Game Theory powers decision making

As a decision making tool, Game Theory is rapidly moving beyond the realm of economics and psychology into the boardroom.  GT is a branch of mathematics that increasingly is helping managers, regulators and lawyers predict how organizations and people will act in certain situations based on what they perceive to be in their best interest.

Up until recently, government, academia and think tanks have used these methodologies to help forecast the actions and reactions of various countries, organizations and leaders around particular issues such as: when will Iran develop a nuclear weapon or how will certain countries negotiate trade deals.    Not surprisingly, managers discovered that GT has practical uses and delivers compelling value in many high risk/high payoff business situations such as:  how to counter a competitive entry; what price should be submitted in a closed auction; how to negotiate with a union; how to negotiate a M&A transaction or; what is the likely competitive response to a price cut. 

Each business “game” contains common elements.   A modeler frames the strategic question, identifies the key players (e.g., competitors, regulators, customers), and estimates their possible options.  In consultation with management, numerical values are placed on the potential positive and negative payoffs of each option.  A computer or mathematical model is then used to determine the best course of action by simulating the interplay of various decisions, the impact of random and planned influences, and the financial results of these decisions.  The consequence of multiple simulations is the prediction of an event and the choice of the ideal strategy for the firm. 

GT is now moving into mainstream business.   The Economist magazine recently highlighted a number of examples in which these tools are being used.  In one noteworthy case, GT was used to assist a consortium of bidders in the 2006 online auction of radio-spectrum licenses run by the Federal Communications Commission in the U.S.. Two bidders, Comcast and Time Warner, ended up paying approximately a third less than their competitors for equivalent spectrum, saving them almost $1.2B.  GT has also been used to help decide which television shows to run;  to ascertain the optimal wholesale pricing for services like electricity and water, and to uncover the best strategies to sway juries and outfox prosecutors.  Interestingly, GT was credited with helping locate Osama bin Laden’s hideout  in Abbottabad, Pakistan. 

All these deployments share some common features.  They utilize custom and sophisticated software programs; they leverage advanced mathematical methodologies and they are pricey, starting from $50K and easily hitting hundreds of thousands dollars.   No doubt, many managers and Boards facing high stakes, strategic questions will look to a bespoke GT solution as an important decision making aid.

However, one doesn’t always need a Ferrari to take them to the corner store. Most GT executions have been expensive, time-consuming exercises.  After making a significant investment in the tool, managers may be tempted to over rely on the model (i.e. the sunk cost effect) at the expense of other valid decision analysis tools.  Furthermore, the high cost and time needed for many exercises makes GT impractical for most important, though not mission critical, decisions faced on a regular basis.  Finally, the value and accuracy of GT become less reliable when non-monetary (i.e. more subjective to calculate) payoffs are critical to the decision. 

We believe GT can be used by the average company in more circumstances than just game-changing decisions.  In order to increase application scope and appeal to more firms, we developed a new product that retains the essence of GT but also reduces the cost, speed and management burden of running simulations.  This express solution keeps the core of GT – the mathematical logic, strategic choices and influences, and management assessments of financial payoffs – while dispensing with the luxuries of a custom software build.  Our GT product is still software-based, but relies on standard Excel modeling. 

This approach has been successful in anticipating competitive reactions to a new product launch and in deciding which channel partners to engage with.  Outside of the cost and time advantages, our solution is also flexible enough to enable managers to more quickly model more scenarios based on new information availability, changing assumptions and multiple impacts of non-financial payoffs.  Finally, the entire modeling experience has proven to be a richly rewarding management education experience.

When it comes to decision analysis, there is no magic bullet.  GT is a powerful complement, and not a replacement, to traditional and innovative decision making strategies such as business war gaming.  Like other management tools, GT’s effectiveness will depend on the skill on which it is used, the expectations around its predictive value as well as the ability of managers to recognize and compensate for inherent biases and incorrect assumptions.   As more case studies are publicized, look for GT to become a standard part of any strategist’s arsenal.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.


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