Game+theory+in+business

=Theory of Games and Economic Behaviour =

Von Neumann wanted game theory to reach a larger audience than mathematicians. He felt the developing field would be of the most use to economists. He teamed with an Austrian economist then at Princeton, Oskar Morgensten, to develop his theory. Von Neumann and Morgensten's //Theory of Games and Economic Behaviour// is one of the most influential and least-read books of the twentieth century. The book thus presents itself as a pioneering work of economics and the introduction is almost apologetic about investigating recreational games. The games are presented as potential models for economic interactions.

Most economists still hadn't read it (and never would); it wasn't even in the libraries of many schools of economics. [|//Theory of Games and Economic Behaviour// is a difficult]book. Today the reader's enthusiasm for plowing through 641 formula-filled pages is dampened by the fact that Von Neumann and Morgensten got sidetracked in their treatment of games of more than two persons.

Fortunately for our purposes, the essential kernel of the game theory is easy to grasp, even for those with little background in-or tolerance for-mathematics. Game theory is founded on a very simple but powerful way of schematizing conflict, and this method can be illustrated by a few familiar childhood games Poundstone, William. 1992. Prisoner’s Dilemma. New York: Doubleday.

=How is Game Theory observable in business environment?=

In any business, interactions with customers, suppliers, other business partners, and competitorsplay an integral role in any decision. Each firm is part of a complex network of interactions; anybusiness decision by a firm impacts multiple entities that interact with or within that firm, and viceversa. Ignoring these interactions could lead to unexpected and potentially very undesirableoutcomes. Our goal in this project is to utilize game theory for studying these interactions. //Source: https://www.academia.edu/2297327/Game_theory_and_its_business_applications//

Playing games is serious business in a lot of M.B.A. programs. Game theory -- or the study of incentives -- appears in many disguises in such courses as marketing, finance, accounting and organizational behavior. Game theory is used to examine strategic interactions between players in a market. "The strongest applications of game theory have come in strategy -- i.e. the science of strategic thinking," says Dan LeClair, an economist and vice president and chief knowledge officer at AACSB International, the Association to Advance Collegiate Schools of Business. "But it's hard to find a course that doesn't incorporate the literature and ideas of game theory."

There are many examples of the prisoner’s dilemma in business. Given such cut-throat competition, how can companies stay in business and make money? One key concept not captured in the prisoner’s dilemma example is the repetition of interactions. In most business to dealings, the players know that they will be in the same “game” for a long time to come, and hence they may choose to cooperate or act nice, especially if cooperation today would increase the chances of cooperation tomorrow. With their repeated actions, companies build a reputation which influences the actions of others in the future. For example, a restaurant might make a higher profit today by selling leftover food from yesterday, but the consequences of such an action could be very costly as it could mean losing many customers in the future due to bad reputation about the freshness of the food. Companies act strategically in their relations not only with their competitors but with their supply chain partners as well. Given that each participant in a supply chain acts on self interest, the individual choices of the participants collectively do not usually lead to an “optimal” outcome for the supply chain. That is, the total profits of a typical “decentralized” supply chain which is composed of multiple, independently managed companies, is less than the total profits of the “centralized” version of the same chain, if such a chain could exist and be managed optimally by a single decision-maker to maximize the entire chain’s profits. The inefficiencies in supply chains due to the participants’ self-centered decision-making is generally known as “double marginalization.” One possible strategy for reducing such inefficiencies is “vertical integration,” where a company owns every part of its supply chain, including the raw materials, factories, and stores. //source: [] pp3// Examples from real business situations: A popular example is the story of how Airbus used brinksmanship with Boeing Co. when Airbus decided to build the A380 superjumbo jet. Airbus announced its plans to build the jet and Boeing immediately said it would do the same. If both makers of airplanes had gone ahead with the project, the market would have been split and neither company could have made a profit. Airbus called Boeing's bluff, however, and began the project in earnest. About the time Airbus unveiled the plane, Boeing brushed aside the move and said it had calculated that such an aircraft could never be profitable. The statement seemed an admission that Boeing never intended to build the aircraft. "The key is to differentiate between a commitment and a bluff," says Mr. Shor. Thomas Buerkle, who teaches personnel economics at Goethe University in Frankfurt and general economics at the University of Applied Sciences in Frankfurt, uses bargaining theory to discuss labor strikes and cooperative game theory as a way to explain why labor contracts should be long term. He says that both employees and companies have two choices when interacting: cooperation or defection. If an employee has a one-year contract and shows up on the last day of work not knowing whether the contract has been extended, she will not invest full energy in the job. Knowing this, the company doesn't give the employee any work to do on her second-to-last day. Realizing the whole contract might be scuttled, the employee doesn't dedicate herself fully on the third day before the contract ends. And so on. "If the date of the end of a relationship is known, no one cooperates," says Mr. Buerkle. "Longer-term contracts still come to an end but do a better job ensuring cooperation for a company because during the relationship no party can be sure when the contract really ends."
 * __Airbus & Boeing Co.__**

"Sometimes game theory is mistakenly viewed as the study of conflict, particularly with the literature on zero-sum games in which I win and you lose," he says. "But, in business, one of the most important contributions of game theory is to help us understand how both parties can win. That's a very fundamental contribution that game theory has to make to business."

source: http://online.wsj.com/articles/SB114374449313812533

Game Theory and Business Strategies
Companies act strategically in their relations not only with their competitors but with their supplychain partners as well.Given that each participant in a supply chain acts on self interest, theindividual choices of the participants collectively do not usually lead to an “optimal” outcome for the supply chain. That is, the total profits of a typical “decentralized” supply chain which is composed of multiple, independently managed companies, is less than the total profits of the “centralized” version of the same chain, if such a chain could exist and be managed optimally by a single decision-maker to maximize the entire chain’s profits. The inefficiencies in supply chains due to the participants’ self -centered decision-making is generally known as “double marginalization.”

One possible strategy for reducing such inefficiencies is “vertical integration”.

Vertical Integration - Ford Motor Co.
In vertical integration a company owns every part of its supply chain, including the raw materials, factories, and stores. An excellent example of vertical integration was Ford Motor Co. early in the 20th century. In addition to automobile factories, Henry Ford owned a steel mill, a glass factory, a rubber tree plantation, and an iron mine. Ford’s focus was on “mass production,” making the same car, at that time Model T, cheaper and faster. This approach worked very well at the beginning. The price of Model T fell from $850 in 1908 to $290 in 1924. By 1914, Ford had a 48% share of the American market, and by 1920 Ford was producing half the cars made worldwide. Vertical integration allows a company to obtain raw materials at a low cost, and exert more control over the entire supply chain, both in terms of lead times and quality. However, we do not see many examples of vertically integrated companies today. Why? Mainly because in today’s fast paced economy, where customers’ needs and tastes change overnight, companies which focus on core competencies and are nimble are more likely to stay ahead of competition and succeed. Hence, we see an increasing trend towards “virtual integration”.

Virtual Integration
Virtual Integration is where supply chains are composed of independently managed but tightly linked companies. Innovative practices, such as information sharing or vendor managed inventory (VMI), are successfully used by some companies such as Dell Corporation to get closer to virtual integration. However, most companies are still reluctant to changing their supply chain practices, and in such cases it is desirable to design contracts (defining the terms of trade) or change the terms of existing contracts, to align incentives and reduce inefficiencies due to double marginalization. This is known as “supply chain coordination” and Similar concepts apply to independently managed divisions within a company as well. In many business “games” the actions of some players have direct consequences for other players. For example, the performance of a company, and in turn, the value to the shareholders, depends on the actions of the managers and workers that are part of the company. In recent years, we have seen examples where top management engaged in misconduct to increase their own compensation while hurting both the shareholders and the workers.

**The Win-Win Strategy**
One common mindset-seeing business as a war says that others have to lose in order foryou to win. Is this always true? In every Game should always one player loose and other players win?

In early 1990s,the US automobile industry was locked into an all-too-familiar mode of destructive competition. End of the year rebates and dollar discounts were ruining the industry’s profitability. As soon as one company used incentives to clear excess inventory at year-end, others had to do thesame. Worse still consumers came to expect the rebates. As,a result they waited for them to be offered before buying the car, forcing the manufacturers to offer incentives earlier in the year. Was there a way out? Would someone find an alternative to practices that were hunting all the companies? General Motors may have just done that. In September 1992,General Motors and House-hold bank issued a new credit card that allowed cardholders to apply 5% of their charges toward buying or leasing a new GM car, up to $500 per year with a maximum of $3,500.The GM card has been the most successful credit-card launch in the history. One month after it was introduced, there were 1.2 million accounts. Two years later, there were 8.7 million accounts-and the program is still growing. Projections suggest that eventually some 30% of the GM’s non fleet sales in North America will be to cardholders.
 * General Motors**

As Hank Weed managing director of GM’s card program explains, the card helps GM to build share through the “conquest” of prospective Ford buyers and others - a traditional win-lose strategy. But the program has engineered another, more subtle change in the game of selling cars. It replaced other incentives which GM offered initially. The net effect has been to raise the price that a non-cardholder-someone who intends to buy a Ford-would have to pay for the GM car. The program thus give Ford some breathing space to raise its prices. This in turn allows GM to raise its prices without loosing itscustomers. If the GM card sounds that good what is stopping other companies from copying it? Imitation is the sincerest form of flattery, but in business it is often thought to be killer compliment.

Textbooks on the strategy warn that if others can imitate something you do, you can’t make money at it. Some go even further, asserting that business strategy cannot be codified. If it could, it would be imitated and any gains would be evaporate. Yet the proponents of this belief are mistaken in assuming that imitation is always harmful. It’s true that once GM’s program is widely imitated, the company’s ability to lure customers away firm other manufacturers will be diminished. But imitation also can help GM. Ford and Volkwagen offset the cost of their credit card rebates by scaling back other incentive programs. The result was an effective price increase for GM customers, the vast majority of whom do not participate in Ford and Volkswagen credit card programs. This gives GM the option to firm up its demand and raise its prices further. All the companies have now more loyal customer base. To understand full impact of the GM card program, you have to use game theory. You can’t see all the ramifications of the programs without adopting an all centric perspective. The key is to understand how others react to GM’s initiative.

When you change the game, you want to come out ahead. That’s pretty clear. But what about the fact that GM’s strategy helped Ford? One common mind set seeing business as war says that one has to loose in order to win the game, well, it is not always, it is sometimes best to let other players win as well. Looking for a win-win strategy has several advantages. **First** because the approach is relatively unexplored, there is greater potential for finding new opportunities. **Second**, because others are not being forced to give up ground, they may offer less resistance to win-win moves, making them easier to implement. **Third**, because win-win moves don’t force other players to retaliate, the new game is more sustainable. And **finally**, imitation of a win-win move is beneficial not harmful. //Source: https://www.academia.edu/2297327/Game_theory_and_its_business_applications//

In many business “games” the actions of some players have direct consequences for other players. For example, the performance of a company, and in turn, the value to the shareholders, depends on the actions of the managers and workers that are part of the company. In recent years, we have seen examples where top management engaged in misconduct to increase their own compensation while hurting both the shareholders and the workers. “While demanding that workers accept cuts, [chief executive of American Airlines] was giving retention bonuses to seven executives if they stayed through January 2005. American also made a $41 million pretax payment last October to a trust fund established to protect the pensions of 45 executives in the event of bankruptcy. This is an industry that is steadily eroding the pensions of ordinary employees. (The Arizona Republic, April 24, 2003)
 * American Airlines**

Source: [] pp4

Uses of Game Theory's aspects in various other situations: http://www.businessinsider.com/how-to-use-game-theory-to-your-benefit-2012-4?op=1