How Game Theory Informs Product Management
As a product manager or someone interested in product management, you may have heard of concepts like product launches, feature prioritization, and competitor analyses. Interestingly, game theory can directly inform our decisions and mental models as we build and scale compelling products. Utilizing concepts like Nash Equilibrium and anticipating the movements of our competitors in a market can offer product managers the leverage they need to launch and distribute their products successfully.
After all the work towards building a product or feature, one of the most notable moments in a product manager’s job is finally launching the product into the world and seeing your Daily Active Users shoot up high. But that moment is so critical it can be just as catastrophic as it can be great if it isn’t done right. Part of getting a product launch right is being able to convert users.
A famous framework for understanding the process of going from initial contact with a user to a loyal, paying customer is the AARRR framework. The framework stands for acquisition (initial contact), activation (users have an excellent first-time experience), retention, referral, and revenue. The most critical moment that must be done right to get users through this user acquisition funnel is the Activation phase. At this phase, users interact with the product for the first time and judge whether it will remain an app on their phone or another app that failed to grab their attention and money.
So, what does game theory tell us about how we, as product managers, can get this critical moment in the user acquisition process right? Well, it’s all about understanding Nash Equilibrium and payoffs. At any given moment, we assume, in economic terms, the market is in equilibrium, and in game theory terms, the players in the market are operating within a Nash Equilibrium. However, when you launch your product, there is a new game. Suddenly, your product offers different payoffs, costs, and benefits. In this new game, there will be a new Nash Equilibrium. To get users to have enough activation energy to switch from their current product, your role as a product manager is to ensure that your product has the correct payoffs to enter the market in a position where your product can garner your target users and provide opportunities to scale your product.
This sounds pretty logical, and our product manager intuition aligns with these concepts from game theory. But what does this mean, and how do product managers begin to create a product whose payoffs in the market are enough to switch the Nash Equilibrium in its favor?
This has everything to do with understanding the players in the market and how your product will play a role in the market. Many in the entrepreneurial community refer to this concept as product-market fit, but the idea is that your product will fit in the market, and it is up to the product manager to craft that fit. With our new intuition of game theory and Nash Equilibrium, product managers or aspiring product managers now have a more enabled understanding of what it takes to get users through the user acquisition funnel as paying customers.
To get the right fit, many factors need to be correct: value proposition, pricing, and features.
Firstly, product managers need to get their product’s value proposition correct. They can do that by understanding the needs of their target users and what features would fill in the user need gaps according to the current market. This is an essential aspect of game theory. When looking at the Nash Equilibrium, each player needs to understand how the other players will play to figure out how they should play.
Another significant aspect of getting the product-market fit right is identifying the correct prices. Now, while most entrepreneurs do not use market-clearing price analysis to determine their ideal product price, understanding the underlying principles of market-clearing prices helps entrepreneurs identify how elastic their product is and how they can price their product appropriately to ensure that their users get access to the product they want. Of course, the concept of market-clearing prices is often under the assumption that each buyer can only be connected with one seller. There is nothing stopping users from paying for multiple competing products if they choose to do so in the real world. Knowing this enhances our understanding of pricing because we know that we don’t need to price our products to match with a user; we need to price our products according to the market to get users entirely through the user acquisition funnel.
Together, product managers can ensure that their products have the correct value propositions and the optimal price to ensure that these factors are aligned together so that users have enough activation energy to become paying customers.
Game theory has applications in almost every aspect of our lives. One exciting and compelling application of game theory is when we apply mental models of game theory concepts like Nash Equilibrium, market-clearing prices, how payoffs affect outcomes and Nash Equilibriums in a given game, etc. to entrepreneurship and product management to enable powerful product thinking, which allows us to build and scale world-class products.
Source: https://metatony.posthaven.com/how-game-theory-can-inform-product-creation-and-management