Let Game Theory Begin: Anticipating Your Rival
Investor's Business Daily
25 January 1996

Investors Business Daily



by Gerald A. Achstatter

Anticipating your opponent: It's key to any sport or business. But unlike sports, where there's a winner and loser, you can have win-win and lose-lose situations in business.

When the competition views your actions as beneficial or at least nonthreatening, it's less likely to retaliate. Conversely, seeing your competitors' actions in the same light can avert a costly price war. Visualizing and anticipating your competitor's moves are the venue of a branch of mathematics called game theory - the study of competitive interaction. Companies use it to anticipate their competitors' reactions in order to improve their own decisions.

Last March, the Federal Communications Commission completed the largest application of game theory - the $ 7 billion auction of wireless personal communication services.

Game theory helps firms better assess their own negotiating position. They can also learn how to change the game they're playing rather than just play the existing one.

Having game theory in your corporate ''bag of tricks'' can mean the difference between success and failure. ''Our company only gets to bid on deals once in a generation,'' said Dallas Luby, executive vice president and chief marketing officer at Stamford, Conn.-based General Re Corp., a property/casualty reinsurer. ''We want the best information possible.''

Game Theory also can help firms look beyond the traditional roles of competitors, customers and suppliers, says Barry J. Nalebuff, management professor at the Yale School of Management and author of the forthcoming book on game theory, ''Co-opetition'' (co-authored by Adam M. Brandenburger, business strategy professor at the Harvard Business School). Too often, firms ''leave out complementors.''

''Sometimes, what you do helps me,'' Nalebuff added. An example is the development of a new airplane. They are ''too expensive for one firm to have/develop alone. Airlines share the development cost.''

It's important to note, however, that firms must avoid collusion.

Another reason game theory is catching on is that firms don't want to be at a competitive disadvantage because they failed to use the tool. At General Re, ''Game theory is a significant part of senior management education,'' Luby said.

The real benefit of game theory is finding areas of cooperation, Luby adds. It helps answer the question: ''What's everybody's motivation in the game?''

Allocentrism - putting yourself in your competitor's shoes - is only one side of the equation. Firms must also look at the added value they bring to the table, Nalebuff says. The Holland Sweetener Co. probably wishes it had done so. It tried to compete with Monsanto's aspartame product, NutraSweet, by building a plant to make the product.

All Holland Sweetener succeeded in doing was to make the aspartame market competitive. Coca Cola Co. and PepsiCo Inc. signed long-term contracts with Monsanto prior to the patent expiration on NutraSweet. They both did so at significantly lower prices.

As it turned out, the NutraSweet name had a great deal of value to both Coke and Pepsi something Holland Sweetener couldn't capitalize on.

The absence of any added value doesn't preclude a company from playing in the game, Nalebuff says. But if you don't have added value, ''You had better realize it and get paid upfront.''

By creating a viable competitor for NutraSweet, Holland Sweetener certainly did Coke and Pepsi a great service. But there are instances when game theory ''is not beneficial to anyone,'' said Avinash K. Dixit, economics professor at Princeton University. In designing the FCC's PCS auction, the government worked hard to ensure productive bidding. The reason? ''Each bidder could have benefited from lying in the grass,'' said Evan R. Kwerel, senior economist at the FCC.

The auction consisted of 112 rounds of open bids. To prevent disruptive bids, each bidder was required to maintain active participation in the auction, Kwerel says. In addition, firms that withdrew bids were subject to penalties.

Like the bids in the FCC auction, the actions firms take are interpreted by their competitors as signals. They convey what's important to the company.

''Firms may give false signals'' to confuse competitors, Dixit said. ''But other firms will not give much weight to signals that can easily be mimicked.''

Game theory helps sensitize companies to such actions as false signaling. ''It safeguards you from being taken advantage of,'' Dixit said.

So what's in store for game theory? ''There will be more cooperation between buyer and seller than you've ever seen before,'' Luby said. As a result, ''more and more people are going to use game theory.'' Game theory will continue to grow because of the importance added value plays in business today, Nalebuff says. It ''helps companies define their added value.'''

And firms will have ''to give up old habits such as thinking that business is war and that they must beat the competition,'' Nalebuff added. ''This is true for card games and sports, but not in business.''


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