter forms the context for that specific modelling.

29.3.2 Nature of Strategic Cooperation/Conflict

The relations between companies at the strategic level are not to be understood as either wholly conflictual or wholly cooperative. If we consider the nature of the relationship between an important buyer and a critical supplier, we see that it is an intricate dance, where both are bound into cooperation because of the costs of disengaging. The buyer would bear the extra costs of setting up anew the quality standards already in place with the incumbent supplier and that supplier would bear the costs of having to change to meet the demands of a new buyer, to say nothing of the costs of finding that new buyer in the first place. They are, however, to some extent also in conflict since, simplistically, the one wants to supply at a high price and the other to buy at a low price.

Where there is a degree of mutuality, communication between the participants will be freer than where conflict is present, and this freedom and sincerity of communicative regard lead to accessibility of one party's rationality by the other. 3 Since game theory generally relies on an assumption of economic rationality on the part of the participants, this is an important issue. The structuring capacity of game theory provides us with a means of judging the validity of our assumptions about the other's rationality. Signalling and screening are examples of this process. Where communication is defective, game theoretic models provide us with the basis for predicting another's behaviour and consequently of hypothesizing about their otherwise inaccessible value system.

29.4 Key Concepts of Game Theory

29.4.1 normal and extensive form.

Table 29.1 shows a duopoly game in what is known as normal or matrix form. It represents the investment choices for two companies in an existing market, namely invest in process to reduce price, invest in quality to improve differentiation, or make no investment . Along the left-hand side are the tactical choices for Row Inc. (who chooses which row of the matrix is played) and along the top are the choices for Column PLC (who chooses which column is played). Each cell of the matrix contains the return to Row and Column, respectively, as a percentage of the existing market. Because of the different inherent capabilities of the firm the pay-offs are not symmetrical. If both choose no investment , the entry barriers to a new entrant will fall and so the bottom right-hand cell shows a reduced total return to the existing sellers of 30 + 30 = 60%. The game is thus not zero-sum.

What should they do? Column figures this way. ‘If I look at each column in turn I can determine the worst thing that could happen if I make each choice. If I pick invest in process , my worst case is if Row chooses invest in quality , which gives me a return of 40%. If I choose invest in quality Row could choose invest in quality , too, in which case I would get a market share of 55%. If, finally, I choose no investment , Row might choose invest in process , when I would get only 15%. My safest choice, then, is to choose invest in quality , so that I will get at least 55%.’

Row, by similar reasoning, also reaches the conclusion that the safest bet is to invest in quality This type of interactive arguing is characteristic of simultaneous games and is often called mini-max reasoning, since it seeks the least worst solution under uncertainty about the competitor's tactics. Note that the reasoning does not depend on Column assuming that Row moves later or earlier. It is as if the moves are made simultaneously, although in practice it may be that they are sequential, but no one notices the effect in the market until after the investment is made.

If the investment decisions were made sequentially, one could draw the matrix out in what is called an extensive form. Figure 29.1 shows the same game, but this time assuming that Row moves first and Column has the advantage of responding when Row's move is known.

Row now thinks in this fashion. ‘If I choose invest in process Column would be stupid not to choose invest in quality for a return of 70%. If I choose invest in quality Column will have to choose invest in quality too, since this gives them the greatest return of 55%. If I choose no investment , Column will gain a 80% market share by choosing to invest in quality The best of these for me is if I invest in quality , and Column does the same, giving me a return of 45% and Column 55%.’ Note that the style of thinking here is subtly different, since in each conditional case, Row can know what Column would have done in response to Row's initial move. In a sense Row is ‘rolling back’ from the twigs of the tree to determine the best first move, and this process can be done whatever size of tree is being considered.

Extended game tree for product/market investment game, payoffs to (Row, Column) respectively

29.4.2 Equilibrium

The concept of equilibrium in game theory is a central one, and presents very knotty problems mathematically We can see its essence, however, in the simple, stylized game of Table 29.1 . An equilibrium solution is a set of tactical choices by the participants such that no party is motivated to move away through their own action alone. Consider the game of Table 29.1 , and look at the options for each player with respect to the central cell (invest in quality, invest in quality) . Column has the option of moving left or right, but in each case the market share is reduced from 55%. Similarly, Row could move up or down, but in each case the return will be either 30% or 20%, both of which are less than the return to Row Inc. of 45% in the central cell.

In many cases an equilibrium solution is not found in this simple form and whatis called a mixed strategy has to be adopted. This occurs when making any single choice makes one predictable, and the best tactic is to choose a judicious random mixture of tactical choices in order to mislead the competition. 4

29.4.3 Iterated games

Some games only exhibit stability when played over and over again. Consider Table 29.2 , an example of the ubiquitous Prisoners'Dilemma , originally described in terms of two criminals in separate cells deciding whether to betray one another and turn Queen's evidence. It portrays the choices to CheatCo Ltd and TrustCo Inc. with respect to their adherence to an agreement prior to its being formalized. The situation is this:

CheatCo and TrustCo have negotiated an agreement jointly to exploit their technologies, which are complementary. Naturally, in the process of reaching that agreement they have, in good faith, exposed certain of their capabilities to the other. One of them, say CheatCo, is then approached by a third party who alleges that TrustCo is in conversation with another company with a view to reneging on CheatCo. If TrustCo were to sign an agreement with a third party, they would already have the advantage of the information released in good faith during the negotiation. The third party offers a similar arrangement to CheatCo, saying that it may not be quite as advantageous to CheatCo to renege than to stay with TrustCo, but how can CheatCo be sure TrustCo will remain loyal? Asking TrustCo, of course, will be pointless, because if they were untrustworthy enough to renege, lying would be of little additional consequence.

Should CheatCo themselves renege on the agreement with TrustCo, and betray TrustCo's good faith for the greater gain of the new agreement?

Table 29.2 shows the dilemma. The cells contain the pay-offs to TrustCo and CheatCo, respectively. If they both remain in cooperation (call this C,C ) they will gain $100 m each, whereas if either defects ( C,D or D,C ), the defector will gain more ($130 m), while the betrayed partner will get only $50 m. CheatCo therefore thinks, ‘If I remain in good faith and TrustCo betrays us, we will lose heavily. I have no choice therefore but to cheat.’ TrustCo, in the meantime, is going through the same thought process. They do not know whether CheatCo are really in good faith, and so have little choice but to renege as well. As a result, neither party sticks with the agreement (D,D) , even though the total profit would have been greatest and each now does worse than if the interim agreement had stuck.

Why then do we not behave in this fashion? There are a number of reasons. First, the game structure is somewhat artificial, in that we have the cover of non-disclosure agreements precisely to prevent this situation. Secondly, rightly or wrongly, companies do build up personal trust between negotiators, so that they feel that they have insight into the integrity of their opposite numbers. Most significantly, however, is the effect of iteration. Imagine what would happen if TrustCo and CheatCo were to look ahead and realize that they were inevitably going to be put into such situations of mutual exposure to betrayal over and over again, perhaps because the industry contained only a few mutually dependent firms. They would then come to the conclusion that, because in the long run it is better to take the return of $100 m each from cooperating rather than the $80 m from defecting, it is better to stick with the agreement rather than take the short-term advantage of cutting and running.

It is worth noting, however, that if a participant believes that this is the last time the agreement will be offered, it is advantageous at that point to renege. It is only if they expect to trade repetitively for the indefinite future that the iterated Prisoners' Dilemma (or IPD, as it is called) has a solution stable in ( C,C ), where both parties keep their words.

29.4.4 Information and Common Knowledge

Information can be argued to be at the very heart of game theory and of strategy itself. Whole topics in strategy concern themselves with the approaches needed to gain long-term advantage through technology strategy and core competence approaches in general. These are deliberate attempts to gain an asymmetry in information in the strategic game which can then be turned into competitive advantage. Many excellent texts deal with the game theoretic aspects of this endeavour, including those of Hirschleifer and Riley ( 1992 ) and of Rasmusen ( 1989 ).

An important issue in strategy is the extent to which the players see the rules of the game as well defined, or whether they are able to invent a new set of options which the other players do not see. The important work of Bennett ( 1980 ) and others (Rosenhead 1989 ) in hypergames, in which different players may see and use different tactical options, provide an important link between the generalizable archetypal games of economics and the strategists' need for specific answers to specific problems. Even hypergame structures, however, cannot insulate us against the consequences of failing to see tactical options on the part of an opponent which redefine the very structure of the game.

29.4.5 Rationality

Game theory generally makes fairly sweeping assumptions about the rationality of participants. It is almost always assumed that players have common knowledge of the rules, and that each is attempting to maximize a return, usually expressed financially, by the end of the game. Players are assumed to be faultless calculators of what is best for them, too. While this may appear somewhat optimistic, it does at least produce an analysis where the opponent is using the best armoury at his disposal. There are other assumptions about players' abilities to see a number of moves ahead and it is not necessary to assume that this decision horizon is limitless. In practice the problem is to know on what basis a limited decision horizon may be assumed.

It is important, also, to understand what this rationality concept does not assume. It is not necessary, for example, to exclude acting in someone else's interest, or to assume that they have to act solely on a financial basis. The weighting of options for OXFAM, for example, would have to include some measure of the emancipatory benefit to be gained by others through a particular business posture, but in all other respects game theoretic concepts just as easily apply to the cooperation between charities and to their battles for the compassionate pound in our pockets as between more conventional profit-making organizations.

29.5 Some Important Types and Examples of Games

29.5.1 chicken—pre-commitment.

Two companies, AspirantCo and ImproverCo are addressing a new foreign market where there is no opportunity for collaboration. Entering the new market will require investment, but if they have a free run at the market the investment will be less than if they both attempt to enter. We can model this situation by a simultaneous move, normal form game like Table 29.3 .

The pay-offs reflect the fact that if the market entry is unopposed, the entrant will make a profit of $1 m and the declining company will lose credibility if it is seen not to have taken advantage of what in retrospect will be seen by shareholders to have been a perfectly viable opportunity. If, on the other hand, both companies decline, the shareholders will be more likely to take the view that the opportunity was never a viable one and the damage will be less. We also assume that it is worse for the two companies to compete in the market because the cost of fighting is less than the likely return.

A game of this structure has no equilibrium, since it is in each party's interest to move away from any emergent agreement. For example, if we start with a position ( Decline, Decline ) where neither exploits the market, each party, separately, has a motivation to move either to Fight, Decline or to Decline, Fight . AspirantCo has the power to move to Decline, Fight for a gain of $1 m (remember that neither will care about the other's gain or loss). Similarly, ImproverCo could move unilaterally to Fight, Decline at a gain of $1 m. Decline, Decline is therefore not a stable position in that at least one of the parties will have both the motivation and the unilateral power to move away from it. Similar arguments show that none of the other states is stable.

This game is well known in the game theory literature. It is called Chicken and derives from a potentially fatal teenage pastime of driving cars down a narrow road towards one another. A player wins if he does not swerve. Swerving is seen as a loss of face. Similarly in our market entry game of Chicken , declining to enter when the other company makes a success of the prospect is bad for our shares. We swerved and lost face.

It would be a mistake to think that there is no solution to the game, how-ever. There is a kind of solution, and it informs our strategic thinking about pre-commitment to action. Morris ( 1992 ) discusses the ‘super-tactic’ of pre-commitment, which, in the context of the teenage tearaways, involves being seen to be totally committed to not swerving. The player chains the wheel in the forward position and arranges to be seen to be drinking heavily from a bottle of spirits, in order to give the strong impression that no rationality will be brought to bear. Hence, the other player must assume that he will employ Fight and that as a result the only rational response will be to Decline . While amusing in a macabre sort of way, Morris's super-tactic does work. In market terms, we would replace the fixing of the steering wheel by a set of prior commitments to exploit the market, say by being seen shaking hands with the President of the country and signing a committing technology transfer deal to which we are committed even if we choose not to enter the market . Thus, we are committed to fighting and our competitor will see that he has no option rationally but to accept our commitment and decline to fight.

In strategic terms, showing prior commitment in situations where our actions could be disarmed through the fear of consequences can be seen as raising entry barriers, showing determination in the face of any subsequent action by the competitor. It also has an effect on companies' choice of differentiation basis when high profile research and development programmes signal commitment to a particular line of differentiation, sending signals to warn off others who might otherwise seek to share an undifferentiated market. An example of this is the distinct separation between US military aircraft programmes (concentrating on conventional high agility fighters) and UK military aircraft R&D (specializing in VTOL 5 aircraft such as the Harrier). The United States could have chosen to fight, and develop VTOL technology, but in the face of a determined and very public espousal of VTOL development by both the UK industry and government, it decided instead to take a licence (in effect) to build the McDonnell Douglas AV8B.

29.5.2 Evolutionary Games

So far we have considered only those situations where individual players make rational decisions on the basis of their economic self-interest. We have noted that the assumption is always that the players will behave as if they had perfect calculating ability; that they both see and act upon whatsoever tactical choices are best for them. To reflect our imperfections in the real world, however, we need a model which reflects what happens when a population displays different game-theoretic behaviours, some successful, some less so and then have the opportunity to learn from their experiences.

The approach developed for this purpose is known as evolutionary game theory, and it represents an important means by which strategists can understand the growth of strategic concepts in industries.

General evolutionary theory relies on three elements:

variation of behaviour or response to the environment (mutation)

testing for success (fitness)

retention of the effect of success and failure (heredity).

In our vocabulary, members of an industry will try out variations of strategic approaches, will succeed or fail thereby, and on that basis of perceived fitness others in the industry will adopt the successful approaches and the successful approaches will propagate.

The essential difference between this approach and that of conventional game theory is that in evolutionary game theory the behaviour (known as the phenotype) is a result of something inherent in the member of the population whereas in the latter, the behaviour is the result of calculation. The focus of evolutionary game theory is how populations behave rather than tracking the rational decision-making of an individual. One starts with a population containing certain proportions of members following one behaviour or another and observes how those proportions alter as the effects of the success of the various behaviour come to bear. A behaviour is referred to as being an evolutionary stable strategy if a population adopting that behaviour cannot be invaded by a mutant behaviour. It should be noted that the mechanism by which successful strategies come to represent relatively greater fractions of the whole is fundamentally different from the mechanism in biology. In the latter the mechanism is breeding success; here it is the observation and adoption of successful behaviours by participants. In a sense this book is part of that process. To the extent that you, as a business person, are convinced by the case studies and theories presented here, you will adopt them and they will form thereby a slightly increased fraction of the whole body of accepted knowledge about business strategy. The emergent topic of memetics (Blackmore 1999 ) discusses the ways in which identifiable components of our assumptions and knowledge propagate around a population and offers some promise of a coherent theory of know-ledge propagation around a knowledge community.

29.5.2.1 Prisoners'Dilemma—Cooperation and Reputation

The Prisoners' Dilemma discussed above had an undesirable, but perfectly rational solution; although the defection of both parties did not lead to an attractive result, the players were forced by their inability to communicate and hence achieve a binding agreement into acting in their local self-interests. In other words, if we are never to meet our prospective business partner again, acting in our narrow and ephemeral self-interest pays more than adhering to any higher and longer term moral imperative. Principles cost money, at least in the short term and without the prospect of retaliation.

An examination into the effect of playing the game over and over again, however, gives a very different result. The work of Robert Axelrod ( 1984 ) in studying the performance of computer opponents trading in an evolutionary computer environment is accessible and very relevant to relationship strategies in business. Axelrod set up a population of algorithms trading one with another according to a Prisoners' Dilemma pay-off matrix. Participants remembered the past history of trading, so that if you had previously reneged on me I would be able to recall it. That then leaves open the prospect of expanding the tactical options available to participants beyond the simple decision to cooperate or defect. Now we can adopt policies which react to previous trading experience. For example, one policy might be Never Forgive , where once another player defected on you, you would always defect in subsequent trading with that player. Another might be Tit for Tat , where whenever a fellow trader defected, you would defect only on the next trading opportunity. Axelrod encouraged the readers of a popular science magazine to offer policies and trialled them over a large number of trading events in his computer environment.

The most successful policy was Tit for Tat , in that over many trades a player who followed that policy gained the greatest return over any other policy. Axelrod then set up another computer environment and invited participants to propose policies aimed specifically at beating Tit for Tat . Again, Tit for Tat won, primarily because the programmes that beat it only did so by small amounts, and they did not do at all well against other policies. Tit for Tat also did well in an evolutionary computer environment, where populations of policies were played against one another to see which were the most successful. In this environment, too, although Tit for Tat did not do well at first, as other ‘nastier’ policies met up with other vindictive policies, they effectively neutralized one another and Tit for Tat came through as the dominant phenotype in the population.

This has something to say about our attitudes to industrial (network) strategy. We rely to a great, often hidden extent on trust and reputation in our strategic intercourse. Clearly, if we are to establish good trading relations with strategic partners we need to have mutual trust, but we are often tempted to renege on agreements for short-term gains. We should not do so if we are likely to be meeting those partners again and again in our industry. Similarly, if we are cheated upon, we should not leave the sin unchallenged as such behaviour will indicate no penalty for subsequent potentially unreliable partners.

29.5.2.2 Hawk–Dove game

The Hawk–Dove game is one of the earliest in evolutionary game theory. It deals with a population of birds who inhabit forest clearings where they compete for food. Whenever two birds alight on a piece of food in the clearing, they fight or share the food depending on their type. If a bird predisposed to fighting (a Hawk) meets a non-fighting bird (a Dove), the Hawk wins most of the food. If, however, two Hawks arrive at the food they will use more energy fighting for the food than it contains and they will both lose. Similarly, if two Doves arrive at a piece of food, they will have to share the food, but they will not use any energy fighting. Given that better-fed birds will breed more, how will the populations of Hawks and Doves evolve over time?

The analogy here is with firms who have to decide how to behave when a market opportunity presents itself. To what extent should they fight for the market opportunity and to what extent should they only prosecute opportunities where the opposition is not aggressive? One can see that a single Hawk in a population of Doves will always win relative to the Doves, because it will always win all the food whereas each Dove–Dove meeting implies a sharing of the food. If, however, a Dove finds itself in a population of Hawks at first glance it will always lose, in that it will be left only with the scraps after each engagement, which the Hawk wins. The issue here, though, is not the absolute increase in energy gained by the Dove, but the amount gained relative to the Hawks, who will be starving because they are using more energy fighting than the food is worth. The Dove is making a small net relative gain and as a result it breeds slightly better than a Hawk, and the population of Doves increases.

The population settles out into a balance between Hawks and Doves. If the population swings towards one type of behaviour, the other phenotype will be slightly advantaged and the fraction of that behaviour will increase to bring the balance back. In corporate terms, if we are in a very aggressive environment where projects appear in a sequence and other firms always fight to the death over work-share, we may well be better off taking a somewhat supine position, accepting a smaller ‘piece of the action’ but at smaller cost to ourselves. For example, some buyers demand ‘fly-offs’ 6 when contracting larger projects. One response is to put investment into this highly uncertain bidding process and take the competitors head-on and the other is to look for small workshares from the resulting winners, taking a smaller return, but using much less resource in the process. Contractors in these environments can be clearly seen to fall into two groups—those who fight aggressively for leadership (i.e. majority work-share) and those who act as substantial subcontractors for, say, production or specialized contributions. Often these ‘Doves’ are as large and successful as the ‘Hawks’ but their core competences are very different, the latter having highly developed bidding teams skilled in fighting the ‘Hawk-Hawk’ game.

29.5.3 Bargaining

Bargaining in game theory means the agreement to share a fixed resource among parties—it is a partitioning exercise rather than necessarily the haggling which is its common language meaning. Western approaches to bargaining between parties assume that each party is out to get the most at the expense of another. Oriental concepts, however, stress that each party should leave the bargaining table happy with the result. Game theory has components of both.

Bargaining is, indeed, a strategic concept. The decision of how long to wait for strategic agreement to bundle technologies in the face of a rising risk that a third company will beat you to the market meets all the recognized criteria for a strategic issue. It is of long-term importance, it involves large resources, it has high uncertainty, etc. Similarly, obtaining a fair division of resources within the divisionalized firm is not just a matter for a synoptic CEO to determine. The CEO may propose, but the divisional MDs dispose. If they are not content with the allocation of resources, they are unlikely to be following a business plan with which they can have confidence. Consequently, the allocation is a negotiation, albeit one which is strongly shaped by the corporate centre.

A key concept is the BATNA (Thompson 1998 :24). Standing for Best Alternative To a Negotiated Agreement , it is the best you can get if you do not agree. Imagine you are the representative of a firmware company which has developed an operating system for a massively-parallel quantum computer. You are in negotiation with the brand new company formed by the inventors of the quantum computer. Together you can access a $10 billion market based on public key encryption, secure funds transfer, advanced aerodynamics, and electromagnetic calculations. If you try to sell your OS to another computer manufacturer the platform will be less capable, allowing you a share in a smaller market worth only $500 k. On the other hand, your potential computer partner cannot exploit his computer at all without an OS but will be able to apply for academic development funds for some $100 k. Your BATNA is $500 k and his is $100 k. Note that this is very different from the investment that each has made to get to the negotiation. You might each have invested equal amounts, say, $1 m each, but as far as the BATNA is concerned that, so to speak, is history.

Figure 29.2 shows a negotiation between two parties, A and B, who want to share an asset, V (say, the profits from a joint market exploitation). The axes represent the amounts each takes away from the negotiation. Clearly neither can take more than V , and so no agreement is possible above the line W, but within the triangle OW any agreement is feasible. Player A, however, will not agree if the agreement allocates her less than her BATNA, V A and player B will not agree if she receives less than V B . We can foresee that if the parties start at the worst situation for both, where they both achieve only their BATNAs, it is in their cooperative interest to move up and to the right towards the line W, upon which all the best joint solutions will lie, since all of the profit Vis then allocated. The best negotiated solution, F, will then lie along the intersection of a straight line through the BATNA point with the line W. Note that this does not define the negotiated solution uniquely, since the slope of the line PF is not defined. This slope is set by the relative powers which the parties have over one another. It is easy to assume that in a ‘fair’ negotiation, this should be equal, so that they each take an equal part of that resource Vover and above the BATNAs. Life, however, is not necessarily fair, and the different parties will have powers over one another which cannot be included in such a simple theory. For example, the negotiation may be between two companies who have existing contracts which are asymmetrical—one may be a supplier to a larger company, for example. Nevertheless, this simple negotiating model can tell us a number of relevant things about our strategic approach.

Starting from the BATNA point, P, the parties move up and right towards a final negotiated position which is better for both of them than their BATNAs

First (as player A), we can base our strategy on increasing the slope of the line PR This represents a straightforward increase in our negotiating power in the discussions. Apart from specific techniques used in the negotiation itself, which do not fall within strategy as generally understood, we can act strategically so as to place ourselves in a more persuasive position. For example, we might have access to competences either through our own organic development or through exterior relationships with partners, to which the other party to the negotiation does not have access. In this respect, then, core competence theory is seen not just as a process of winning and husbanding bundles of skills to improve competitive advantage per se, but also as a power play in obtaining advantageous relationships with partners.

Secondly, we can act strategically so as to increase our BATNA. This will move the BATNA point from P to P* (see Figure 29.3 ) and the resulting agreement can be seen to be more favourable to us, player A. What, strategically, would constitute a raising of our BATNA? Imagine that we are negotiating a joint entry to a foreign market with a prospective partner, who is bringing channels to market where we bring an existing product or technology. Perhaps we are thinking of jointly offering our product to the Japanese market, where knowledge of local distribution networks and practices is particularly difficult for a new entrant to access. If we have no other development path for our product, our BATNA is low—we have no alternative but to do a deal with somebody or we will not be able to realize fully the investment we have made in our product. To raise our BATNA we could carry out similar negotiations aimed at another market, say South America. By having a real alternative to doing the deal with our Japanese partner, we raise our BATNA and increase the likely value of the deal to ourselves. Such an argument would lead us, in terms of strategic product/market development, to adopt multiple opportunities and we would have to balance in our development strategy the advantages of being put into a good negotiating position against the inevitable costs of multiple options investigation.

A can increase her portion either by increasing her BATNA or by decreasing B's BATNA

Third, the result is likely to be more in our favour if we can find a way to reduce the other party's BATNA. Figure 29.3 shows that if we can move point P to the position P∧ by reducing the value of the other party's fall-back position, we will gain in the final outcome. We might do this in our market exploitation example by tying an existing relationship into this negotiation, say, by pointing out to the other party that failure to agree a joint position here will endanger continuing work for them on existing products.

Negotiation and bargaining, then, can be seen to be of material importance to strategy, particularly in respect of network strategy and the externalities of the firm. We have only been able to touch the surface of this complex topic and the interested reader is recommended to consult Leigh Thompson's comprehensive book on the topic (Thompson 1998 ), which deals not only with the game theoretic structure of negotiating, but also with the socio-dynamics and practicalities.

29.5.4 Rendezvous Games—Focal Points

A certain class of games, called assurance or rendezvous games, deals with situations where the participants wish to cooperate but are unable to communicate directly An example often quoted (Jervis 1978 ) is the strategic relationship between the USSR and the US in the arms races of the last century Each had the opportunity either to invest in strategic nuclear assets or to invest that fraction of their GDP in social improvement. There are two stable solutions: either both should invest in nuclear assets or both should not. Clearly the latter is the preferred solution, but because of the atmosphere of distrust and ideological conflict between the two super-nations, communication between them was necessarily defective. It could be argued that the ideological basis of their relationship provided a focal point of expectation of conflict, so that each could not believe that the joint social investment solution was a safe one.

A game which examines this focal point issue in more detail is Rendezvous . Two parties, Emma and Dai, have arranged to meet in a particular city, say Cardiff, at noon on a specific date. On the way to the meeting each realizes that they have failed to specify where they are to meet. What should each do?

This is clearly a cooperative game where communication is defective. If we imagine that there only two places to meet in Cardiff (the steps of the National Museum and the main railway station, for example) we can see the essential structure of the game. See Table 29.5 .

Each party now has a dilemma, since they each want to choose the same rendezvous as the other. The nature of the solution lies in understanding what knowledge or preconceptions the other has. Dai (as one might imagine) knows Cardiff rather well, but Emma does not and Dai knows this. He therefore has to assume that Emma will not know of the National Museum as an obvious rendezvous, and therefore will assume that she will go to the main railway station. Emma has no such choice to make. She does not know the city and therefore will choose some focal point obvious to anyone who does not know Cardiff. In this case, then, the game solves itself because of a peculiarity of the two parties, but in general the solution is more difficult and depends on the extent to which one player's focal points are accessible to the other. One can work to improve this visibility. A farsighted parent may well say to a child in a busy Christmas department store, ‘If you get lost, go to the toy department and stay there. I'll find you’, thus predetermining a focal point.

A number of strategic situations are structurally similar to the Rendezvous game, and the approach of establishing or discovering common focal points amongst groups of participants is helpful. Consider, for example, the behaviour of an industry consisting of prime contractors and subcontractors tendering together to a community of buyers. The civil engineering industry follows this form. In tendering for civil engineering contracts, buyers and contractors are concerned with (among other things) the management of project risk, and there have emerged a small number of risk management packages (ProMap, Risk Man, etc.) to help with this. Investment in each of these packages is demanding both in terms of initial investment in the software and in the extensive training required for engineering and project staff. It is not feasible, even for very large companies, to run more than one package. As a result the contractors can be viewed as being in a rendezvous game. The subcontractors and primes want the same risk management package in order to minimize nugatory investment, but each package has its advocates and each its detractors. In time, of course, de facto standards emerge whereby successful prime contractor/subcontractor teams succeed using particular approaches and propagate them thereby. One can view these dominant frames as the focal points of the Rendezvous game of software investment, and the wise subcontractor in such an environment spends time detecting the fashion in these affairs in order to provide a natural solution to a series of Rendezvous games with prime contractors.

Achieving agreement between SBUs on technology strategy in a divisionalized company is a further example of focal points. To the extent that the SBUs share natural foci of understanding, either in terms of desirable overall corporate objectives or simply at the level of common technological frames of reference, agreement will be more easily reached between them, and it may well be more efficient for the corporate centre to concentrate upon engendering and uncovering focal points rather than attempting to prescribe the specific nature of the agreement to be reached.

29.5.5 Discrete Space Games—From the General to the Specific

It will not have escaped attention that, in the main part, the games described so far have presented generalized, almost archetypal, conclusions. They are very good at presenting generalizable results and patterns of thought but are rather less good at offering actions specific to a strategic problem. There is another group of games deriving from the operational research (OR) community (as opposed to economics) which are aimed at modelling specific situations, strategic in nature, but requiring detailed management agenda setting and action planning.

These OR game structures see the world as consisting of a network of states which may or may not be realized according to the various powers and motivations of the participants to bring them about. In many respects they present an extension of the scenario planning view of the world, where planning can be viewed as navigation around a set of futures. Our management agenda then consists of such things as deciding which of the futures we prefer, what we have to do to pursue trajectories which lead to those desired end-points, and what we have to do to unravel the plans of other parties who may wish to divert our progress.

In the games examined so far, the states of play have been defined by the tactical choices made by the players. An alternative view is that the tactics stem from the likely outcomes and our reaction to these likely states of affairs. In drama theory (Howard, Bennett, et al. 1992 ; Bennett and Howard 1996 ; Bennett and van Heeswijk 1997 ; Howard 1998 ), for example, players adopt positions identifying their initial and subsequent negotiation points, and analysis consists of examining the abilities of players to move between these positions in order eventually to come to some sort of resolution. A key element of the analysis is the identification and treatment of characteristic dilemmas for players. For example, a player may experience a cooperation dilemma when joint action is needed to move together with another player to a mutually advantageous new position. As in the Prisoners' Dilemma, there will be a natural suspicion of the other's intent and ability to renege to his short-term advantage. Drama Theory provides a structuring process by which these dilemmas can be resolved to provide a mutually beneficial (or at least stable) solution. The method has been applied to company situations and to political problems such as the recent Bosnian conflict and is frequently used in the military context. The episodic nature of negotiation, through initial exposure of positions, realization of dilemmas and resolution to outcomes is reflected naturally in the Drama Theory structure and, significantly, the game positions are not defined by the players' tactics, but rather the other way around. What the players have to do to resolve their dilemmas results from consideration of the game structure.

The same generative approach can be seen in Powergraph (Powell 1999 ) Here, the first step is to establish a set of possible outcomes for the situation which form a network of states. See Figure 29.4 This is done by consideration of the motives and interests of the participants. Next we consider the ability of the participants to move the game from one state to another. Sometimes these transitions can be brought about by a player on her own, sometimes only in combination with others. A map of the conflict can then be drawn which shows the possible states of affairs and who has control over the transitions between those states. Consideration is then given to the preferences of the players between the various states. Clearly if a player is to utilize his power to move from one particular state to another, this must be seen by him to be desirable as well as being within his power. Both power and motivation are necessary for a transition to take place.

Powergraph network structure. Players' utilities for each state are shown thus: [A, B, C]. Here A will choose to move from S1 to S2. C will choose to move from S2 to S5. A will then choose to move from S5 to S6

The result is a kind of map of the game where the likely paths around the map can be examined. Even quite complex conflict/cooperative situations can be easily modelled. Using the map we can ask very directed questions leading to management action plans, such as:

Bearing in mind the state(s) we prefer, what do we have to do in order to force the transitions we want? Whom (if anyone) do we have to carry with us?

What can the competition do to prevent these transitions we desire? Whom can we influence to block those moves?

What transitions will the competition be trying to engender? Who do they need to carry with them? What can we do to prevent these transitions?

Can we create new states which resolve conflicts of interest and objective?

These kinds of questions lead naturally to the very directed kind of action plans needed to manage high energy inter-company conflicts such as hostile takeovers, major project struggles, and the like.

In early 1993 BAe Systems and Services were strengthening their position in the defence naval market and were tracking two major projects, a frigate, called at the time CNGF (Common New Generation Frigate) and a submarine, a replacement for the Trafalgar Class nuclear submarine called B2TC (Batch 2 Trafalgar Class). BAe had been expecting the CNGF programme to appear after the submarine tender, and so it came as a surprise when the CNGF programme took a leap forward. The company had to review its commitment to potential partners in the two parallel programmes.

The clear front runner on the submarine programme was Vickers Ship Engineering Limited (VSEL), a company with a good track record in submarine design and manufacture. Relationships between BAe and VSEL had been good, with a history of joint project work and a growing mutual respect stemming from common work on the feasibility phase of B2TC VSEL were clear that they wanted BAe in their CNGF team because of BAe's surface weapons and system engineering capability. While VSEL were prepared to include BAe in ‘their’ submarine programme, and could see some advantages in a joint approach, they were confident about their ability to prosecute the submarine programme without major additional help. VSEL were determined to bid for both programmes.

On the frigate programme the situation was somewhat different. GEC Naval Systems, with their access to experienced shipyards, were the front runner, but perhaps not so clearly as were VSEL on the submarine programme. GEC saw advantages in having BAe on the frigate team. They were keen to deny VSEL any advantage on the submarine programme and could see their probabilities of a win on the submarine programme increasing if the innovative approaches of GEC and BAe were to be joined.

At a meeting to decide BAe's teaming, the Commercial Director offered the following argument. ‘It doesn't make sense for us to bid with anyone but the most likely winner. As a result we should offer to team with GEC on the frigate and with VSEL on the submarine.’ The Managing Director agreed. ‘We have things to offer each of them and I don't intend to increase the risk of losing by going on either project to a likely loser.’

Reluctantly, the Project Director prepared work-share agreements which offered BAe's services to GEC on the frigate alone and to VSEL on the submarine alone.

Was the Commercial Director right?

The Explosion

The Managing Director spoke to GEC the following afternoon. They took the news fairly well that BAe were available for the frigate but not for the submarine.

At a big institutional dinner in London that evening, the BAe MD took the chance to break the good news to VSEL that BAe would be happy to join them in their submarine bid. Of course, they must understand that, as GEC were the front runners on the frigate, BAe would have to go with them. The VSEL Chairman was most unhappy. ‘You expect us to include you in our submarine bid while you compete with us for the frigate business we desperately need to keep our yard open. I don't think so.’

The BAe MD retired to consider the position. If he now approached GEC for a position on the submarine as well, his negotiating position would be very weak.

What went wrong?

Figure 29.5 shows the Powergraph model of the dilemma. There are seven states.

Powergraph model of battle for Trafalgar. B = BAe, G = GEC, V = VSEL. Utilities of each state shown thus: [B, V, G]

The controlling Players' symbols, B, V , and G are attached to the relevant transitions. The only transitions which are shown in this simplified diagram are those where a player has both the power to move and has the motivation so to do. Thus, we see that once BAe makes the split offer the other two players have control over the situation. VSEL, in particular, has the power to reject the split position and (because the chain of command was shorter) did so immediately, putting the game into the state frigate only , less desired by BAe than either of the alliance states. BAe could have achieved a state more highly valued (6 against 5) if they had offered an alliance to GEC straight away, but the game structure shows that

Split is unstable

once having given the initiative away by offering split, if VSEL reject the offer there is no recovery from the moderately acceptable frigate only position

if GEC had acted to reject split uncharacteristically quickly, there was a recovery path to an alliance with VSEL.

BAe negotiated with GEC and achieved an adequate work share on the frigate programme. Their submarine market position was shaky and the continuing desire to play in this important market led to an abortive attempt to purchase VSEL.

Shortly after that attempted purchase the results of the submarine competition were announced.

GEC won on merit and price.

29.6 Applicability and Limitations: A Patchwork of Theories

Game theory is a way of thinking. It requires that we should take into account that we live and manage within a system structure, in which others have interests, some of them legitimate. Our actions are no longer to be seen as being optimizing in the limited sense that we decide what we want and then plan unilaterally to achieve it because other strategists are taking their own views, and we have no alternative but to take their actions into account. This system approach is what game theorists refer to as ‘strategic thinking’ and in many respects it aligns itself well with the relativist concepts of core competence, for example, in strategy. Our competences are not seen as being bundles of skills measured in any absolute sense, but must be judged relative to others' competences and in a context of opportunity. There are problems, however, inherent in the economic game theory approach.

Ghemawat sums up the essential difficulties of migrating game theory from its home in economics into the adjacent field of strategic management. ‘Game theory has taken over industrial economics but has barely had an effect on the applied field of business strategy. The gap that has opened between game theory's formidable analytical advances and its lackluster empirical applications appears to be a large part of the reason.’ (Ghemawat 1997 : 27). Rumelt, Schendel, and Teece (Rumelt 1991 ) summarize this problem of the ‘semi-detachedness’ of game theory in terms of the different perspectives of economists and strategists. They claim that

The strategic phenomena themselves lie outside the domain of economic game theorists.

The game theorists seek to explain events and mechanisms rather than to establish their normative effect.

Game theory has a natural focus on a few economic variables to the exclusion of those variables well known to strategists as having practical importance, such as technology, politics, and organization, limits its testability and even its utility in business.

The degree of rationality required to achieve game theoretic equilibrium may well be too demanding.

Game theory tends to focus on external transactions while the source of competitive advantage tends to be internal.

Other writers, too, are concerned about the ease with which game theory gravitates to the most mathematically convenient assumptions for Players' rationality. Almost always the assumptions of complete rationality and ability to calculate are made, whereas there is clear evidence (Camerer, Johnson, et al. 1993 ) that in a social context rationalizing behaviour is limited by concepts of fair play and equity and extremes of return to any player tend not to be realized. Shubik comments that ‘even if we have a full description of “the game” we have to make an inductive leap based upon our social perceptions as to what we wish to consider to be a solution.’ (Shubik 1983 : 12). In our application of the theory to strategy, then, we should be aware that what we consider to be an appropriate solution is highly conditioned by our collective socialized understanding of strategic behaviour, i.e. by ethics, norms of behaviour, and business expectations.

Game theory is also very distinctly end-directed in a way that most of strategy is not. ‘Rationality is cast as a means–end framework with the task of selecting the most appropriate means for achieving certain ends’ (Heap and Varoufakis 1995 ), whereas much of contemporary strategic writing stresses the need for adaptation and responsiveness to developing situations.

In general terms, Shubik sums up the situation concisely. ‘[I]n the current state of game theory there does not appear to be a uniquely agreed upon set of assumptions concerning intent or behaviour but there are many different solution concepts and a patchwork of partial theories which have been more or less justified in certain usages’ (Shubik 1983 : 12). This observation remains valid today; we should view game theory's contribution to strategy in two different forms.

It provides a set of schemata for the understanding of the interaction between archetypal elements of the interactive business system in which strategy is developed and implemented. In this respect we should not expect direct and specific guidance on, say, negotiating behaviour or oligopoly effects in our industry at this time. Rather, we should see game theory as a structure of economic archetypes of behaviour upon which we can generalize and build, incorporating our own knowledge of the specifics of our situation. In spite of its abstraction, this contribution is at least as useful as that of any essentially descriptive theory.

We note that strategy is a grounded subject and demands grounded answers. Strategic managers seek to manage and consequently to act in the world, and quite reasonably expect specific solutions to real-world problems. Game theory has the ability to achieve this specificity through (among others) the discrete space model-ling approaches discussed above. Additionally, these specific models do allow us to combat the difficulties inherent in assuming global rationality since, because of our detailed knowledge of the situation, we may be in a better position to identify likely failures of rationality or calculation in the competitor. No such assumption is safe in a generalized model.

29.7 Future Developments

The dramatic sweep of game theory through economics has produced an intricate richness of models which are generally accepted to fall short of the needs of strategists. ‘Game theorists, dissatisfied with the sensitive dependence of their predictions on the detailed protocols of games, are trying to develop predictions that hold more generally. Unfortunately it has proved impossible so far, to satisfy this craving for generality without sacrificing specificity’ (Ghemawat 1997 : 18). There is little doubt that this search for specificity will continue and form a strong component of the applied game theory agenda. There are arguments against this ‘natural’ agenda, however.

There is an assumption that the generalized game theoretic models fall short of requirements, in some sense, because they do not deal with specifics. This is to mistake their purpose which is not to provide some universally applicable model of behaviour which can be migrated without adaptation into the domain of management so much as to provide modalities of thought which we can combine, using the nuts of our experiences and the bolts of our knowledge of the particularities of the situation.

There appears to be an inherent difficulty in moving from a general game theoretic model to a specific one. The characteristics of the models which give their generalizability lead to an arbitrariness in the specific modelling. Fudenberg and Maskin ( 1986 ), for example, illustrate that one can persuade one particular type of game theoretic model, the non-cooperative one, to provide any behaviour one desires by assuming different kinds of incomplete information in it.

In spite of these difficulties, strategy will seek for specifics, but it is likely to find them not in an extrapolation of generalized economic models but in two topics addressed in this chapter, namely economic game theory and discrete models.

There is a widely held assumption that we live in a world of historically unsurpassed uncertainty, change, and chaos. While one might offer the observation that times were pretty uncertain and trading conditions fast moving in middle Europe for most of half a millennium, we undoubtedly have to cope with a highly dynamic environment and, moreover, one where the contacts between trading entities, because of improved communications and globalization, are more frequent. These are the very conditions in which the assumptions of evolutionary game theory thrive. We can confidently expect strategic thinking to be informed as general evolutionary economic theory and knowledge management come together. Specifically, the impact of memetic thinking (Blackmore 1999 ) on the horizontal strategy of a company, and particularly in terms of the strategy for innovation and adaptation to competitive environments, is bound to be extensive. This interaction between the competitive advantage of the firm and the information flow in the environment around it sees the firm being defined as much by the information which flows in and out of it as by its traditional definitions as a social construct, a bundle of skills or a nexus of contracts. The crucial difference is that in the memetic concept it is the information which is engaged in game theoretic behaviour as much as the competing firms.

Lastly, the OR-derived modelling methods provide real hope of specificity in strategic management. The joint mobilization of scenario planning methods more flexible in approach and more ambitious in their intent alongside modeling methods like drama theory and Powergraph approaches have a real possibility of providing practising strategic managers with specific answers to strategic problems.

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The process of determining the value of a target company to protect shareholders' interests before a deal is struck.

… or indeed, a band of small determined men.

The reverse is easy to see. If we are not in sincere communicative regard with another, there is a real possibility that, since we will have defective information on the value system of the other, we will judge actions which are, in fact, consistent with the other's value system, as irrational because they do not comply with our erroneous assumption of the other's value system.

Penalty takers in soccer do not always choose the same side, and neither do the goalkeepers in response. They are both adopting mixed strategies.

Vertical take-off and landing.

A contracting scheme where bidders have to make huge risk investments to develop prototypes which are then trialled one against the other, the winner taking full control of the project.

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GAME THEORY

“Never interrupt your enemy when he is making a mistake.”

– Napoleon Bonaparte

When I was an undergrad at Stanford, I took a class on game theory, and oh man was I lost…way too much math and obscure theory. When I began to work on competitive strategy projects , I began to understand the importance of game theory and how it can apply to many decisions around pricing , marketing , products , and investments.

When a company acts, competitors often react. Thinking through action and reaction dynamics can be very helpful in decision making . Many industries have suffered because the leading players did not think through and understand the repercussions of the natural competitive reactions to decisions. You see this dynamic a lot in price wars, where one player believes that they can take market share by dropping the price when all that often does is force competitors also to drop the price, so they don’t lose market share.

What is game theory?

Game theory is the analysis of potential and actual strategies and actions between competitors. An organization’s strategy can never be developed in isolation but has to consider the potential reactions of competitors. Game theory helps think through expected payoffs, potential reactions, counteractions, and equilibriums of strategic options .

Let’s start with a hypothetical pricing game between two hypothetical companies. Let’s say we have two fictional beverage companies, Wild Goose and Butler, and they have very similar products. Wild Goose wants to increase profits by running a pricing promotion to take market share. Let’s say hypothetically if Wild Goose does the promotion and Butler doesn’t react with a promotion, then Wild Goose will make $2 million more in profit , and Butler will lose $1 million. If Butler decides to match the promotion, then both Wild Goose and Butler will lose $.5 million. And, if Butler does the promotion and Wild Goose doesn’t follow, then Butler will make $2 million more, and Wild Goose will lose $1 million.

In game theory, there is the important concept of a payoff matrix, a simple 2×2 matrix outlining the potential options of two competitors and the subsequent payoffs of their decisions. An example of the payoff matrix of the Wild Goose and Butler pricing game is below, with the options of promote and don’t promote, and the subsequent payoffs I just went over. In the parentheses of each box are the potential payoffs, with Wild Goose’s payoffs on the right, and Butler’s payoffs on the left. So, in the top left box, if Wild Goose promotes and Butler doesn’t promote, Wild Goose will make $2 million more, while Butler will lose $1 million.

So, let’s get into the game theory of this pricing game. This is where things can get a bit circular in logic. If Wild Goose follows through on their promotion, then Butler should logically react with a promotion to reduce the loss in market share and reduce its profit loss from $1 million to $.5 million, which would also lead Wild Goose to lose $.5 million. Both, Wild Goose and Butler should be thinking through the potential competitive reactions and payoffs to promotions. And, if they were thinking through this game theory, they would both conclude the best mutual thing to do is to both not promote.

Yet, unfortunately, it is rarely the case that two companies would not promote. In fact, if one of them doesn’t promote, the other is highly incentivized to promote to get the gain of $2 million. And, if one of them does promote, then the other is forced to also promote to minimize losses. And, this dilemma, where the mutually beneficial decision for both parties is to not promote, though their incentive is to promote, in both the situation that the other party promotes or doesn’t promote is called the prisoner’s dilemma. And, the likely decision that both parties will promote is called the Nash Equilibrium, created by John Nash. As you can see given this supposedly simple example, game theory can get pretty circular and confusing in its logic. And, if you are lost, no worries, let’s move on to the implications of game theory.

How do you incorporate game theory into your strategic thinking?

While the theory and math of game theory can be difficult to understand, the implications aren’t. Here are the best insights and practices of real-life competitive game theory.

Understand the behavior of your competition

Strategic leaders aren’t typically as super-rational as economists and mathematicians make them out to be in their models. Understanding how competition makes decisions, where they are trying to go, and how they react to situations (e.g., promotions, new products, developments), is so important in trying to understand how they may respond or often, not respond to strategies and decisions.

Tit for tat strategy

One of the most pragmatic best practices that have come out of game theory is the idea of tit-for-tat strategy, which is, if you find yourself in the lead and you want to keep that lead, simply follow the moves of your competitor. I was reminded of tit-for-tat strategy when sailing. My friend and I were racing with some other friends. We found ourselves in the lead with a few miles to go, and our competition not far behind. We were both going in the same direction with the same wind, so to keep that lead we simply followed the actions of our competitors. When they turned right, we turned right. When they turned left, we turned left. And, by following exactly what they did, we kept our lead and won the race.

In the event of being hit, hit back harder

This is one of the most critical implications of game theory. Imagine a bully walking up to a bigger kid, hitting them, and trying to take their lunch money.  What is the best reaction? For the bigger kid to hit the bully back harder, where it counts. Then the bully knows not to mess with the bigger kid. It is the same situation in competitive situations. When a competitor gets aggressive with something like a promotion, the best response is to respond to the promotion in force. Otherwise, the competitor typically continues to use promotions to gain market share. This is another form of tit-for-tat strategy. Only by signaling, you will follow their every move, will they potentially stop.

Unfortunately, I worked with a retailer who didn’t hit back when a competitor would open stores really close to their big moneymaking stores. The retailer never retaliated and hit back by opening up stores right next to the competitor’s big money-making stores or dropping massive marketing and promotions. So, the competitor, over the next 10 years, simply continued to open up stores next to the retailer’s big stores, since they never got into a fight.

Be careful what you wish for

In the ‘80s, American Airlines pioneered the airline loyalty program concept thinking it would lead to increased sales and loyalty. A funny thing happened over the next 10 years, the loyalty program simply increased the costs of the entire airline industry. From a game theory perspective, most of the major airlines incorporated a tit-for-tat strategy and launched their own loyalty programs. So, any advantage American Airlines had with its loyalty program quickly dissipated.

The takeaway is when you’re thinking of introducing a game-changing program, make sure competitors can’t easily copy it. On the other hand, if a competitor comes out with a new program, like a loyalty program, from a game theory standpoint, you have to typically match their actions, so they don’t structurally change the competitive landscape in their favor.

Announce your intentions

While actual collusion by organizations is illegal, there are many things organizations do to announce or signal their intentions to competitors, to try and thwart competitive behavior. The most classic example is announcements of large investments in a market, like “Over the next 3 years, company A will invest $500 million in a new manufacturing plant in Chile.” The typical reason organizations announce these types of investments is to signal to other potential competitors that they shouldn’t think about investing in a particular industry or geography since the expected payouts will probably be low with multiple players.

Don’t start price wars

Unless you have a highly differentiated product, be careful not to start a price war within your market. If you drop the price, typically the only logical option for competitors is to match, or even worse, try to beat your price. And, all of a sudden, you’ll find yourself in a terrible price war, which only shrinks the total profits of the industry. Once a price war starts, they are really hard to stop.

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The Power of Game Theory in Business Strategy

  • September 20, 2023
  • Business Strategy & Innovation

strategic plan game theory

The power of game theory in business strategy is a topic that highlights the importance of understanding the dynamics of the business game.

Contrary to the language borrowed from military and sports, business is not about winning and losing, but rather about finding win-win solutions.

By applying game theory, managers can make strategic decisions that consider both cooperation and competition.

This article explores the significance of playing the right game and designing the right strategies to achieve success in the innovative world of business.

Table of Contents

Key Takeaways

  • Business language borrowed from military and sports can be misleading.
  • Game theory provides insights for managers to make strategic decisions.
  • Changing one or more elements of the game can design a game that suits the company.
  • Success in business depends on playing the right game.

Understanding the Basics of Game Theory

Game theory provides insights for managers to make strategic decisions and understand the basics of how games are played in the context of business. This analytical and strategic approach is essential for companies operating in real-life scenarios and within the field of economics.

Game theory in business involves studying the interactions between different players and the strategies they employ to maximize their outcomes. By understanding the principles of game theory, managers can identify the motivations and behaviors of their competitors, customers, and suppliers. This knowledge allows them to develop effective strategies that consider both cooperative and competitive approaches.

Game theory also helps managers identify the interdependencies between players, allowing them to make informed decisions that consider the broader impact on the market. By applying game theory in real-life scenarios, managers can navigate the complexities of the business landscape and increase their chances of success.

Applying Game Theory to Strategic Decision Making

Applying insights from game theory helps managers in making strategic decisions by considering the reactions and behaviors of others involved. Game theory applications provide a framework for understanding the strategic interactions in business settings.

By analyzing the decisions of competitors, suppliers, and customers, managers can develop effective strategies that maximize their own outcomes while considering the interests of others. Strategic decision-making techniques derived from game theory emphasize the importance of cooperation and competition.

Managers must identify the participants and the interdependencies in the game of business to make informed decisions. They can then design strategies that create win-win situations, where all parties involved can benefit.

This analytical and strategic approach to decision-making is crucial in a dynamic and innovative business environment, where companies must constantly adapt and stay ahead of the competition.

The Role of Cooperation and Competition in Business Games

Cooperation and competition are integral in shaping the dynamics of business games. They influence strategies and outcomes. In business, it’s important to recognize that success doesn’t mean causing others to fail. Companies can achieve success through both cooperative and competitive approaches. This creates win-win situations instead of zero-sum games. Managers and decision-makers who desire innovation and success should understand this. By incorporating game theory principles, companies can identify participants and interdependencies in the game of business. This allows them to strategically plan and design the right game for their goals. Balancing cooperation and competition can lead to favorable outcomes, driving innovation and success in the world of business.

Designing the Right Game for Business Success

In the pursuit of business success, companies must carefully craft a strategic framework that aligns with their goals and maximizes their chances of achieving favorable outcomes. To design the right game for business success, companies should consider the following:

Game theory in the digital age: With the advancements in technology and the rise of digital platforms, game theory has become even more relevant in business strategy. Companies need to understand the dynamics of the digital landscape and how it impacts their competitive advantage.

The ethics of game theory in business: While game theory can provide valuable insights for decision making, it is crucial for companies to consider the ethical implications of their strategies. Balancing competition and cooperation ethically ensures a sustainable and responsible approach to business.

Identifying the key players and interdependencies: Designing the right game requires a thorough understanding of the players involved and the interdependencies between them. This enables companies to create strategies that leverage their strengths and exploit their competitors’ weaknesses.

Leveraging cooperative and competitive approaches: Companies should embrace both cooperative and competitive approaches when designing the right game. By fostering collaboration and partnerships, while also being mindful of the competitive landscape, companies can increase their chances of success in the ever-changing business environment.

Enhancing Decision Making Skills in the Game of Business

Improving decision-making skills is crucial for individuals navigating the complexities of the business world. In order to succeed, individuals need to develop effective decision-making techniques and incorporate strategic planning into their approach.

Decision making is a crucial aspect of strategic planning and competitive strategy, as it determines the direction and outcomes of business decisions. By utilizing decision-making techniques and strategic planning, individuals can make informed decisions that align with their goals and objectives. This analytical and strategic approach allows for a more objective evaluation of options and potential outcomes.

Incorporating decision-making techniques and strategic planning into the game of business enables individuals to make well-thought-out decisions that drive innovation and success. It empowers individuals to take calculated risks and make informed choices that can lead to significant advancements in their business endeavors.

Leveraging Game Theory for Competitive Advantage

By leveraging game theory, companies can strategically position themselves to gain a competitive advantage in the marketplace. Game theory applications offer valuable insights and strategies for companies looking to excel in their marketing efforts.

Here are four ways game theory can be applied in marketing:

Optimal pricing: Game theory helps companies determine the most effective pricing strategies by considering competitors’ reactions and customers’ preferences.

Advertising and promotion: By analyzing the competitive landscape and understanding consumer behavior, game theory enables companies to design effective advertising and promotion campaigns that stand out in the market.

Product differentiation: Game theory helps companies identify opportunities for product differentiation, allowing them to create unique offerings that attract customers while minimizing competition.

Market entry and expansion: Game theory assists companies in assessing the potential risks and rewards of entering new markets or expanding their presence, enabling them to make informed strategic decisions.

Incorporating game theory into marketing strategies can give companies a significant edge, leading to increased market share, customer loyalty, and overall success in the dynamic business environment.

Frequently Asked Questions

What are some common misconceptions about the language of business and its relation to war and sports.

Some common misconceptions about the language of business include equating it with war and sports. However, business is not about winning or losing like war or sports. It’s a high-stakes game with its own rules and dynamics.

How Does Game Theory Provide Insights for Managers in Making Strategic Decisions?

Game theory provides managers with insights for strategic decision making. By focusing on decision making models and strategic thinking, managers can analyze the interdependencies and participants in the game, increasing their chances of success.

What Are the Key Elements of a Game That Need to Be Identified in Order to Design a Game That Suits a Company?

To design a game that suits a company, the identification process involves pinpointing the key elements: players, added values, rules, tactics, and scope. A customized design can increase the company’s chances of success.

How Can Companies Consider Both Cooperative and Competitive Approaches in Changing the Game?

Companies can strike a cooperative competitive balance by leveraging game theory implementation. By considering both approaches, they can design a game that suits their needs, increasing their chances of success.

What Are Some Practical Ways to Improve Decision-Making Skills in the Context of Business?

Improving decision-making skills in the context of business involves enhancing strategic thinking. Companies can consider practical ways like decision-making courses and training to hone skills. These measures will help in achieving innovation and success.

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What Is Game Theory?

  • How It Works
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The Nash Equilibrium

Impact of game theory, types of game theories.

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Game Theory

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

strategic plan game theory

Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics. Specialties include general financial planning, career development, lending, retirement, tax preparation, and credit.

Investopedia / Katie Kerpel

Game theory is a theoretical framework for conceiving social situations among competing players. In some respects, game theory is the science of strategy, or at least the optimal decision-making of independent and competing actors in a strategic setting.

Game theory is used in various fields to lay out various situations and predict their most likely outcomes. Businesses may use it, for example, to set prices, decide whether to acquire another firm, and determine how to handle a lawsuit.

Key Takeaways

  • Game theory is a theoretical framework to conceive social situations among competing players.
  • The intention of game theory is to produce optimal decision-making of independent and competing actors in a strategic setting. 
  • Using game theory, real-world scenarios for such situations as pricing competition and product releases (and many more) can be laid out and their outcomes predicted. 
  • Scenarios include the prisoner's dilemma and the dictator game among many others.
  • Different types of game theory include cooperative/non-cooperative, zero-sum/non-zero-sum, and simultaneous/sequential.

How Game Theory Works

Game theory tries to understand the strategic actions of two or more "players" in a given situation containing set rules and outcomes. Any time we have a situation with two or more players that involve known payouts or quantifiable consequences, we can use game theory to help determine the most likely outcomes.

The focus of game theory is the game, which serves as a model of an interactive situation among rational players. The key to game theory is that one player's payoff is contingent on the strategy implemented by the other player. 

The game identifies the players' identities, preferences, and available strategies and how these strategies affect the outcome. Depending on the model, various other requirements or assumptions may be necessary.

Game theory has a wide range of applications, including psychology, evolutionary biology, war, politics, economics, and business. Despite its many advances, game theory is still a young and developing science.

According to game theory, the actions and choices of all the participants affect the outcome of each. It's assumed players within the game are rational and will strive to maximize their payoffs in the game.

Useful Terms in Game Theory

Here are a few terms commonly used in the study of game theory:

  • Game : Any set of circumstances that has a result dependent on the actions of two or more decision-makers (players).
  • Players : A strategic decision-maker within the context of the game.
  • Strategy : A complete plan of action a player will take given the set of circumstances that might arise within the game.
  • Payoff :   The payout a player receives from arriving at a particular outcome. The payout can be in any quantifiable form, from dollars to  utility .
  • Information set : The information available at a given point in the game. The term information set is most usually applied when the game has a sequential component.
  • Equilibrium : The point in a game where both players have made their decisions and an outcome is reached.

The key pioneers of game theory were mathematician John von Neumann and economist Oskar Morgenstern in the 1940s. Mathematician John Nash is regarded by many as providing the first significant extension of the von Neumann and Morgenstern work.

Nash equilibrium is an outcome reached that, once achieved, means no player can increase payoff by changing decisions unilaterally. It can also be thought of as "no regrets," in the sense that once a decision is made, the player will have no regrets concerning decisions considering the consequences.

The Nash equilibrium is reached over time, in most cases. However, once the Nash equilibrium is reached, it will not be deviated from. After we learn how to find the Nash equilibrium, take a look at how a unilateral move would affect the situation. Does it make any sense? It shouldn't, and that's why the Nash equilibrium is described as "no regrets."

Generally, there can be more than one equilibrium in a game. However, this usually occurs in games with more complex elements than two choices by two players. In simultaneous games that are repeated over time, one of these multiple equilibria is reached after some trial and error.

This scenario of different choices over time before reaching equilibrium is most often played out in the business world when two firms are determining prices for highly interchangeable products, such as airfare or soft drinks.

Game theory is present in almost every industry or field of research. Its expansive theory can pertain to many situations, making it a versatile and important theory to comprehend. Here are several fields of study directly impacted by game theory.

Game theory brought about a revolution in economics by addressing crucial problems in prior mathematical economic models. For instance, neoclassical economics struggled to understand entrepreneurial anticipation and could not handle the imperfect competition. Game theory turned attention away from steady-state equilibrium toward the market process.

Economists often use game theory to understand oligopoly firm behavior. It helps to predict likely outcomes when firms engage in certain behaviors, such as price-fixing and collusion .

In business, game theory is beneficial for modeling competing behaviors between economic agents. Businesses often have several strategic choices that affect their ability to realize economic gain. For example, businesses may face dilemmas such as whether to retire existing products and develop new ones or employ new marketing strategies. 

Businesses can often choose their opponent as well. Some focus on external forces and compete against other market participants. Others set internal goals and strive to be better than their previous versions. Whether external or internal, companies are always competing for resources, attempting to hire the best candidates away from rivals, and gather the attention of customers away from competing goods.

Game theory in business may most resemble a game tree as shown below. A company may start in position one and must decide on two outcomes. However, there are continually other decisions to be made; the final payoff amount is not known until the final decision has been processed.

Internet Encyclopedia of Philosophy

Project Management

Project management involves social aspects of game theory as different participants may have different influences. For example, a project manager may be incentivized to successfully complete a building development project. Meanwhile, the construction worker may be incentivized to work slower for safety or delay the project to incur more billable hours.

When dealing with an internal team, game theory may be less prevalent as all participants working for the same employer often have a greater shared interest for success. However, third-party consultants or external parties assisting with a project may be incentivized by other means separate from the project's success.

Consumer Product Pricing

The strategy of Black Friday shopping is at the heart of game theory. The concept holds that should companies reduce prices, more consumers will buy more goods. The relationship between a consumer, a good, and the financial exchange to transfer ownership plays a major part in game theory as each consumer has a different set of expectations.

Other than sweeping sales in advance of the holiday season, companies must utilize game theory when pricing products for launch or in anticipation of competition from rival goods . A balance must be found. Price a good too low and it won't reap profit, yet price a good too high and it might scare customers toward a substitute .

Cooperative vs. Non-Cooperative Games

Although there are many types of game theories, such as symmetric/asymmetric, simultaneous/sequential, and so on, cooperative and non-cooperative game theories are the most common. Cooperative game theory deals with how coalitions, or cooperative groups, interact when only the payoffs are known. It is a game between coalitions of players rather than between individuals, and it questions how groups form and how they allocate the payoff among players .

Non-cooperative game theory deals with how rational economic agents deal with each other to achieve their own goals. The most common non-cooperative game is the strategic game, in which only the available strategies and the outcomes that result from a combination of choices are listed. A simplistic example of a real-world non-cooperative game is rock-paper-scissors. 

Zero-Sum vs. Non-Zero Sum Games

When there is a direct conflict between multiple parties striving for the same outcome, it is often called a zero-sum game . This means that for every winner, there is a loser. Alternatively, it means that the collective net benefit received is equal to the collective net benefit lost. Lots of sporting events are a zero-sum game as one team wins and another team loses.

A non-zero-sum game is one in which all participants can win or lose at the same time. Consider business partnerships that are mutually beneficial and foster value for both entities. Instead of competing and attempting to "win," both parties benefit.

Investing and trading stocks is sometimes considered a zero-sum game. After all, one market participant will buy a stock and another participant sells that same stock for the same price. However, because different investors have different risk appetites and investing goals, it may be mutually beneficial for both parties to transact.

Simultaneous Move vs. Sequential Move Games

Many times in life, game theory presents itself in simultaneous move situations. This means each participant must continually make decisions at the same time their opponent is making decisions. As companies devise their marketing, product development, and operational plans, competing companies are also doing the same thing at the same time.

In some cases, there is an intentional staggering of decision-making steps, enabling one party to see the other party's moves before making their own. This is usually present in negotiations ; one party lists their demands, then the other party has a designated amount of time to respond and list their own.

One Shot vs. Repeated Games

Game theory can begin and end in a single instance. Like much of life, the underlying competition starts, progresses, ends, and cannot be redone. This is often the case with equity traders, who must wisely choose their entry point and exit point as their decision may not easily be undone or retried.

On the other hand, some repeated games continue on and seamlessly never end. These types of games often contain the same participants each time, and each party has the knowledge of what occurred last time. For example, consider rival companies trying to price their goods. Whenever one makes a price adjustment, so may the other. This circular competition repeats itself across product cycles or sale seasonality.

In the example below, a depiction of the Prisoner's Dilemma (discussed in the next section) is shown. In this depiction, after the first iteration occurs, there is no payoff. Instead, a second iteration of the game occurs, bringing with it a new set of outcomes not possible under one shot games.

Examples of Game Theory

There are several "games" that game theory analyzes. Below, we will briefly describe a few of these.

The Prisoner's Dilemma

The Prisoner's Dilemma is the most well-known example of game theory. Consider the example of two criminals arrested for a crime. Prosecutors have no hard evidence to convict them. However, to gain a confession, officials remove the prisoners from their solitary cells and question each one in separate chambers. Neither prisoner has the means to communicate with the other. Officials present four deals, often displayed as a 2 x 2 box.

  • If both confess, they will each receive a five-year prison sentence. 
  • If Prisoner 1 confesses, but Prisoner 2 does not, Prisoner 1 will get three years and Prisoner 2 will get nine years. 
  • If Prisoner 2 confesses, but Prisoner 1 does not, Prisoner 1 will get 10 years, and Prisoner 2 will get two years. 
  • If neither confesses, each will serve two years in prison. 

The most favorable strategy is to not confess. However, neither is aware of the other's strategy and, without certainty that one will not confess, both will likely confess and receive a five-year prison sentence. The Nash equilibrium suggests that in a prisoner's dilemma, both players will make the move that is best for them individually but worse for them collectively.

" Tit for tat " is said to be the optimal strategy in a prisoner's dilemma. Tit for tat was introduced by Anatol Rapoport, who developed a strategy in which each participant in an iterated prisoner's dilemma follows a course of action consistent with their opponent's previous turn. For example, if provoked, a player subsequently responds with retaliation; if unprovoked, the player cooperates.

The image below depicts the dilemma where the choice of the participant in the column and the choice of the participant in the row may clash. For example, both parties may receive the most favorable outcome if both choose row/column 1. However, each faces the risk of strong adverse outcomes should the other party not choose the same outcome.

Dictator Game 

This is a simple game in which Player A must decide how to split a cash prize with Player B, who has no input into Player A’s decision. While this is not a game theory strategy per se, it does provide some interesting insights into people’s behavior. Experiments reveal about 50% keep all the money to themselves, 5% split it equally, and the other 45% give the other participant a smaller share.

The dictator game is closely related to the ultimatum game, in which Player A is given a set amount of money, part of which has to be given to Player B, who can accept or reject the amount given. The catch is if the second player rejects the amount offered, both A and B get nothing. The dictator and ultimatum games hold important lessons for charitable giving and philanthropy.

Volunteer’s Dilemma

In a volunteer’s dilemma, someone has to undertake a chore or job for the common good. The worst possible outcome is realized if nobody volunteers. For example, consider a company in which  accounting fraud is rampant , though top management is unaware of it. Some junior employees in the accounting department are aware of the fraud but hesitate to tell top management because it would result in the employees involved in the fraud being fired and most likely prosecuted.

Being labeled as a whistleblower may also have some repercussions down the line. But if nobody volunteers, the large-scale fraud may result in the company’s eventual bankruptcy and the loss of everyone’s jobs.

The Centipede Game

The centipede game is an extensive-form game in game theory in which two players alternately get a chance to take the larger share of a slowly increasing money stash. It is arranged so that if a player passes the stash to their opponent who then takes the stash, the player receives a smaller amount than if they had taken the pot.

The centipede game concludes as soon as a player takes the stash, with that player getting the larger portion and the other player getting the smaller portion. The game has a pre-defined total number of rounds, which are known to each player in advance.

Game theory exists in almost every facet of life. Because the decisions of other people around you impact your day, game theory pertains to personal relationships, shopping habits, media intake, and hobbies.

Types of Game Theory Strategies

Game theory participants can decide between a few primary ways to play their game. In general, each participant must decide what level of risk they are willing to take and how far they are willing to go to pursue the best possible outcome.

Maximax Strategy

A maximax strategy involves no hedging. The participant is either all in or all out; they'll either win big or face the worst consequence. Consider new start-up companies introducing new products to the market. Their new product may result in the company's market cap increasing fifty-fold. On the other hand, a failed product launch will leave the company bankrupt. The participant is willing to take a chance on achieving the best outcome even if the worst outcome is possible.

Maximin Strategy

A maximin strategy in game theory results in the participant choosing the best of the worst payoff. The participant has decided to hedge risk and sacrifice full benefit in exchange for avoiding the worst outcome. Often, companies face and accept this strategy when considering lawsuits. By settling out of court and avoiding a public trial, companies agree to an adverse outcome. However, that outcome could have been worse if the case had gone to trial.

Dominant Strategy

In a dominant strategy, a participant performs actions that are the best outcome for the play, irrespective of what other participants decide to do. In business, this may be a situation where a company decides to scale and expand to a new market, regardless of whether a competing company has decided to move into the market as well. In Prisoner's Dilemma, the dominant strategy would be to confess.

Pure Strategy

Pure strategy entails the least amount of strategic decision-making, as pure strategy is simply a defined choice that is made regardless of external forces or actions of others. Consider a game of rock-paper-scissors in which one participant decides to throw the same shape each trial. As the outcome for this participant is well-defined in advance (outcomes are either a specific shape or not that specific shape), the strategy is defined as pure.

Mixed Strategy

A mixed strategy may seem like random chance, but there is much thought that must go into devising a plan of mixing elements or actions. Consider the relationship between a baseball pitcher and batter. The pitcher cannot throw the same pitch each time; otherwise, the batter could predict what would come next. Instead, the pitcher must mix its strategy from pitch to pitch to create a sense of unpredictability that it hopes to benefit from.

Limitations of Game Theory

The biggest issue with game theory is that, like most other economic models, it relies on the assumption that people are rational actors that are self-interested and utility-maximizing. Of course, we are social beings who do cooperate often at our own expense. Game theory cannot account for the fact that in some situations we may fall into a Nash equilibrium, and other times not, depending on the social context and who the players are.

In addition, game theory often struggles to factor in human elements such as loyalty, honesty, or empathy. Though statistical and mathematical computations can dictate what a best course of action should be, humans may not take this course due to incalculable and complex scenarios of self-sacrifice or manipulation. Game theory may analyze a set of behaviors but it can not truly forecast the human element.

What Are the Games Being Played in Game Theory?

It is called game theory since the theory tries to understand the strategic actions of two or more "players" in a given situation containing set rules and outcomes. While used in several disciplines, game theory is most notably used as a tool within the study of business and economics.

The "games" may involve how two competitor firms will react to price cuts by the other, whether a firm should acquire another, or how traders in a stock market may react to price changes. In theoretic terms, these games may be categorized as prisoner's dilemmas, the dictator game, the hawk-and-dove, and Bach or Stravinsky.

What Are Some of the Assumptions About These Games?

Like many economic models, game theory contains a set of strict assumptions that must hold for the theory to make good predictions in practice. First, all players are utility-maximizing rational actors that have full information about the game, the rules, and the consequences. Players are not allowed to communicate or interact with one another. Possible outcomes are not only known in advance but also cannot be changed. The number of players in a game can theoretically be infinite, but most games will be put into the context of only two players.

What Is a Nash Equilibrium?

The Nash equilibrium is an important concept referring to a stable state in a game where no player can gain an advantage by unilaterally changing a strategy, assuming the other participants also do not change their strategies. The Nash equilibrium provides the solution concept in a non-cooperative (adversarial) game. It is named after John Nash, who received the Nobel Prize in 1994 for his work.

Who Came Up with Game Theory?

Game theory is largely attributed to the work of mathematician John von Neumann and economist Oskar Morgenstern in the 1940s and was developed extensively by many other researchers and scholars in the 1950s. It remains an area of active research and applied science to this day.

Game theory is the study of how competitive strategies and participant actions can influence the outcome of a situation. Relevant to war, biology, and many facets of life, game theory is used in business to represent strategic interactions in which the outcome of one company or product depends on actions taken by other companies or products.

Stanford Encyclopedia of Philosophy. " Game Theory ."

Princeton University Press. " Theory of Games and Economic Behavior: Overview ."

The Nobel Prize. " John F. Nash Jr. "

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Game Theory: Strategic Analysis and Practical Applications

Master game theory with strategic analysis for real-world applications. Elevate decision-making and problem-solving skills.

Game Theory, an essential framework in economics and strategic studies, offers insight into the complex realm of human decision-making. By examining the interactions among rational players within competitive and cooperative environments, Game Theory provides a structured approach to predicting and influencing outcomes in various scenarios. This article delves into the intricate principles of Game Theory, exploring its practical applications in decision-making, economics, the burgeoning technology and AI industries, as well as addressing the challenges and criticisms it faces. Whether applied to everyday life decisions or complex market behaviors, Game Theory remains a powerful tool for strategic analysis and problem-solving.

In doing so, we will shed light on not just the theory itself but also on how one can deepen their understanding through structured learning opportunities like an online certificate course or a comprehensive problem solving certification .

The Principles of Game Theory

The underpinning concepts of Game Theory are integral to understanding strategic interactions. At its core, this mathematical model assumes rational players who are looking to maximize their personal payoffs, whether that entails cooperation or competition. The theory divides games into various categories such as cooperative or non-cooperative, symmetric or asymmetric, and zero-sum or non-zero-sum, each describing different strategic situations the players may face.

Assumptions in Game Theory are the bedrock of its predictive capabilities. Participants are commonly presumed to be rational, seeking to maximize their utility. They have perfect knowledge of the payoff matrix structure, albeit not necessarily of the actions other players will take. Furthermore, the number of players, available strategies, and potential outcomes are known. Although these assumptions are idealized versions of reality, they create a simplified framework to analyze complex interactions.

Illustrations through real-life examples make the abstract principles of Game Theory far more tangible. Markets operate under the premise of competition, where companies must anticipate competitors' actions. Political campaigns are strategic in nature, as candidates aim to win voters under the assumption of rational choice. These parallels between theoretical concepts and real-world scenarios validate Game Theory's extensive applicability and facilitate the understanding of its core principles.

Game Theory in Decision Making

In the realm of decision making, Game Theory serves as a vital tool for analyzing strategic interactions in various sectors, from business negotiations to political strategy. It allows individuals and organizations to anticipate the moves of others and respond in a way that will most likely result in a favorable outcome. This strategic anticipation involves identifying best responses, potential retaliations, and aligning actions to align with desired objectives.

Understanding dominant strategies is a key facet of utilizing Game Theory effectively. A dominant strategy occurs when one particular strategy results in preferable outcomes for a player, irrespective of the other players' actions. Identifying these strategies can greatly simplify the decision-making process and is especially vital in competitive environments where the margin for error is remarkably thin.

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Nash Equilibrium, named after mathematician John Nash, is another fundamental concept in Game Theory. It is a state within a game where no player can benefit by changing their strategy while the other players keep theirs unchanged. This concept is paramount as it often predicts the outcome of strategic interactions, providing a stable solution where individuals or firms make decisions considering the likely responses of others.

Real-world decision-making scenarios are replete with examples of Game Theory at play. Corporate decisions on pricing, product launches, and market entries often hinge upon anticipating competitors' moves and formulating counter-strategies. International relations and diplomatic strategies are grounded in Game Theory, with governments analyzing potential responses before making critical decisions on alliances, treaties, and conflicts.

Economical Aspect of Game Theory

Game Theory holds an influential position in economics by providing a structured approach to understanding and predicting individual and collective behaviors within markets. It serves as a cornerstone of microeconomic theory, which deals with the actions of individuals and firms, and has extensive implications for market dynamics and economic policy design.

Market competition is an area where Game Theory's principles are vividly applied. Firms engage in strategic moves, such as price setting, creating barriers to entry, or forming alliances, each of which can be modeled and studied through the lens of Game Theory. Analyzing these competitive environments helps businesses optimize their strategies for better market positioning and profitability.

Market negotiation

Market negotiations, too, serve as a fine illustration of Game Theory's applicability. Whether in mergers and acquisitions, contract negotiations or resolving trade disputes, the theory guides participants in making strategic offers and counteroffers. The anticipation of the other party's moves, preferences, and possible outcomes greatly influences the tactics and final agreements.

Illustrations in the economic field are not short in supply. The OPEC oil pricing negotiations are a testament to Game Theory, where each member country must consider the actions and reactions of others when deciding on production levels. Similarly, auction designs for selling government securities or privatizing public assets are deeply rooted in Game Theory principles. These examples embody the theory's power to model and shape economic behaviors.

Game Theory in the Technology and AI Industry

The role of Game Theory in the technology and AI sector is rapidly expanding. As systems become more interconnected and autonomous, creating effective algorithms that can anticipate and adapt to other agents' behaviors becomes crucial. This has profound implications for the design of software, as well as the strategic decisions made by tech companies.

Game Theory is intricately woven into the development of AI and machine learning algorithms. As AI systems interact with one another and with humans, they must make decisions that align with optimizing their set objectives, a process that Game Theory models proficiently. Whether in autonomous vehicles, financial trading algorithms, or content recommendation engines, these strategies play a pivotal role.

Real-life examples bolster our understanding of Game Theory's role in AI. Autonomous vehicles, for instance, must predict the actions of human drivers and other autonomous systems to navigate safely and efficiently. In e-commerce, recommendation algorithms use Game Theory principles to optimize their suggestions based on user interactions and competitive dynamics within the marketplace. These instances highlight the seamless integration of Game Theory in the technology and AI sectors.

Challenges and Criticisms of Game Theory

Despite its widespread application, Game Theory is not without its limitations and challenges. One of the primary concerns is that the theory relies heavily on the assumption of rational behavior, which does not always align with actual human decision-making that can be influenced by biases, emotions, and imperfect information.

Criticism of Game Theory often revolves around its sometimes oversimplified model of human behavior and the potential detachment from real-world complexity. Critics argue that the assumptions of complete information and rational action are rarely met, questioning the practical relevance of its predictions and solutions.

In defense of these criticisms, scholars and practitioners highlight that Game Theory provides a foundational framework from which more complex and nuanced models might be developed. Admitting that no model can perfectly encapsulate human behavior, proponents underline that Game Theory excels as a starting point for understanding strategic interactions, one that can be iteratively refined to better reflect real-world complexities.

Throughout this exploration, the versatility and significance of Game Theory in analyzing and informing strategic decisions have been apparent. Its principles shed light on the intricacies of human and organizational behavior, offering a lens through which competitive and cooperative activities can be understood and optimized. The value of structured learning in the form of an online certificate course in Game Theory should not be underestimated, as it offers individuals the comprehensive knowledge and expert approach required to apply these concepts effectively.

In sum, Game Theory presents a robust set of tools that continue to influence not only academic thought but practical decision-making across various sectors. As we look to the future, ongoing advancements in AI, machine learning, and the digital economy will likely bring Game Theory into even greater prominence, suggesting its continued evolution and application in increasingly sophisticated ways.

What are the key concepts and principles in game theory that are most essential for strategic analysis?

Game theory fundamentals.

Game theory offers a framework for understanding strategic interactions. It bridges economics, political science, and psychology. Strategic analysis heavily relies on several key concepts. Each principle plays a pivotal role in analyzing competitive and cooperative settings.

Rationality

At its core, game theory assumes rational agents. Players aim for the best outcome, given their preferences. They make decisions to maximize utility. Analysts predict outcomes by assuming rational choices.

Games fall into different categories. These include cooperative vs. non-cooperative and zero-sum vs. non-zero-sum. Cooperative games involve binding agreements. Non-cooperative games do not. Zero-sum games have fixed winnings. Non-zero-sum games allow mutual gains or losses.

Payoff Matrices

The payoff matrix is a visual representation. It shows the payoffs for each player. Matrices help players understand potential outcomes. Analysts use them to predict likely choices.

Nash Equilibrium

A Nash Equilibrium occurs when no player benefits by changing their strategy. It reflects stability in the game. Each player's strategy is optimal, given the others'. It's a fundamental concept in predicting outcomes.

Dominant Strategies

A dominant strategy outperforms others, regardless of opponents' actions. If it exists, it simplifies analysis. Not all games have dominant strategies.

Subgame Perfect Equilibrium

This refers to strategies that maintain equilibrium. It's relevant in games with sequential moves. It ensures players do not make empty threats or promises.

Repeated Games

Some games occur more than once. These are repeated games. They allow for reputation effects. They may lead to different strategies than in one-shot games.

Information Assymetry

This occurs when players have different information. It can lead to adverse selection or moral hazard. Games model these information gaps.

Mixed Strategies

Pure strategies may not always suffice. Players sometimes randomize their actions. They use mixed strategies to do so. This can prevent opponents from predicting their play.

Game theory brings clarity to strategic decisions. The concepts mentioned above are building blocks. Together, they form a solid foundation for strategic analysis. Understanding these principles is crucial for making informed decisions in any game-theoretic context.

How does game theory inform decision-making processes in the context of practical applications?

Understanding game theory.

Game theory explores strategic interaction. It applies to economics, politics, and more. Scholars and practitioners heavily rely on it. It informs various decision-making processes.

Decision-Making in Economics

In economics, game theory deals with market strategies. Firms consider competitors' potential moves. They anticipate reactions and strategize accordingly. This process influences pricing, product launches, and advertising campaigns.

- Pricing : Firms set optimal prices.

- Product launches : Timing and features reflect competition.

- Advertising : Firms counter competitors' campaigns.

Political Strategy and Elections

Politicians use game theory to plan campaigns. They predict opponents' moves. They tailor messages to sway swing voters. Alliances form based on shared interests.

- Predicting moves : Parties analyze rivals' plans.

- Messaging : Politicians craft appealing narratives.

- Forming alliances : Coalitions emerge strategically.

Military Tactics and Diplomacy

Game theory guides military decisions. Leaders evaluate risks and rewards. They consider enemies' likely actions. Diplomacy involves similar calculations.

- Risk assessment : Commanders weigh potential losses.

- Enemy actions : Moves are anticipated.

- Diplomatic negotiations : Countries bargain, predict outcomes.

Business Negotiations and Contracts

Executives negotiate using game theory. They assess other parties' strategies. This ensures advantageous contract terms. Profit maximization is the goal.

- Strategy assessment : Executives predict others' terms.

- Advantageous terms : Negotiations aim for the best deal.

- Profit maximization : The ultimate objective.

Solving Social Dilemmas

Social dilemmas involve group interaction. Individuals make choices impacting the collective. Game theory helps design incentives for social good.

- Individual choices : Personal decisions affect groups.

- Collective impact : Outcomes have broader effects.

- Designing incentives : Strategies encourage cooperative behavior.

Health and Medicine

Doctors and policymakers apply game theory in health. They strategize to control diseases. Vaccination and treatment plans are game-theoretic strategies.

- Disease control : Strategies limit spread.

- Vaccination plans : Approaches aim for herd immunity.

- Treatment plans : Patient compliance is critical.

Game Theory's Practical Impact

Game theory evolves as a crucial tool. It offers structured frameworks for choices. Decision-makers better forecast outcomes using it. It enhances strategic planning across fields. Game theory informs smarter, forward-thinking decisions.

Can you provide any examples where game theory has been successfully applied to resolve real-world, strategic dilemmas?

Game theory in real-world strategic dilemmas.

Game theory stands as an essential part of modern strategy. This theory finds utility in diverse areas — economics, politics, psychology, and more. Experts often turn to game theory to clarify strategic interactions among rational actors. These actors could be individuals, businesses, or nations. Analyzing their choices leads to insights about cooperation and conflict. Several real-world examples show how game theory has proved effective. Below are a few domains where game theory has shone.

Economics and Business

In economics, firms use game theory for pricing strategies. They consider rival pricing before setting their own. This behavior follows the Cournot Competition model. Firms decide on quantities to produce, knowing rivals will respond similarly. Pricing and output choices reflect understanding of this strategic interdependence.

Auction design serves as another strong example. Game theory helps craft auctions to maximize seller profit. The well-known 1994 FCC spectrum auction demonstrates this well. The government used game theoretic insights to sell radio frequencies. This method ensured efficient use and maximized revenue.

Corporate takeovers also involve game theory. Companies strategize to manage hostile takeovers. They play a game predicting rival maneuvers. Then they prepare defenses or counteroffers. The "poison pill" strategy is a direct outcome of such game-theoretic planning.

International Relations

Game theory applies to international relations, especially in conflict resolution. The Cuban Missile Crisis is a classic case. Both the US and the Soviet Union had to contemplate each other's potential moves. They understood the grave consequences of escalation. This mutual understanding helped to avoid a nuclear standoff.

Trade negotiations also use game theory principles. Nations negotiate tariffs and trade deals, ensuring mutual gain while protecting home industries. Game theory helps parties understand the benefits of cooperation over protectionism.

Environmental Policy

Environmental agreements incorporate game theory. Nations face the temptation to free-ride on others' conservation efforts. Game theory models, such as the Tragedy of the Commons, guide policymakers. This model aids in designing better incentive systems for pollution control.

Negotiations on climate change involve game theory too. The Paris Agreement is an instance where countries tackled the free-rider problem. They committed to individual but cooperative action to reduce emissions.

Technology and Cybersecurity

Tech companies design networks with game theory principles. They prepare for potential breaches by considering how hackers might strike. Then they bolster defenses accordingly. This proactive approach reduces system vulnerabilities.

In cybersecurity, defense strategies become a game against attackers. Defenders make moves to protect data. Attackers respond with new hacking techniques. This ongoing interaction defines the state of cybersecurity.

The diverse applications of game theory offer a glimpse into its power. In each case, strategic decision-making becomes clearer. Leaders rely on game theory to seek optimal solutions to complex problems. The examples provided affirm its value in addressing strategic dilemmas. Game theory's influence stretches across domains, showing its universal relevance.

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Olivia Guy-Evans, MSc

Associate Editor for Simply Psychology

BSc (Hons) Psychology, MSc Psychology of Education

Olivia Guy-Evans is a writer and associate editor for Simply Psychology. She has previously worked in healthcare and educational sectors.

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Saul Mcleod, PhD

Editor-in-Chief for Simply Psychology

BSc (Hons) Psychology, MRes, PhD, University of Manchester

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Game theory is a theoretical framework that is used for the optimal decision-making of players in a strategic setting. A key characteristic of game theory is that a player’s payoff is dependent on the strategy of other players.

Game theory is thought to apply to any situation with two or more players where there are known payoffs or quantifiable consequences. This theory helps players to determine the most likely outcomes while considering the actions and choices of others, which will affect the result.

John von Neumann, a mathematician and physicist, was believed to have developed the idea of game theory. He collaborated with economist Oskar Morgenstern on a book called A Theory of Games and Economic Behavior ; in 1944.

The book asserts that any economic situation could be defined as the outcome of a game between two or more players.

game theory

What are the components of a game?

The components that are necessary to a game, according to game theory, are:

A player is a strategic decision-maker within the context of the game. A game needs to have at least two players to be considered a game. If someone is the sole player, then the game theory would not apply. The players also need to be able to interact with each other in some way.

Strategies are the actions that the players take in a game depending on the circumstances that might arise in the game.

Strategy is often based on personal self-interest and what the other players are expected to do.

Other elements of a game

In a game, players share ‘common’ knowledge of the rules, strategies available to them, and the possible payoffs of the game. There is often an ‘information set,’ which is the information available at any given point in the game.

This term is usually applicable when the game has a sequential component.

To end the game is to reach equilibrium, which is the point in the game where the players have made their decision, and an outcome is reached.

The main principles of a game are that it can be assumed that the players act rationally and they act according to their personal self-interest.

Types of game theory

The prisoner’s dilemma.

This game is one of the most well-known examples of game theory. There are many variations of the game, but one of the scenarios is as follows:

There are two criminals who are caught red-handed for committing a crime together.

They are taken to the police station and are placed in separate interrogation rooms for questioning, so neither can communicate with one another.

The prisoners are told that if they both confess to the crime, then they will each receive a 5-year jail sentence. If neither confesses, they will each serve a 2-year sentence.

However, if one prisoner confesses, but the other does not, the prisoner who confesses will serve a 3-year sentence, whereas the one who does not confess will serve nine years.

The dilemma in this scenario is that the payoff of each prisoner is dependent on the behavior of the other. If they were able to confer, they might agree not to confess to getting a shorter jail sentence.

However, there is no certainty of what the other person will do. To avoid the worst-case scenario of 9 years, the safest option is to confess and receive a maximum of a 5-year sentence.

The Ultimatum Game

This game is a simple take-it-or-leave-it bargaining game involving two players. One player is assigned as the proposer, while the other is the responder.

The proposer is allocated a sum of money, for instance, $4. They then must decide how much of this $4 to give the responder. The responder decides whether to accept or reject the offer.

If the responder accepts, the players split the money in the way the proposer suggested. If the responder rejects the offer, neither player gets any money.

Some proposers may act in self-interest and offer a low amount, but then there is a likely risk that the responder will not accept the offer, and they both get nothing.

However, some suggest that the responder should accept any offer, even as low as $1, since it may not be much, but it is still a gain.

This game assumes that the players are rational, although, in reality, there can be many factors that could influence someone’s decision.

The Volunteer’s Dilemma

In a volunteer’s dilemma, someone must undertake a chore or job for the good of everyone. This is often a relatively unpleasant task that everyone presumably has the skills to complete but no one really wants to do.

In the worst-case scenario, the task does not get done, and everyone in the group suffers consequently.

Examples of tasks can include chores such as cleaning up, repairing a broken item, or completing a group project.

Each member of the group needs to decide whether to be the one to step forward to complete the task or not.

Since there is no added benefit for the volunteer to carry out the task, there is no real incentive for acting since everyone else benefits as well.

The Centipede Game

This is an extensive-form game in which two players alternately have the chance to take a larger share of a slowly increasing pot of money.

It is arranged so that if a player passes the money pot to the other player, who then takes the money, the player receives a smaller amount than if they had taken the pot.

The game ends when a player decides to take the pot of money, with that player getting the larger portion and the other getting the smaller share. There are 100 total rounds, but the game can end at any point, even after the first round.

Cooperative vs. non-cooperative game theories

Cooperative and non-cooperative game theories are the most common types of game theory.

Cooperative game theory looks at how cooperative groups, or coalitions, interact when only the payoffs are known. It is a game between groups of players rather than between individuals.

Non-cooperative games deal with how rational players deal with each other to achieve their own goals.

It is a game with competition between individual players in which only the available strategies and the outcomes that result from a combination of choices are listed.

An example of a real-world non-cooperative game is rock-paper-scissors.

Types of game strategy

Below are some of the game strategies that players can use according to game theory:

Maximax strategy

A maximax strategy is used when the player attempts to obtain the maximum possible payoff available. The player who uses this strategy will prefer to take a chance of achieving the best possible outcome, even if a highly unfavorable outcome is possible.

In the Prisoner’s Dilemma, the player who uses the maximax strategy would choose the option with the smallest prison sentence no matter what the other person chooses.

This strategy is often viewed as naïve and overly optimistic since it assumes there will be a highly favorable environment for the player, which may not always be the case.

Maximin strategy

A maximin strategy is where a player chooses the best of the worst payoff. This is commonly chosen when a player cannot fully rely on the other players to keep to any prior agreement.

In the Prisoner’s Dilemma, the worst payoff from confessing is to get five years (if the other player confesses), and the worst payoff from denying is nine years (if the other player confesses).

Thus, the best of the worst payoff, the maximin strategy, is to confess.

Dominant strategy

The dominant strategy is the best outcome for the player, irrespective of what the other players decide to do. In the case of the Prisoner’s Dilemma, the dominant strategy would be for each player to confess.

However, while the dominant strategy may be great in the case of non-alternative if someone is part of a game with more dominant strategies (e.g., each player has a dominant strategy), then this approach will not be optimal.

What is Nash Equilibrium?

Nash Equilibrium is named after economist John Nash who proposed that even in high-level competitive games, there exists an ‘equilibrium’ where no side would benefit from changing course.

Nash equilibrium is a solution to a game involving two or more players who want the best outcome for themselves. In order to reach this equilibrium, players must consider the actions of others.

Considering the Prisoner’s Dilemma game theory, we can work out the Nash Equilibrium of the choices both prisoners make:

The best option for prisoner one, if prisoner 2 confesses, is to also confess because if they deny the crimes, prisoner one will receive a 9-year sentence.

The best option for prisoner one if prisoner 2 denies the crimes is to also deny to only have a 2-year sentence.

Thus, the Nash Equilibrium would be achieved if either both prisoners deny or they both confess.

However, as previously stated, one prisoner cannot be sure what the other is going to do, so the most optimal course of action is to confess to avoid the worst possible outcome.

Sometimes, there is one Nash Equilibrium in a game, but often there can be more than one, as evident from the Prisoner’s Dilemma.

In simultaneous games that are repeated over time, one of the multiple equilibria is reached after some trial and error.

The Nash Equilibrium can also be thought of as ‘no regrets’ in the sense that, once a decision is made, the player will have no regrets concerning their decision when considering the consequences. Equilibrium is usually reached over time and once found, it will not be deviated from.

One can consider how taking a different move would affect the situation, and if it does not make sense, then that means that one has found Nash Equilibrium.

What is game theory used for?

Game theory can be applied to many aspects of life outside of the dilemma games. Some examples of everyday life applications include:

Rock, paper, scissors game

War strategies and conflict analysis

Market shares and stockholders

Business strategy

When applying game theory to business, for instance, there are a number of strategic choices which govern their ability to achieve a desired payoff.

Business can :

Make decisions on price and output

Make decisions on products as to whether to keep existing products or develop new ones.

Make decisions on promoting products, such as whether to spend more on advertising, spend less, or keep things constant.

Derive a range of payoffs from their strategy choices, such as making profits, improved chances of survival, and getting rid of rivals.

How does game theory relate to psychology?

While game theory can be used and explored across a variety of fields, it can also be used in the context of human psychology.

By using methods such as eye trackers, electroencephalography ( EEG ), and galvanic skin response (GSR), researchers can understand the decision-making process within games.

A study used GSR within the Ultimatum game to investigate how emotions can impact decision-making (Hajcak et al., 2004). It is thought that GSR responses are associated with aversive stimuli.

The researchers found that less ‘rational’ behavior was associated with GSR responses. In the Ultimatum game, a rational response would be to always accept the offered money, as this is better than receiving no money.

Other researchers have looked at brain activity in participants taking part in the Prisoner’s Dilemma game (Babiloni et al., 2007).

Using EEG, an association was found between cortical activity in the anterior cingulate – an area associated with emotional control – and the likelihood of betrayal.

This is potentially one way that shows the processes controlling how humans make emotional decisions.

In a study by Harlé & Sanfey (2007), participants’ emotions were before taking part in the Ultimatum game by watching short movie clips. It was found that induced sadness (from sad movie clips) interacted with offer fairness in the game, with higher sadness resulting in lower acceptance of unfair offers.

This result demonstrates that even subtle incidental moods can play an important role in biased decision-making.

A further study used eye-tracking glasses to study the characteristics of visual perception in decision-making in the Prisoner’s Dilemma game (Peshkovskaya et al., 2017).

The total viewing time and the time of fixation on areas corresponding to non-cooperative decisions related to the participant’s levels of cooperation.

Namely, increased attention to non-cooperative choices was associated with such outcomes.

Babiloni, F., Astolfi, L., Cincotti, F., Mattia, D., Tocci, A., Tarantino, A., Marciani, M., Salinari, S., Gao, S., Colosimo, A. & Fallani, F. D. V. (2007, August). Cortical activity and connectivity of human brain during the prisoner’s dilemma: an EEG hyperscanning study. In 2007 29th Annual International Conference of the IEEE Engineering in Medicine and Biology Society  (pp. 4953-4956). IEEE.

Economics Online. (2020, January 20). Game Theory. https://www.economicsonline.co.uk/business_economics/prisoners_dilemma.html/

Farnsworth, B. (2018, August 21). Game Theory and Human Behavior [Introduction and Examples]. IMotions. https://imotions.com/blog/game-theory-introduction-examples/

Hajcak, G., McDonald, N., & Simons, R. F. (2004). Error-related psychophysiology and negative affect.  Brain and cognition, 56 (2), 189-197.

Harlé, K. M., & Sanfey, A. G. (2007). Incidental sadness biases social economic decisions in the Ultimatum Game.  Emotion, 7 (4), 876.

Peshkovskaya, A. G., Babkina, T. S., Myagkov, M. G., Kulikov, I. A., Ekshova, K. V., & Harriff, K. (2017). The socialization effect on decision making in the Prisoner’s Dilemma game: An eye-tracking study.  PloS one, 12 (4), e0175492.

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What game theory tells us about politics and society

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Alexander Wolitzky

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Alexander Wolitzky

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Alexander Wolitzky leans back in his office chair, pauses, and starts to describe “Cycles of Conflict: An Economic Model,” a journal article he co-authored.

“There’s a simple idea in that paper,” Wolitzky offers, describing its thesis: While conditions of mistrust can lead to political violence, they may also change as antagonists better understand their opponents, leading to an eventual reduction of hostilities.

Wolitzky’s work is a blend of streamlined concepts like this and complex social phenomena. A professor in MIT’s Department of Economics, he deploys game theory — the formal study of strategic decision-making — to illuminate observed behavior across a range of political and social institutions. Almost no topic is off limits: Wolitzky builds models concerning war and international affairs, labor relations, networks, technology adoption, and more.

“We have the view that economic institutions, the way governments are set up, norms, laws, are all very important for economic development, for growth,” Wolitzky says. “But they can be vague concepts: What do these things mean?” His work digs into the mechanisms underlying those concepts.

Take “Cycles of Conflict,” which appeared in the American Economic Review in 2014, co-authored with colleague Daron Acemoglu. As the paper notes, analysts have observed that misperception and distrust have led to violence and warfare in many geopolitical situations — Uganda, Kenya, Northern Ireland, the Balkans, and more. Indeed, as Acemoglu and Wolitzky point out, it was also the explanation Thucydides offered for the origins of the Peloponnesian War.

In any case, fears of inevitable conflict can lead to pre-emptive warfare. But how do such situations de-escalate? In an original contribution, the MIT authors model how a spiral of aggression unwinds — because one side or both will learn that the aggression was unnecessary, a dynamic observers have used to describe events in Colombia, among other once-troubled places.

These types of coherent models can play an important role in the intellectual ecosystem by organizing and illuminating messy sets of  empirical data. And Wolitzky is determined to model large-scale events, not just micro-level individual decisions.

“I think this department really values people who have some breadth and can talk to people across fields a little bit,” Wolitzky says. For his research and teaching, Wolitzky was recently awarded tenure.

New and relevant

Wolitzky grew up in Madison, New Jersey, and attended Harvard University as an undergraduate, writing a senior thesis about voter behavior.

“From relatively early on I was interested in [the] intersection of game theory and modeling institutions broadly,” Wolitzky says. In MIT he spied a place where he could continue that course of study, so he attended the Institute as a graduate student in economics, working with faculty members Glenn Ellison (his principal advisor), Acemoglu, and Muhamet Yildiz, among others.

Wolitzky zipped through the PhD program in four years. Being a graduate student at MIT only enhanced Wolitzky’s sense that he could try to range broadly across topics.  

“One thing I did pick up strongly from Glenn and Daron,” Wolitzky says, “is this sense that — well, a question students sometimes ask is, ‘Should I specialize in the technical aspects of a work, or on doing something conceptually new, or on applied work?’ But these aren’t either/or propositions. Successful research can do something new and also be relevant. That’s a vibe you have here that I think is true, and has definitely had an effect on me, as something I can aspire to.”

After graduating in 2012, Wolitzky joined the faculty at Stanford University as an assistant professor. He stayed in Palo Alto for two years before returning to MIT in 2014 as the Pentti J. K. Kouri Career Development Chair in economics. Wolitzky was promoted to associate professor in 2016 and granted tenure in the spring of 2018.

Cutting-edge tools: Pad and pen

Wolitzky says the “collegial” atmosphere in the MIT Department of Economics is very important for his work. But some of his key insights are due to quiet reflection.

“The moments when I get the main ideas for my papers are me sitting in my office with a pad of paper and a pen,” says Wolitzky. 

Sometimes, Wolitzky develops models that refer to one sphere of life, such as politics, and later realizes that parts of them apply to something else entirely. The “Cycles of Conflict” model fed into a new paper he has authored alone, “Learning from Others’ Outcomes,” forthcoming from the American Economic Review , which is about technology adoption.

“You write down some model to think about conflict, and you realize it’s related to these models used for other purposes, and you have to think about the connection,” Wolitzky says. In this case, the model describes how people will more readily adopt new technologies if they can tangibly observe productive outcomes stemming from them, but are less ready to adopt technologies that merely make the same amount of productivity cheaper.

“ They’re both models of dynamic social learning where you don’t fully understand why the other person is doing what they’re doing,” Wolitzky says.

Wolitzky also models and teaches network theory at MIT; a 2013 paper of his, “Cooperation with Network Monitoring,” published in the Review of Economic Studies , originiated in his PhD work. In it, Wolitzky examines the extent to which monitoring people in a network engenders cooperation, as well as the ways in which people central to the network have a contagious effect among others.

Wolitzky also teaches a relatively new course, 14.18 (Mathematical Economic Modeling), that gets undergraduates to learn the craft of modeling and to develop their own projects.

“It’s interesting to see the diversity of things students have ended up working on, as you might imagine,” Wolitzky says. “Different students work on models of strategic communication, or the economics of Bitcoin — it’s been all over the place.”

It sounds familiar. Indeed, encouraging students to pursue their own idiosyncratic projects strikes a chord with Wolitzky — after all, it’s what others have done for him at MIT too.

“The norms here get passed down from generation to generation,” he concludes.

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Policonomics

Game theory I: Strategic form

  • Game theory: a definition

Information:

  • Complete information
  • Common knowledge
  • Perfect information

Description of games:

  • Strategic form
  • Extensive form

In game theory , the strategic form (or normal form) is a way of describing a game using a matrix. The game is defined by exhibiting on each side of the matrix the different players (here players 1 and 2), each strategy or choice they can make (here strategies A and B) and sets of payoffs they will each receive for a given strategy (p 1A ,p 2A ; p 1A ,p 2B ; p 1B ,p 2A ; p 1B ,p 2B ).

Strategic form

The strategic form is usually the right description for simultaneous games , where both players choose simultaneously, as opposed to sequential games for which is better to describe the game using the extensive form (or tree form). It’s worth mentioning that simultaneous games imply there is complete and imperfect information , and the rules of the game as well as each player’s payoffs are common knowledge .

Prisoner's dilemma

Although is not very common, sequential games can also be described using the strategic form. Considering the following example: player 1 has to decide between going up or down (U/D), while player 2 has to decide between going left or right (L/R). In this case, we can represent this game using the strategic form by laying down all the possible strategies for player 2:

-go Right if player 1 goes Up, go Left otherwise;

-go Left if player 1 goes Up, go Right otherwise;

-go Right no matter what;

-go Left no matter what.

We can see how this game is described using the extensive form (game tree on the left) and using the strategic form (game matrix on the left). Since this is a sequential game, we must describe all possible outcomes depending on player 2 decisions, as seen in the game matrix. There is an perfect subgame Nash equilibrium (green) and a subgame imperfect Nash equilibrium (red).

Strategic form - Sequential game

Browse Course Material

Course info.

  • Alessandro Bonatti

Departments

  • Sloan School of Management

As Taught In

  • Business Ethics
  • Game Theory

Learning Resource Types

Game theory for strategic advantage, course meeting times.

Lectures: 2 sessions / week, 1.5 hours / session

Prerequisite

Game theory is applied in many other courses offered at Sloan. These applications are wide-ranging: Games played between competing firms in 15.013 (Industrial Economics); games played between firms and their suppliers and between managers and their employees in 15.903 (Managing the Modern Organization); not to mention applications in strategy, negotiations, international macroeconomics, corporate finance, etc.

A single course could not suffice to study even a fraction of these particular applications in any depth. While the course is designed to complement Sloan’s other economics and strategy offerings, it is self-contained. There are no prerequisites beyond the Core economics course 15.010 or equivalent: 15.010 / 15.011 Economic Analysis for Business Decisions , 15.015 Macro and International Economics , or 14.01 Principles of Microeconomics .

A game is a multi-person decision problem: Tic-tac-toe and chess are games, but game-playing is also serious business. Managers frequently play games both within their firm (with other divisions and subordinates) as well as outside (with competitors, customers, and even capital markets). In turn, politicians, lobbyists, and other stakeholders play games with firms (e.g., when designing auctions or regulations).

The goal of this course is to enhance your ability to think strategically in such complex, interactive environments. In particular, the course emphasizes four themes for acquiring advantage in games:

  • Identifying Structures: Being able to identify the key elements of the situation is critical for strategic thinking.
  • Selecting Strategic Moves: Changing the game being played to your advantage through credible commitments, threats, and promises.
  • Exploiting Hidden Information: When to reveal information or not, and how to handle uncertainty about others’ information.
  • Recognizing the Limits of Rationality: How to play when others may not be fully rational, and when others may be uncertain about your rationality.

My view is that the important ideas of game theory are best mastered not at the level of some abstract theory but in the context of real examples. For this reason, we will discuss numerous real-world examples and analyze games that arise frequently in business settings.

To deepen your thinking in a concrete setting, a crucial element of the course is a team project in which students will identify a real-world game of interest, analyze it using the tools of the course, and offer concrete strategic advice to some player in the game.

My goal is to teach game theory, not mathematics. That being said, examples and cases alone do not suffice to get a deeper appreciation and understanding of the material, so some general parts of game theory will be introduced as well. You will discover a fascinating paradox: The more transparent the mathematics, the more interesting and challenging the issues that can arise.

To complement the formal analysis, we will use an interactive approach that includes in-class live games , discussion of take-home games , as well as two problem sets.

Course Plan

The course will move from the abstract towards the concrete. In the first part of the course (Classes 1–11), we will cover the foundations and a wide spectrum of applications of game theory. In the second part (Classes 12–22) we will put the foundations to work in three multi-week, advanced applied segments. The advanced applications will be:

Classes 12–14: Long-run Relationships

Classes 15–18: Auctions and Market Design

Classes 19–21: Communication, Credibility, and Reputation

Exemplary team projects will be presented and discussed in the final week (Classes 22–24).

There is no required textbook for the course. Required and supplementary readings are listed in the Readings section. For further reading, the following text is a good source (note that earlier editions would work fine):

Dixit, Avinash, Susan Skeath, and David Reiley. Games of Strategy . 3rd ed. W. W. Norton & Company, 2009. ISBN: 9780393931129.

In addition, we will assign a number of Harvard (and other) cases.

Assignments and Grading

Grading will depend on class participation, two problem sets, and a team project. Class participation will include games played during class, games to be prepared ahead of class, as well as class attendance and the standard forms of useful participation.

These components of the course will receive the following weights:

Class Participation

The class participation grade is equally determined by the following factors.

In-class Games : In several lectures, we will play a game in class that will need everyone’s participation. It will be important for your own learning and your classmates’ that you attend and participate.

Before-class Games : A few games require preparation before class. This will involve completing and submitting a 1–2 page worksheet, or a web form, taking no more than 20 minutes per game. Full participation credit will be given for a thoughtful effort.

Team Project

Your team must provide strategic advice to a player of a “real-world” game. (You need not gather actual data. It suffices to consider a hypothetical scenario that could be real.) Team project deliverables include an initial proposal and final project with an appendix. See the Assignments section for additional details.

Timeline : The team project has the following parts: (i) team formation by Session 5, (ii) project proposal by Session 10, (iii) project progress report by Session 21, and (iv) final project on Session 23. A progress report (which is not graded) is due in Session 21 because some projects will be selected for in-class presentations during Sessions 22 and 23.

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The Booming Business of Cutting Babies’ Tongues

One family’s story of “tongue-tie release” surgery on their newborn..

This transcript was created using speech recognition software. While it has been reviewed by human transcribers, it may contain errors. Please review the episode audio before quoting from this transcript and email [email protected] with any questions.

From “The New York Times,” I’m Sabrina Tavernise, and this is “The Daily.”

A “Times” investigation has found that doctors are increasingly performing unnecessary medical procedures that generate huge profits while often harming patients.

Today, my colleague Katie Thomas — on the forces driving this emerging and troubling trend in American health care and the story of one family caught in the middle of it. It’s Monday, February 19.

So Katie, tell me about this investigation.

So I am a health care reporter who writes about the kind of intersection of health care and money. And I was working with two other colleagues, Sarah Kliff and Jessica Silver-Greenberg. And together, the three of us had long been interested in, are the medical procedures and the tests and other things that we get when we go to the doctor or into a hospital — are they always necessary?

But what we were really interested in exploring was not just are these procedures and are these tests, et cetera — are they necessary, but in some situations, could they actually be harmful to patients? And so that’s what we decided to try and take a look at. And so we had gotten started in our reporting when we got a tip. And it was from a mom in Boise, Idaho. And her name was Lauren Lavelle.

Nice to meet you.

Hi, how are you?

And my colleague Jessica Silver-Greenberg and I went to her house to meet with her.

And where does her story start?

I am a mom of two. I live in Boise. My daughter, June, is four, and I have a 17-month-old, Flora.

Her story starts when Lauren gets pregnant with her daughter, June.

So by the time we got pregnant with June, November of 2018, about eight months after we had the miscarriage, I think I was just more hesitant and nervous than anything.

Lauren and her husband had trouble conceiving, and so they were so happy when they learned that they were going to have June. And like most first-time parents, they were also a little bit nervous.

But being type-A and super prepared, I did all my homework. We hired a doula. I wanted an epidural. Having a natural childbirth absolutely was not for me.

And Lauren is very organized. She’s always on top of everything, and she makes all sorts of plans. And she gets a lot of different providers lined up ahead of time —

I didn’t know anything about breastfeeding, like zero things.

— including one that she has hired to help her with breastfeeding.

Where did you find out about her?

So I asked our doula for a list of recommendations, and she gave me a very short list. At the time, there were very few lactation consultants in the Valley. And Melanie was one of them.

She ended up deciding to work with Melanie Henstrom, who was a local lactation consultant in Boise.

She sold this package at the time. I don’t know if she still did, but it was like prenatal visit breastfeeding class. And then, she’ll come to the hospital and help you latch, and then she’ll come to the house a couple of times after. And I thought, well, this sounds perfect. Great. You know, I’m covered there.

So one week after her due date, she gives birth. And it was a difficult labor. It took 24 hours. Lauren was completely exhausted. But once June arrived, the family was very, very excited to have her.

And I remember June coming out and that surreal feeling have when you see your first baby for the first time, like oh, my God, there’s a baby in the room.

And June was a healthy baby, but she was having trouble breastfeeding.

She would not latch. Like, she wouldn’t even attempt. She would scream. It was the only time she ever cried — if you tried to make her to breastfeed.

And so as her pediatrician was making the rounds, they noticed that June was having trouble and said that June’s tongue is really tight.

We can clip it if you’d like.

And that they could clip it.

What does that mean exactly, Katie — clipping her tongue?

What it means is that there’s a small percentage of babies whose tongue is very tightly tethered to the bottom of their mouth. And for a very small percentage of babies, their tongue is almost tied so tightly down that they can’t nurse well.

So it makes breastfeeding very difficult if a baby has a tongue like this.

Exactly. If you bottle-feed your baby, the baby can basically adjust and make do. But if you want to breastfeed, some babies have trouble, basically, latching on to their mother when they don’t have that tongue motion. And so some version of clipping these tongue ties has been done for centuries. Midwives have been doing it. Pediatricians do it.

And traditionally, what it’s been is a very quick snip right underneath the tongue just to loosen up the tongue. And traditionally, that procedure is extremely straightforward. There’s little to no follow-up care. And basically, the baby naturally heals as it learns to breastfeed.

And so we said, OK. They explained that it was completely painless. They’d do it with scissors. She wouldn’t even feel it. And all of that was true. They clipped it. I don’t even think she woke up.

But in June’s case, it didn’t seem to help much, and she and Lauren were still having problems breastfeeding afterwards. So while she’s still in the hospital, she calls up the lactation consultant that she had hired — Melanie Henstrom — just to let her know what was going on. And from talking to her on the phone, Melanie said that the situation was actually much worse than Lauren had thought and that Lauren’s baby needed another tongue-tie procedure — a deeper cut under the tongue.

How did she make this diagnosis, Katie? Was it over the phone? How did she know this?

Yes, Lauren told us that it was from a phone conversation. And in addition to that, she also warned her that, basically, Lauren and her husband should really take this seriously and consider getting it done, because if she doesn’t get it fixed, it could lead to a whole host of problems beyond just problems breastfeeding.

She’ll have scoliosis, and she’ll suffer from migraines, and she’ll never eat, and she’ll have a speech impediment, and she won’t sleep — I mean, just, like, the long list of things over the phone.

And Lauren starts panicking.

I mean, first of all, I felt — I’ve never felt more terrible in my life than that first day or so after giving birth. Like, the comedown from the hormones, the drugs — all of it — the sleep deprivation. And then, here was this baby we’d wanted, we were told we probably would never have after one miscarriage. And she’s so perfect, like, the most beautiful baby I’d ever seen. And you think that she has some deformity that’s going to ruin her.

But Melanie says it’s OK. She has a solution. And she tells Lauren that there’s a dentist in town who can handle cases that are as severe as June’s.

A dentist? Why a dentist?

Well, there’s a procedure that’s done in a dentist’s office that’s a laser surgery. And dentists use this high-powered laser machine that can quickly cut the flesh that connects the lips and the cheeks to the gums. So according to Lauren, Melanie tells her that by chance, this dentist has an opening, because she said a family coming in from Oregon had just canceled their Saturday appointment.

So I thought, OK, wow, people are coming in from Oregon to see him. So we talked about it. We both felt unsure. But we said, well, let’s at least take the appointment, and then we can at least meet with the dentist, and also, someone can look at her mouth and assess.

And so Lauren agrees to go in and meet the dentist.

Like, I think some people, when they hear this story, think, like, why would you believe that? It just sounds so scammy. But to me, there is a lot of things that you hear in the hospital that sound insane. Like, it’s no different than someone saying, like, your baby’s orange because their bilirubin levels are too high, so we got to go put them under these lights. Like, that sounds insane. That sounds more insane than, your baby’s having a hard time eating because their tongue is too tight and it needs to be cut. Like, that seems rational, actually.

And all of this seemed really weird to Lauren at the time. But in the context of the hospital and having a baby, lots of things about health care are weird.

So one day after they got back home from the hospital, Lauren and her husband pack up the car and go to the office early in the morning.

You know, I was wearing my hospital diaper and an ice pack, took the elevator up to his office, and —

And what happens?

So Melanie greets them at the door. They sign some paperwork, and pretty soon, the dentist, Dr. Samuel Zink, arrives.

And then, he, like, very briefly — very briefly — looks in her mouth and is like, yeah, she’s got whatever — however he classified it — grade 4 or whatever he says — class 4 — and she has a lip tie, which — that had never been mentioned to us before, so it’s very much on the spot, this new piece of information.

You know, pretty quickly, the dentist diagnosed June as having a couple of ties. He confirmed that she had a tongue tie, and he said it was severe. He also said that she had tightness under her top lip, called a lip tie. And so the baby actually needed to get two cuts. And again, Lauren said that the dentist and the consultant told her how important it was for her to do this for her baby.

One of us says, like, what happens if we don’t do the procedure? , Like what are our alternatives? And it was basically like, there’s no alternative. Like, you have to do this. Otherwise, again, long —

So Lauren and her husband decided to do it. But before the procedure starts, Melanie actually stopped Lauren from coming into the room.

Melanie turned around and put a hand on my shoulder and said, oh, no. And I said, oh, am I not going with you? She goes, well, we can’t tell you no, but if you hear her cry, it’ll impact your milk supply, like, adversely.

What do I know? So I said, oh, OK. And she pulled out the white-noise machine and said, what do you want to listen to? And I had no idea what she was talking about. I had no idea what it was. And so then she just turned it on — white noise — and left.

What happens next is, Melanie turns on a white-noise machine in the room.

And that was the moment that I was like, get your baby and get out of here. And I didn’t listen to it. It was like all of my mom intuition firing, being like this isn’t right, you know. It’s like, I don’t know how to describe it, but your full body — you have to get your baby and get out of here. And I just ignored it.

She said her maternal instincts really kicked in, and she just had this instinctive fear about the procedure and whether June would be OK. But the procedure itself was very quick. Within just a couple of minutes, Melanie returns with June.

And she was screaming. Like, screaming, and so worked up. This was, like, hysterical, inconsolable. And she was also choking on something, like, gagging.

And June was so worked up. Lauren had only had her for a couple of days, but she said that this was on a different level than any other way she had ever seen June crying. And June just wouldn’t stop crying.

And she looked over to Melanie, and Lauren said that she remembered Melanie saying this was very typical. And so they pay the dentist. They pay $600 for the procedure, and then they go home.

Over the next several days, June did not get better as Melanie had assured them. You know, she was basically inconsolable, Lauren said — just crying hysterically. And Lauren and her husband — they don’t know how to comfort her. They’re new parents. They’ve only had a baby a couple of days. And they’re almost beside themselves.

There was nothing we could do. And I remember finally, I said, like, this is not normal. We’re going to an emergency room.

And they decided to go to the emergency room, where a doctor looks inside June’s mouth and finds a large sore in her mouth that he says is probably causing her so much pain.

And so he said, you know, it breaks my heart to see a sore that big in a baby this small. It was like the floodgates opened, and there was nothing but guilt and shame. Like, unmanageable guilt and shame.

Like, what have we done? Who are these people? What have I done to my baby? Will she ever be the same? Like, what did I do?

So at this point, Lauren is really understanding that her intuition about this surgery was probably right and that she and her husband may have really made a mistake with this. What does June’s recovery look like?

So June never did end up breastfeeding successfully, which was the main reason why Lauren and her husband had decided to do this procedure.

That was the whole point, right?

That was the whole point. Right. And over the next couple of years, June had a number of issues that there’s no official medical diagnosis for, but Lauren has attributed a lot of her behaviors to what had happened to her when she was just a few days old.

I mean, you couldn’t close a fridge door too loud, or else it would set her off. Or, we would attempt to take her for a stroller walk on the Greenbelt, which is the walking path, and she’d be asleep in her car seat, you know, stroller, and someone would try to pass us on their bike and ring their bell, and it would startle her, and it would just set her off. So she just was very, very, very fragile.

So Lauren just wanted to get answers, and she really wanted to hold Melanie and the dentist accountable. So she gathered all of the paperwork that she had — texts, emails, other correspondence — and she went to the Idaho Board of Dentistry, where she filed a complaint against the dentist. And then, she also went to a professional organization that certifies lactation consultants and filed a complaint with them as well.

And did she get anywhere with either of them?

At first, no. The Idaho dentistry board didn’t want to investigate, and Lauren appealed, and she lost her appeal. And she didn’t initially hear back at all from the lactation board.

No one wanted to take responsibility. That’s the thing. No one wanted to stick their neck out there. What’s the alternative? The story never gets told?

And that’s when she decided to reach out to us. And after our story came out, the lactation board finally told Lauren that they were investigating Melanie.

And Katie, you guys were reporting the story. I’m assuming you reached out to both the dentist and to Melanie. What did they say?

Beyond a very brief phone conversation that I had with Melanie in which she defended her work and she said that she had a number of very satisfied customers, she didn’t respond to detailed questions about Lauren’s story or the stories of her former clients. And Dr. Zink did not respond to our requests for comment, but he did tell the dentistry board that Lauren’s baby’s procedure was uneventful and that an extremely small percentage of patients do not respond well to the procedure.

And how big of an issue is this, Katie? I mean, how common is it for mothers to have an experience like Lauren’s?

So after we got the tip from Lauren and we dug deeper into her story, we found ourselves really surprised by how big this industry was for tongue-tie releases. And in part, it’s been driven by this movement for breastfeeding and the Breast is Best campaign and a growing number of parents who are choosing to breastfeed their children.

In turn, that has sparked this big boom in tongue-tie releases. One study that we found showed that these procedures have grown 800 percent in recent years.

Yeah. And also, as we started talking to other parents around the country, we learned that some of them had similar stories to what Lauren had told us. There’s plenty of instances where there’s no harm done to the baby at all when they get these procedures.

But we also found cases where babies were harmed, you know, where they developed oral aversions, which basically means that they don’t want to eat because they fear having anything put in their mouth, including a bottle. We found cases where babies became malnourished, had to be hospitalized. We found more than one instance in which babies had to be given a feeding tube just weeks after the procedure.

So these sounds so painful and awful for a newborn — these problems. But I guess there’s always a risk, Katie, in any medical procedure, right? I mean, how much of this is just the risk you sign up for when you agree that your baby should have a surgery?

Well, that’s true. I mean, there’s always a risk. But what you’re supposed to do is weigh the risks against what the potential benefits of a procedure are. And when we really started drilling down into what those benefits were and into the medical research, we found there just wasn’t a lot of potential benefit for these procedures, if at all, in many cases.

Really? So the procedures don’t have a medical reason to exist?

That’s right. We reviewed all of the best-quality medical research on this. And other than that old-fashioned snip under the tongue, which does show that in some cases, it can reduce pain for breastfeeding mothers, but otherwise, all of this growth and all of these other more invasive procedures — we found there just wasn’t good evidence that they helped babies. And the more we looked into tongue ties and started to connect it to the other reporting we were doing, we started to realize that it was driven by some really big forces in our health care system that really had the potential to harm patients.

We’ll be right back.

So Katie, we talked about this new surge in a procedure that surgically unties infants’ tongues from the bottom of their mouths, often needlessly, sometimes even harmfully. And you said your reporting found that this surgery was actually part of a broader trend. Tell me about this trend and what’s driving it.

So that’s what this investigation was really about — to find the procedures that are doing unnecessary harm to patients and to really understand why this is happening. You know, like, what’s driving the prevalence of these procedures? And there’s just a lot of unnecessary surgeries out there, but we decided to center our reporting on three particular surgeries that had the potential to harm patients, in addition to tongue ties. We focused on a particular hernia surgery, a bariatric surgery, which can be overdone and cause harm, and a vascular surgery done on patients’ legs to help us understand the forces that were at work that were driving all of this.

And what did you find when you dug deeper into those surgeries?

Well, it’s very complex, but we ultimately found three main drivers that were underlying all of these. First, there’s a financial incentive for the doctors to perform these surgeries. There’s also a real push from the medical device companies that make these surgeries possible. And last, there’s a huge information void for solid medical advice that a lot of these doctors and companies take advantage of in order to push the surgeries.

OK, so let’s start with the money, Katie. How exactly is that incentivizing doctors to perform a lot more of these procedures? Like, what are the mechanics of that?

So the reality of our health care industry today is that in many places, even in places like non-profit hospitals, the doctors who work there are not getting a salary, a straight salary that’s just kind of, you get paid for showing up to work that day. Instead, they’re actually getting paid based on the procedures that they’re doing, how complex those procedures are, or possibly how lucrative.

And it’s not every doctor. There are still doctors that get paid salaries. But it’s increasingly the case that doctors have — at least a part of their pay is tied to the procedures that they’re doing.

Interesting. So the procedure is growing in importance in terms of actual compensation for doctors.

Right. I mean, in part, it’s kind of baked into the health care system that we’ve always had. You can even think about it as the small-town doctor who operated his own independent practice or her own independent practice. It’s essentially a small business, and they would get paid based on the patients that they saw.

But increasingly, even in, for example, large hospital systems where you might think that a doctor is just getting paid a salary to work in a hospital, in fact, a chunk of their bonus, for example, can sometimes be tied to the procedures that they’re doing, and that is increasingly the case.

Interesting.

And so one particularly egregious example of this was at a hospital that’s in New York — Bellevue Hospital. And basically, what my colleagues found there was that they had basically turned their surgery department into an assembly line for bariatric surgery, which makes your stomach smaller and can lead to weight loss. But what we found was that they were greenlighting patients that, basically, didn’t meet the qualifications for the surgery, which is a serious surgery. And what they found was that there were several situations where people had very serious outcomes as a result of getting the bariatric surgery there.

OK, so this is an extreme case of a hospital turning to a particular surgery to drive profits. And it wasn’t uncommon in your reporting, it sounds like.

No, it wasn’t the only example, but it was the most striking. And when we reached out to Bellevue, they defended their work, and they said that their practices were helping patients who wouldn’t otherwise get care. But our reporting was pretty conclusive that the program was churning through a record number of surgeries.

So what else was driving this increase in harmful surgeries that you guys found?

So we found it wasn’t just the hospitals who were benefiting. The other major player that benefits are these companies that are making the tools and the products that doctors are using during the procedures. And in order for them to sell more of their products, a lot of time, what they end up doing is promoting the procedures themselves.

So like medical device makers, like the company that made the laser in June’s surgery.

Right. And they do this in a number of ways. They’re giving them loans to help them buy the equipment, and in some cases, they’re even lending them money to help set up those clinics where the procedures are performed.

So they’re really underwriting these doctors so that they can perform more surgeries and, ultimately, sell more machines.

Yes. And the other things that they do is — the laser companies, for example — they will host webinars where they will have dentists who frequently perform these procedures show other dentists how to do the procedures. We even discovered this conference that was created by one of the laser companies, and it had kind of a wild name. The name of the conference was Tongue Ties and Tequilas.

(CHUCKLING) Right. It brought in dentists to talk about how to make money off the procedures. You know, how to promote themselves on social media, how to actually perform the procedures, and of course, when they were all done, they got to celebrate with an open tequila bar.

OK, so a lot of this really amounts to these companies trying to popularize these procedures, basically, like, to get the word out, even if the procedures don’t really work or, in some cases, cause harm.

Right. But they also play a big role in the other factor that’s driving a lot of this, which is the information that they put out there about the surgeries. These companies often sponsor research, which doctors often rely on to guide their practices. And part of what we’ve found is that it can create this echo chamber where doctors feel more comfortable and justified in doing these procedures when they have this whole alternate universe that is telling them that it’s OK to do these procedures, and in fact, it’s beneficial to patients.

So tell me about this echo-chamber effect.

The best example of this we found was a doctor in Michigan named Dr. Jihad Mustapha. He calls himself “the Leg Saver.” And what we found was that he and several other doctors do these procedures called atherectomies, which is basically like inserting a tiny roto-rooter inside an artery to get the blood flowing.

And Dr. Mustapha in particular was not only a very prolific performer of these procedures, but he actually founded his own medical conference, and he even helped start a medical journal that was devoted to using these procedures. And you know, tongue ties — there’s really no good evidence that these are actually beneficial to patients. And in fact, despite his nickname as “the Leg Saver,” one insurance company told Michigan authorities that 45 people had lost their limbs after getting treated at Dr. Mustapha’s clinic over a four-year period.

45 people lost their limbs?

I mean, that is the ultimate version of harm, right?

Right. Now, he did speak to us, and he defended his work and said that he treats very sick people. And despite his best efforts, some of these patients are already so sick that they sometimes lose their limbs.

And how much did he receive for each procedure?

Doctors like him typically receive about $13,000 for each of these atherectomy procedures.

But we found that misinformation, or poor information, also applied when doctors were learning new types of surgeries.

Really? Like how?

So one of the areas we looked at was the area of hernia surgery that I mentioned. And there’s a particular type of surgery. It’s a very complex version of a hernia surgery, called component separation. And the expert surgeons that we spoke to said that it’s difficult to learn, and you have to practice it over and over and over again to get it right. But one recent survey of hernia surgeons said that one out of the four surgeons had taught themselves how to perform that operation.

Yeah, not by learning it from an experienced surgeon but by watching videos on Facebook and YouTube.

I mean, how unusual is that? I guess, to me, it strikes me as very unusual. I mean, I think of learning about how to take my kitchen faucet apart on YouTube, but I do not think of a doctor learning about how to perform a surgery on YouTube.

Right. And it has actually become increasingly popular in recent years, and there’s not good vetting of the quality of the instruction. We even found videos on a website run by a medical device company that was intended to be a how-to for how to do these surgeries, but the video contained serious mistakes.

Wow. And Katie, all of these videos — some of them with serious mistakes — I mean, is this something that would be subject to medical regulators? Like, is there any kind of rules of the road for this stuff?

You know, there’s less than you would expect. Sometimes hospitals have rules about what sort of education their doctors need before performing a surgery. But we were surprised that there was a lot less regulation than we thought there would be and much less vetting of these videos than we anticipated.

So essentially, what you found was this complex, oftentimes interconnected, group of forces — device companies pushing their products, hospitals bolstering their bottom line, and rampant misinformation that, as you said, all really trace back to the same motivating factor, which is money. But wouldn’t the fear of being sued for medical malpractice prevent a lot of this behavior?

You know, this kept popping up during the course of our reporting. I do think we have this idea that any time a doctor does anything wrong, they’re going to get sued. But it just wasn’t always the case in our reporting. There’s a lot of statutes of limitations, time limits on when somebody can file a lawsuit, and other ways that make it somewhat hard to really hold a doctor accountable.

One example is the regulatory organizations that oversee doctors. The one doctor that I mentioned earlier — Dr. Mustapha — state investigators had found that his overuse of procedures had led people to lose their legs. And yet, he ultimately settled with the state, and he was fined $25,000. That actually adds up to about two of these atherectomy procedures.

So it sounds like malpractice is not necessarily going to be the route to rectifying a lot of this. But I guess I’m wondering if the federal government could actually rein some of this in before the patients are harmed.

It’s possible. But this is just a very difficult issue. Some of the themes that we explored in this reporting are really just firmly embedded in our health care system in the way that it works. The fact is that we have a for-profit health care system, right? So everyone, from doctors to hospitals to the device companies, benefit when more procedures are done. All of the incentives are pointing in the same direction.

And so trying to find one or two simple solutions will probably not easily fix the issue, as much as we all hope that it could.

So is the lesson here, be much more discriminating and vigilant as a patient? I mean, to get a second opinion when you’re standing in front of a doctor — or a dentist — who’s telling you that you or your baby needs a procedure?

Yes. I think that is one of the takeaways. But look, we understood that even reporting on all of this was risky, because people could hear about these harmful surgeries and start wondering if everything that their doctors tells them is a scam. And of course, while some of these procedures are harmful, a lot of procedures are lifesaving. But ultimately, for now, patients are kind of left on their own to navigate what’s a pretty complex and opaque health care system. When you have somebody standing in front of you saying, you should do this, it can be very confusing.

And this is something that Lauren talked a lot about — just how confusing all of this was for her.

There’s a lot of information that you’re getting that is truly like someone is speaking a foreign language. And because they do it all day long, it’s not user-friendly. Like, it isn’t designed for the comfort or understanding of the person receiving the information.

There is so much blind trust and faith that you have in the system, in the providers who are giving you this information. You trust, like, this is what they do all day long. So there is no real reason to question. That is the system that we have in this country.

Katie, thank you.

Here’s what else you should know today. On Friday, the Russian authorities announced that opposition leader Alexei Navalny died in prison. He was 47.

Navalny, a charismatic anti-corruption activist, led the opposition to Vladimir Putin for more than a decade. His popularity was broad, extending far outside the realm of liberal Moscow. And that proved threatening to the Russian authorities, who attempted to poison him in 2020.

Navalny survived and later extracted a confession from his would-be assassin on tape. Navalny believed that Russia could be a free society, and he had the extraordinary ability, through sheer force of his personality, charisma, and confidence, to get others to believe it, too. Though he had been in prison since 2021, his death still came as a shock.

[SPEAKING RUSSIAN]

His wife, Yulia Navalnaya, made a surprise appearance at a security conference in Munich shortly after the Russian authorities announced her husband’s death.

She received an emotional standing ovation.

In Moscow, my colleague, Valerie Hopkins, spoke to Russians who were placing flowers in his honor —

— and expressing disbelief that he was gone.

Then I asked them if they believe in the beautiful Russia of the future that Navalny talked about. And they said, yes, but we don’t think we will survive to see it.

At least 400 people have been detained since his death, including a priest who had been scheduled to hold a memorial service in Saint Petersburg.

Today’s episode was produced by Asthaa Chaturvedi, Diana Nguyen, Will Reid, and Alex Stern, with help from Michael Simon Johnson. It was edited by Michael Benoist, with help from Brendan Klinkenberg, contains original music by Diane Wong and Dan Powell, and was engineered by Alyssa Moxley. Our theme music is by Jim Brunberg and Ben Landsverk of Wonderly.

That’s it for “The Daily.” I’m Sabrina Tavernise. See you tomorrow.

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  • February 21, 2024   •   23:33 What Happens if America Turns Its Back on Its Allies in Europe
  • February 20, 2024   •   40:44 Stranded in Rafah as an Israeli Invasion Looms
  • February 19, 2024   •   35:50 The Booming Business of Cutting Babies’ Tongues
  • February 16, 2024   •   39:24 An Explosive Hearing in Trump’s Georgia Election Case
  • February 15, 2024   •   29:38 How China Broke One Man’s Dreams
  • February 14, 2024   •   33:06 The Biden Problem Democrats Can No Longer Ignore
  • February 13, 2024   •   27:23 Why the Race to Replace George Santos Is So Close
  • February 12, 2024   •   21:57 Why Boeing’s Top Airplanes Keep Failing
  • February 11, 2024   •   42:04 The Sunday Read: ‘The Unthinkable Mental Health Crisis That Shook a New England College’
  • February 9, 2024   •   34:05 Kick Trump Off the Ballot? Even Liberal Justices Are Skeptical.
  • February 8, 2024   •   36:53 A Guilty Verdict for a Mass Shooter’s Mother
  • February 7, 2024   •   29:15 El Salvador Decimated Gangs. But at What Cost?

Hosted by Sabrina Tavernise

Featuring Katie Thomas

Produced by Asthaa Chaturvedi ,  Diana Nguyen ,  Will Reid and Alex Stern

With Michael Simon Johnson

Edited by Michael Benoist and Brendan Klinkenberg

Original music by Diane Wong and Dan Powell

Engineered by Alyssa Moxley

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A Times investigation has found that dentists and lactation consultants around the country are pushing “tongue-tie releases” on new mothers struggling to breastfeed, generating huge profits while often harming patients.

Katie Thomas, an investigative health care reporter at The Times, discusses the forces driving this emerging trend in American health care and the story of one family in the middle of it.

On today’s episode

strategic plan game theory

Katie Thomas , an investigative health care reporter at The New York Times.

A woman holding a toddler sits on a bed. The bed has white sheets and pink pillows.

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Inside the booming business of cutting babies’ tongues .

What parents should know about tongue-tie releases .

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The Daily is made by Rachel Quester, Lynsea Garrison, Clare Toeniskoetter, Paige Cowett, Michael Simon Johnson, Brad Fisher, Chris Wood, Jessica Cheung, Stella Tan, Alexandra Leigh Young, Lisa Chow, Eric Krupke, Marc Georges, Luke Vander Ploeg, M.J. Davis Lin, Dan Powell, Sydney Harper, Mike Benoist, Liz O. Baylen, Asthaa Chaturvedi, Rachelle Bonja, Diana Nguyen, Marion Lozano, Corey Schreppel, Rob Szypko, Elisheba Ittoop, Mooj Zadie, Patricia Willens, Rowan Niemisto, Jody Becker, Rikki Novetsky, John Ketchum, Nina Feldman, Will Reid, Carlos Prieto, Ben Calhoun, Susan Lee, Lexie Diao, Mary Wilson, Alex Stern, Dan Farrell, Sophia Lanman, Shannon Lin, Diane Wong, Devon Taylor, Alyssa Moxley, Summer Thomad, Olivia Natt, Daniel Ramirez and Brendan Klinkenberg.

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Katie Thomas is an investigative health care reporter at The Times. More about Katie Thomas

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East, West, Centre: The bold plan to expand the game

East, West, Centre: The bold plan to expand the game

Brad Walter

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The NRL's historic season opening double-header at Allegiant Stadium may be just the beginning of a bold expansion plan that could also see NRLW and Super League played in the US.

With the game boasting unprecedented financial strength after generating a record $701m revenue and $58m profit in 2023 , ARLC chairman Peter V’landys and NRL CEO Andrew Abdo declared their ambition for further growth.

“Where do we go in the future,” Abdo told reporters after the ARLC AGM. “It’s really simple – West, East and in the Centre.”

West is America, where the NRL will become the first Australian sporting competition to play a premiership match when South Sydney meet Manly and Sydney Roosters taken on Brisbane at Allegiant Stadium on March 3 (AEST).

The NRL will open the season at Allegiant Stadium

East is the Pacific, where the NRL is investing at both the elite level with the end-of-season Pacific Cup and in grassroots through development programs.

Why wouldn't you take a women's game to America Peter V'landys

The Centre is the game’s traditional base, which the NRL is planning to expand in coming seasons with the introduction of new teams while investing $420m in grassroots over the next five years.

“There's been a lot of talk about the West, and this is the most exciting, we've seen our fan base in the start of any season,” Abdo said.

“The move to America and the move to taking an existing product to the world's biggest sports market is very strategic. It's very deliberate and it's all about revenues.

“The move East is about the bottom of the pyramid. We have a unique opportunity to make rugby league the sport and a language of the Pacific, literally to change people's lives; to create employment, to use rugby league as a tool to get better educational outcomes and better social outcomes.

“And, of course, to increase our fan base and to give rugby league content, which we know is very popular in that region, an opportunity to really grow and develop talent.

Macdonald's special homecoming

“The Pacific strategy and the US strategy are exciting expansion opportunities [but] they are very different.

"Then in the Centre, the Commission will not take their eye off the ball on the opportunities with us right here, right now – expansion of the men’s competition, expansion of the women’s competition, re-thinking and revitalising how we invest into grass roots.”

NRLW in Vegas

While the NRL is committed to taking two Telstra Premiership matches to Las Vegas for the next five seasons, V’landys said he was already looking at other opportunities for the code.

The Rock and Mailata chat NRL

Sydney Roosters supremo Nick Politis has suggested playing an NRLW match in the United States, as well as the NRL matches, and V’landys said Super League teams may also be invited in the future.

“Nick said ‘you’ve got a unique situation with the women’s game. Why wouldn't you take a women's game to America’,” V’landys said.

“That would take our game to another to another level, especially considering how good they are.

“The other one that we're going to look at is Super League itself, because our research has shown that the biggest travellers are English.

“To take a Super League game there, as well, would generate a lot more people coming from England to the US.”

Biggest ever TV audience

A visit to media giants Amazon and Facebook when V’landys and Abdo were looking to negotiate the most recent broadcast deal convinced that the best way to grow revenue was to increase the NRL’s fan-base beyond Australia.

Another trip to the US, as a guest of president Joe Biden, left V’landys believing that the game was missing out on potential revenue from the Watch NRL app.  

A video narrated by Russell Crowe that explains the rules of rugby league to NFL fans and a deal to broadcast the season opening double-header to a potential 70 million US audience on Fox 1 are first steps.

March 2nd in Las Vegas NRL National Rugby League 2 games Live Allegiant Stadium https://t.co/OYekTsA00H — Russell Crowe (@russellcrowe) February 20, 2024

“You’ve got to have a long-term vision and that's why we said five years,” V’landys said.

“An important element of that vision, however, is the support of our partner, Fox, because we need to be on Fox 1 in America, and for the first time ever, through the great support of Lachlan Murdoch, we are on Fox 1 for both games.

“I think they've taken off some American sport to put us on, so that's how important it is to them.

“It's the biggest audience that we're ever going to show our game to, but it can't stop there. We need to be on Fox 1 every week in order to be able to promote it and we're working very hard with Fox in America to be able to achieve that.

"Another person I want to thank significantly is Russell Crowe. He's done one of the best promotional videos in explaining our game, and last night he tweeted it out.

"He's got 2.9 million followers, and through the NRL app and through NRL.com, it's now had a million views."

Best kept secret in America

It is also hoped that more overseas fans will subscribe to Watch NRL, where they can watch every match as well as league shows broadcast on Fox Sports, while the NRL is seeking to take advantage of the thriving US sports wagering market.

Graham and Woods appear on Fox in Las Vegas

“When I was over at the White House, a senior business figure in New York, who was an Australian that was looking after $600 billion in assets, wanted to meet with me because, he said, I had saved him,” V’landys said.

“I said, ‘what do you mean I saved you?’ He said that during COVID, when they were contained in their homes, it was Watch NRL that saved him, because of his mental situation, by being able to watch NRL games.

“He said ‘it's the best kept secret in America because no-one knows about Watch NRL. There's only 3000 subscriptions in America on Watch NRL but there’s hundreds of thousands of Australians in America that we can market Watch NRL to.

“Even if we just got a small percentage of them, that's $25 million extra revenue, but we're aiming much higher than that, naturally.”

Ready-made UK market

V’landys said that there were only a similar number of Watch NRL subscribers in Britain so that was another market with potential for the NRL.

With no additional costs, each new NRL Watch subscription is profit for the game.

“We already have Super League so you've got a ready-made market and again there’s hardly a subscription sold in England,” he said.

“We are going to attack that market as well and every dollar, because from an accounting point of view, it's all addition. There's no expense.

“We've already paid the players, we've already paid for the production, we've already paid for everything so it's a matter of whatever revenue you get, you get it clear.

"It also gives us, in my view, a real niche when we go to do the next broadcasting rights because not only do you have the domestic, which is really not that big a market, but you're gonna have international, which will be a much bigger market."

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National Rugby League respects and honours the Traditional Custodians of the land and pay our respects to their Elders past, present and future. We acknowledge the stories, traditions and living cultures of Aboriginal and Torres Strait Islander peoples on the lands we meet, gather and play on.

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Super Bowl 2024: Why the glaring contrast in Chiefs, 49ers new OT rules preparation may have decided the game

The chiefs prepared and knew proper strategy for the new playoff ot rules; the 49ers did not.

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The NFL playoff overtime rules changed several years ago, but  Super Bowl LVIII was the first playoff game where the new format was in effect. The basics of the new overtime rules are simple: both teams get possession of the ball no matter if a team scores a touchdown on the opening possession or not. 

The Kansas City Chiefs certainly knew what was going on. The San Francisco 49ers did not. And that was the ball game: Chiefs 25, 49ers 22.

Here's a look at the striking difference in the way the two teams were prepared for a potential overtime.

49ers didn't know the new playoff rules

In the aftermath of the Chiefs' overtime Super Bowl victory, San Francisco players admitted they did not know the new overtime rules -- even though they were in place for two years. 

"I guess that's not the case," 49ers fullback Kyle Juszczyk said,  via The Ringer . "I don't really know the strategy." 

Juszczyk thought a team that got the ball first in overtime won if they scored a touchdown, which was the rule instituted in 2010. Under those playoff overtime rules, the game would not immediately end if the team that gets the ball first scores a field goal on its first possession -- but the game would end if a touchdown is scored by the offense or if the defense scores a safety on the first possession of the overtime period.

The 49ers'  Arik Armstead also admitted he wasn't aware of the new overtime rule, not knowing the other team got possession of the ball even if the team that won the coin toss -- and chose to receive -- scored a touchdown. Those were the sudden death overtime rules pre-2010. 

If 49ers players were unaware of the new overtime rules, did Kyle Shanahan know? If Shanahan did know, how did he prepare for a Super Bowl that certainly had the potential to go to overtime? It was a possibility that skyrocketed after kicker Jake Moody had an extra point attempt blocked with 11:22 left in the fourth quarter, resulting in only a 3-point lead.

The 49ers decided to take the ball first in overtime, a decision made even worse since at least some of Shanahan's players did not know what the protocol was if the 49ers scored. Since both teams get possession of the ball in overtime, going first wasn't the optimum strategy.

No matter what the 49ers did, the Chiefs knew exactly what they needed when they got the ball. Yes, in case the 49ers didn't know: The Chiefs were getting the ball in overtime. Of course, by choosing to get the ball first, Shanahan wouldn't be aware of what was needed, or what the Chiefs might do.

"This is something we talked about with, you know, that none of us have a ton of experience of it but we went through all the analytics and talked with those guys and we just thought it would be better, we just wanted the ball third," Shanahan said after the game, via a league transcript. "If both teams matched and scored, we wanted to be the ones who had the chance to go in. 

"We got that field goal, so we knew we had to hold them to at least a field goal. And if we did then we thought it was in our hands after that."

The 49ers clearly showed a lack of awareness. With the Niners' field goal, the Chiefs knew they needed a touchdown to win the Super Bowl. Even if the 49ers had scored a touchdown, the pressure would've been on them to choose between kicking the extra point or attempting a two-point conversion.

In fact, the only way the 49ers benefitted from choosing to get the ball first would've been by scoring a touchdown and then converting the two-point attempt. Anything else? Advantage, Chiefs.

Chiefs talked playoff OT strategy with analytics coordinator

Kansas City was certainly prepared for the new overtime rules, as head coach Andy Reid kept discussing the rules with his team throughout the playoffs. He knew the possibility of an overtime game was always on the table. 

How did Reid know what to do if the Chiefs had won the coin toss? Reid trusted Mike Frazier, who has been with Reid all 11 seasons in Kansas City as the Statistical Analysis Coordinator. Frazier had the same role with the Philadelphia Eagles from 2003 to 2012 -- also with Reid. 

"That's the value of Mike. He does a great job with that," Reid said, via a league transcript. "There's two ways you can go with it. You can either kick it off or you can receive it. I'm not sure there's a right answer necessarily. Ours ended up being the right one. 

"That easily could have gone the other way. That's what we felt was the right thing to do...That was just something that we chose throughout studies. We felt that was important."

The Chiefs wanted the ball second. The 49ers wanted the ball third (if that was a possibility). 

Clearly the 49ers made a mistake once they failed to get into the end zone. With Patrick Mahomes on the opposite sideline, the 49ers should have put the pressure on him to score a touchdown first (and Reid to make a decision whether to go for two afterwards).

Of course, this would have been avoided if San Francisco knew the rules. Neither the players -- nor the head coach -- were aware of the situation. 

And that was the ball game. 

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