Game Theory for Managers in Times of Uncertainty
Game theory is not only a mathematical tool that generates a specific answer, but it is also an applicable technique for making informed managerial decisions. When facing complex, uncertain situations, Game theory can be a strategic tool for managers to access viable options and develop foreseeable outcomes.
In today’s economic environment, global downturns and reforms have caused radical shifts in demand, market capacity, and prices. In addition, companies are developing new models and novel corporate objectives, further complicating the business landscape and making it more unpredictable using traditional corporate strategies.
While traditional game theory delivers the optimal solutions and equilibriums, this article introduces a revised model where players only consider a likely set of actions and their effect on important metrics. This is an example of how principles in game theory are adapted and used in developing corporate strategies and managerial decisions.
The article uses the example of the deregularization of passenger railways in the European Union. Large existing corporations are facing the attacks of many new entrants, whose actions are close to impossible to predict. Narrowing this question down, there are four most likely moves to be made by the attackers: imitating the incumbents by providing similar or identical service, offering more attractive services, specializing by offering a niche service, or differentiating by providing a clearly distinctive service.
The list of actions available to the incumbent can be analyzed and distilled to ignoring the attackers by not reacting, counterattacking by changing prices, services, and schedules, to coexist by sharing the resources, or to exit a route by terminating certain services. Through analysis, the counteractions can now be clearly laid out. Then, in every situation, an expected payoff can be estimated based on the players’ actions.
However, the biggest challenge in applying game theory principles to complex business situations is to know the factors that can significantly affect the payoffs. In this example, the article discusses the effects of changes in total demand, cost differences, network advantages, and price sensitivity and how dramatically each can change the payoffs in the game.
If you are interested in learning about the details of the analysis, I would encourage you to take a moment and give this article a read. In the end, the model suggests that although the attacker has lower costs and appear to be favorable, it will likely take only a silver of market share. This is because of a general increase in rail use. As a result, the incumbent will remain dominant.
This passage not only provides an interesting use case of game theory in corporate strategy, but also presents honest analysis on the challenges of using game theory analysis in real life business scenarios. The process of analyzing possible options, choosing the optimal one (based on highest payoffs), and achieving an equilibrium between players is almost exactly like what we have learned in class. The concept of Nash equilibrium can be seen when both parties finally come to consistent behaviors. It demonstrates the impact of game theory principles in the business world and how powerful it can be to support strategic decisions. Nevertheless, the process of analyzing external factors and narrowing down likely outcomes reveal the extra thought and careful consideration needed when mapping business problems into games.
https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/making-game-theory-work-for-managers