Game theory can assist business owners, CEOs and managers make better strategic decisions when confronted with the uncertainty of competition. Competitive conduct will not always be "fair play" and if you don't change your game plan to seek out the advantage, your competition will.
Chess can teach us a lot about strategy in business and sport. Chess players understand that superior strategic decisions necessitate that you consider, and focus careful forethought on, the likely moves and countermoves of your opponent.
Chess players studiously examine their opponent's methodology to the game-plan and ascertain the expected sequence of moves that will follow any particular move they themselves make. By looking forward and reasoning backward, they drive the game toward a checkmate!
This talent to look forward and reason backward is extremely effective for strategic decision-makers. The success of new marketing or pricing strategies relies on whether competitors replicate them.
In oligopoly markets (in which a market or industry is dominated by a small number of sellers), it is hard to identify a strategic decision that isn't influenced by the retaliatory countermoves it sets off. The finest business strategists must be accomplished at forecasting forthcoming rounds of competitive conduct.
Easier said than done, I realise.
Ambiguity often surrounds competitive conduct, and many leaders either expect the companies they compete against to employ the manner of competitive behaviour they see as typical, or make some other educated guess. But such assumptions can be treacherous.
Businesses unintentionally set off value-destroying price wars, get buried when incumbents retaliate in markets those businesses have attempted to enter, and cannibalise their own core markets because they have either ignored, or made incorrect assumptions, about the reactions of competitors.
The good news is that game theory offers a well thought-out process that can aid you to make better strategic decisions when confronted with the uncertainty of competitive conduct.
Game theory isn't new; economists, mathematicians, and political scientists have been developing it for more than 60 years.
What is new, is an increased emphasis on game theory as a practical tool that real-world business owners and alike can use for making strategic decisions.
A good game theorist gets inside the heads of competitors to understand their economic incentives and likely behaviour. To do this, you should focus on five key elements of competitive intelligence.
- Identify the strategic issue
What decision are you trying to formulate: pricing, capacity, market entry? How is it inter-related to other strategic decisions being made in the market?
If your decision is on capacity investment, for example, it is vital that you know whether others in the market are also considering entering or leaving it.
- Uncover the significant players
Which competitors' actions will have the maximum impact on the success of your strategy? It is a mistake to assume that all your strategic games are played against competitors and that there is always a winner and a loser.
Many strategic decisions revolve around the dealings of other players in the market - suppliers, distributors, providers of complementary goods - and "win-win" outcomes are achievable.
- Ascertain each player's strategic objectives
In real business games, players often base decisions, at least in the short term, on criteria such as market share or growth. It is vital to get such criteria correct.
If you make the decision to enter a new market in the belief that the incumbent players are "profit maximisers" when they are really driven primarily by short-run "market share" objectives, you might suffer unexpected losses when the incumbents slash prices to maintain share.
- Uncover the probable actions for each player
For each player in the game, including your organisation, develop a list of potential actions on the strategic issue. Generate this list from the perspective of the other organisations, not just your own.
What options might they be considering? How will they evaluate these options?
Don't assume that you and your competitors have the same set of strategic options. Competitive role-playing exercises, involving external experts, peers and your own employees, can help generate these lists.
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Resolve the possible structure of the game
Will decisions be made simultaneously, in isolation, or sequentially, over time? If sequentially, who is likely to lead and to follow? Will this be a one-shot decision, or will it be repeated?
Most business games are repeated, sequential games. Pricing decisions, for example, are made over and over, in sequence, in most markets.
Learning from the game
You need not identify unique, robust equilibrium solutions for this approach to be a valuable strategic decision-making tool. Since the process itself compels you to think unambiguously about the incentives and likely moves of other players, it can generate a breakthrough in strategic insight, even when the game can't be mapped-out explicitly.
Qualitative role-playing exercises and thorough discussions may engender enough insight to show the way to a variation of direction on new-entry, capacity addition, pricing, and other fundamental strategic decisions.
Importantly, while endeavoring to map-out the current industry, you invariably develop insights about how to change strategies to drive more favorable outcomes.
Unlike sports such as rugby, business games don't have fixed rules, players, and referees. Although game theory can help you play your current game better, its greatest value often comes from helping players define new strategies and "rules".
In certain circumstances, game theory predicts that current market conditions make price wars highly likely because customers switch easily between competitors.
This five step approach would help identify the need to change the strategy by implementing customer loyalty programs, that create value for customers and companies and decrease incentives for destructive price competition.
Try out game theory when next you need to formulate a strategic decision about which competitive interactions are of importance. Look forward and reason backward to generate insights.
If you don't change your game to gain advantage, one of your competitors will, and there is not much value in being the best rugby player when everyone else is playing cricket!