Game Theory

ACCA F2 - Management Accounting

Game Theory in Strategy

Game theory helps analyze dynamic and sequential decisions at the tactical level.  The main value of game theory in strategy is to emphasize the importance of thinking ahead, thinking of the alternatives, and anticipating the reactions of other players in your "game."  Key concepts relevant to strategy are the payoff matrix, extensive form games, and the core of a game.  Application areas in strategy are:

·         new product introduction

·         licensing versus production

·         pricing

·         R&D

·         advertising

·         regulation

The Importance of Understanding "The Game"

Successful strategy cannot depend just on one firm's position in industry, capabilities, activities, or what have you.  It depends on how others react to your moves, and how others think you will react to theirs.  By fully understanding the dynamic with others, you can recognize win-win strategies that make you better off in the long term, and signaling tactics that avoid lose-lose outcomes.  Moreover, if you understand the game, you can take actions to change the rules or players of the game in your favor. Brandenburger and Nalebuff (1995) give some good examples of this.  One way a company can change the game and capture more value is by changing the value other players can bring to it, as the Nintendo example illustrated.  In summary, companies can change their game of business in their favor by changing:

·         players ("Value Net") - customers, suppliers, substitutors, and complementors (not just the competitors)

·         added values - the value that each player brings to the collective game

·         rules - laws, customs, contracts, etc. that give a game its structure

·         tactics - moves used to shape the way players perceive the game and hence how they play

·         scope - boundaries of the game.

Game theory has been a burgeoning branch of economics in recent years.  It is a complex subject that spans games of static (one-time) and dynamic (repeated) nature under perfect or imperfect information.  The references below will be helpful for those wishing to explore the theory and modeling of game theory in more detail.  For strategy, though, it can often be a major step just to recognize certain situations as games, and thinking about how a player can set out to change the game.

References:

Introduction to game theory in corporate strategy

·         Oster, S.M., Modern Competitive Analysis, Chapter, 13, Oxford Press, 1994, pp.237-250.

·         Brandenburger, Adam M.; Nalebuff, Barry J.  "The right game: use game theory to shape strategy" Harvard Business Review v73, n4 (July-August, 1995):57.

Basic introduction to game theory concepts

·         A.K. Dixit and B. J. Nalebuff, Thinking Strategically: The Competitive Edge in Business, Politics, and Everyday Life, W.W. Norton & Company, pp. 347-367

·         Gibbons, R., Game Theory for Applied Economists, Princeton: Princeton University Press, 1992.

·         Binmore, K., Fun and Games: A Text on Game Theory, Lexington: D.C. Heath & Co., 1992.

More advanced economics texts on game theory

·         Fudenberg, D. and J. Tirole, Game Theory, Cambridge: MIT Press, 1991.

·         Myerson, R., Game Theory: An Analysis of Conflict, Cambridge: Harvard University Press, 1991.

Ref:   EES&OR483  Strategy and Marketing Primer (version 3.0) Page 10

The Prisoners' Dilemma