The Game Theory in Strategic Behavior of Firms - Research Paper Example

Introduction The Game theory has gained wide application on a series of fields in the corporate and economic arena today. This is largely as result of its ability to simplify matters and provide scientific backing for understanding complex strategic phenomenon. Despite these obvious advantages, the Game theory is not an all satisfying theory because it is particularly difficult to understand certain aspect strategic behaviour in firms and also the behaviour of economic actors. The purpose of the essay is to look at how the game theory cannot be applied in understanding these two scenarios with specific case studies. The two companies that will form the basis of this paper are Shell (declared the most profitable company in the United Kingdom in 2008) and Tesco; also one of the most profitable retail chain stores in the United Kingdom. General ideas expressed in the game theory Game theory is used to understand competitive situations. These are normally those scenarios in which the chances of a certain outcome largely depend on parties involved and also on a bit of chance. Consequently, the theory focuses on predicting what these respective players will do and hence the most appropriate alternative is chosen by the analyst. There is a particular mathematician who was responsible for this theory and was known as John Von Neumann. (Miller, 2003) Through his work in the mid twentieth century, the expert was able to spearhead several divisions in this interesting theory. Some of the divisions include Cooperative and uncooperative Zero sum versus non zero sum 2-person versus n- person In the 2-person versus n-person division, the 2-Person approach largely focuses on the choices available to two players and how to bring out optimum outcomes. On the other hand, in the n - person division, great attention is given to the occurrences and coalitions that are likely to come out of prevailing circumstances. Then again the cooperative division of the game theory largely dwells on choices that are available to parties who have been bound by certain agreements. In uncooperative game theory, parties may find themselves obliged to one another because of the negative outcomes that may emanate out of their choices. Lastly, in the Zero sum scenario, players are likely to loose everything when the other party gains something. On the other hand, in the non zero sum, a player can gain something and still room for his or her opponent to gain it too. Despite all these branches, there are certain common characteristics that make the game theory what it is today. These can be summarized under the following three criterions Extensive or game tree form Normal or strategic matrix Characteristic function All forms of the game theory usually indicate the sequences or patterns of choices available to players and their chances of occurrences. The latter part largely depends upon a device and is usually backed up by some pay offs that are likely to occur after the end of a pattern of choices. The second aspect that makes the game theory what it is the normal, strategic or pay-off matrix. In this kind of approach, one is supposed to look though a series of avenues available to other players in the competition or event. Intersections of these avenues reflect the payoffs granted to a particular player doing the analysis. Additionally, the characteristic function is that possible coalitions that a particular player can ensure for another player regardless of what others end up doing in the process. (Osborne, 2004) Criticisms of the game theory in understanding economic factors or strategic behaviour of firms The most important thing to note in the game theory is the fact that players involved within a certain scenario are rational. It is also assumed that these players have well defined gaols that have been ranked from most important to least important. Besides these, the game theory is founded upon the fact that all decisions that are being made by certain individuals can be attached to a particular value and that players always tend to choose the most appropriate over the last appropriate outcome. However, these assumptions create a hoard of complications in reality. Part of the reason for this is that there may be no unconditionally best or dominant strategy for particular players since there are a number of dynamics that have to be factored in at any one time. (Don, 2008) To illustrate this assertion, one can look at Shell as a case study. The latter company is faced with a lot of pressure from lobby groups, consumers, environmentalists and politicians to include a green product in their product range. Shell asserted that it is working on the program but has never launched this program. The Game theory would suggest that Shell have chosen to delay in launching this program because it is the most productive outcome for them. It would assert that given the overall strategic plan of Shell, introducing environmentally friendly products would not fall in line with Shell's most favourable outcome. However, this may not necessarily be true. Shell may be pushed to their current scenario due to inadequate resources needed to create this line or they may have been pushed to a state of inaction by the failure of their competitors to launch a green product, alternatively, their behaviour may be as a result of poor marketing or so many other factors. Some of them may not even be linked to the ultimate best scenario that the game theory presupposes. Consequently, it can be asserted that this theory in not satisfactory in understanding why Shell have chosen not to make a commitment to environmental issues in their company. The nature of the game theory itself is such that it is best suited to analyze certain scenarios more than others. For instance, the game theory presupposes that possible moves to be made by opponents are well known. However, this is not usually the case, in fact, in certain areas such a politics and business, it may almost be impossible to understand what other players are thinking at that particular time. In business, some players may not be familiar with all the rules in operation or they may not know exactly what options are available to their opponents. (Gul, 2008) Tesco UK best illustrates this scenario. In attempting to compete with other retailers in the market, Tesco began making supply contracts with manufacturers to produce brands specifically for Tesco i.e. it began sourcing for in store brands. The latter company made this decision under the assumption that it would be extremely expensive for other smaller retail stores to the same. However, since Tesco was not familiar with all the rules, they proceeded to streamline their supply chain with the knowledge that they were making the right choice. However, later on, many other retail companies followed in their footsteps thus making their strategic decision invalid. Tesco was no longer the only innovative company in terms of this supply chain. Consequently, it can be argued that Tesco was not aware of all the possible choices available to their competitors and this lack of knowledge of the future possibilities affected the overall best outcome of their decisions. This aspect had not been taken into account by game theory enthusiasts. There are certain cases in which the game theory has been used in understanding economic actors. For instance, this theory is particularly applicable in determining which economic alignments are most suitable for certain actors and which ones would yield the most feasible results for them. For instance, in understanding emerging world economics, the game theory has been used to understand the dynamics that explain alliance formation in the twenty first century. (Osborne, 2004) During the twentieth century, alliances were a common issue especially among European countries. However, in current times, many economists want to study the potential behaviour of emerging Asian economies such as China. Using the game theory, these adherents have tried to determine whether China will align with other Asian countries such as Japan and Thailand in order to be a stronger super power or whether it will liaise with western countries in order to curb competition among fellow Asians. The game theory tries to bring out how countries are likely to make their decisions in order to have the most feasible outcome for their economy. However, many critics have brought out the fact that using such a theory to understand the world's macro economic situation would be trying to oversimplify matters. In fact, these opponents claim that the game theory reduced countries to extremely rational parties who consider each and every intricate detail before making their decisions. Additionally, using the game theory in this manner also highlights the fact that the theory has not considered the human aspect of the theory i.e. that economic actors are jut like any other human beings and they have emotions as well. The game theory attempts to treat economic actors like bloodless individuals or automated machines and this severely impedes the usability of this theory. The game theory is largely based on a number of counterfactuals. In fact, most critics assert that the game theory is quite inadequate to prove scientifically because most of the fact that the decisions made by players cannot be measured empirically. Additionally, those issues cannot be properly observed and this makes the theory extremely hard to rely on. For instance, most of the time, it is assumed that certain players are well aware of the contingencies and that they have taken them into account. However, it may be very difficult to measure some of these contingencies and the process of reconstructing them is extremely difficult. (Gintis, 2000) Taking the example of Tesco retail stores; the latter company made the option of introducing low fat or low calorie diets because of the fact that they were wanted to attract a large client base. This decision to introduce a new of commodities must put include a number of factors such as; Potential market Likely market segment Value of new product line Possible demand for the commodity Production capabilities Competitors product offerings Etc The game theory presupposes that the party making this decision had the ability to consider the decisions to be made by Tesco's suppliers who were the ones to produce them. The game theory would also suppose that Tesco knew what their competitors were planning and even quantified it in terms of the process offered for the new product line. Additionally, the theory would also assume that Tesco was well aware of the transportations and logistics dynamics involved in making this new innovation a reality. While some of the latter assertions may be true, it should be noted that Tesco had no way of factoring in all these dynamics for making that strategic choice. Consequently, the game theory brings out a high level of abstractness in analysing Tesco's strategic choices. (Miller, 2003) The game theory largely presupposes that actors are extremely rational individuals. It brings to the fore the importance of making strategic decisions in maximising one's profitability or one's positive outcomes. While this assertion may seem like it makes a lot of sense on paper. Most of the time, it does not apply to real life scenarios. Shell was declared the most successful company in 2007 during the UK companies report. In response to this declaration, most critics have asserted that Shell's profitability is not as a result of the strategic direction; instead, these individuals have claimed that Shell has been doing well because of the oligopolistic nature of the petroleum industry in the UK. Additionally, it has benefitted from the fluctuations in oil prices and also forms the fact that the commodity is a necessity. Most of these reasons do not fall in line with any rational choice. In fact, most of them have come out of external factors that have favoured the company rather than conscious decisions made by this particular actor. In other words, the game theory would not have been successful in explaining why certain decisions have been made. This is because it is rather difficult trying to justify certain kinds of patterns of behaviour when one has very little that they can contribute towards controlling it. The latter table is an illustration of the basic concept behind the game theory and exactly what needs to be done in order to realize this phenomenon. A A1 A2 A3 B B1 0 2 4 B2 -1 0 3 Source; (Gul, 2008) Through the latter table, it will be possible to understand how inappropriate the game theory is in real life scenarios especially in terms of placing certain issues in context. The first thing that can be seen from the latter diagram is the fact that the game theory places a lot of importance to the aspect of players. According to adherents of this theory, it is possible to understand economic actors or parties within a certain business deal only when one treats them as opponents. Players are likely to reap maximum rewards when they dwell with their respective payoffs. It should be noted that by treating each player as an opponent to the other, then the game theory is introducing a bias that critics like to call the 'competitive bias'. In other words, the game theory presupposes the fact that every single business entity is governed by individualist ethics. While there have been adjustments made in this theory to include non cooperative scenarios, one cannot ignore the fact that a large chunk of the theory dwells on the issue of opposition to one another. In close relation to the latter fact is promoting the idea that all the players in a certain business scenario are fixed. The n-person versus the two person approach is common one in the game theory. Most of the time, there is an inclination to reduce these numbers of players so as to come up with a comprehensive analysis. However, in the process of doing this, the game theory fails to take into account the different dynamics that go on macro entities such as organisations. (Gintis, 2000) For instance game theory adherents would use the game theory to explain why Tesco retail stores are doing exclusively well in their respective industry. The theory would treat the entire Tesco as a player in its own right with synchronized thoughts and ideas. In reality, this is not true. Tesco is a diverse entity with various employees. While these groups may share a common vision, they all have their own talent, capabilities and interests. Treating Tesco like a single entity may undermine the contributions made by specific individuals. For instance, in trying to place the matter in context through the game theory, one may not see the contributions that particular employees made in creating the Tesco concept. This makes the theory a simplistic one. It should be noted that some of assertions made in this game theory are not flexible enough for real life scenario. For instance, in the case that a particular scenario or business entity is faced with strategic decisions, it is assumed that the choices considered prior to making that strategic decisions are highly static. In real life scenarios, this is not usually the case, a number of negotiations may be made or agreements introduced in the process of trying to understand why certain decisions are made and why others are not. Consequently, the game theory operates in such a manner that it does not recognize unusual or new solutions. Taking the example of Shell; in order to maintain its lead position as one of the most profitable companies in the region, Shell had to keep its expenses to a minimum. Consequently, game theorists would assert that this company's strategic decisions would be to place greater precedence on minimising cost rather than on employee satisfaction. However, in real life, there are other entities that changed the dynamics of this issue. One such group is made up trade unionists. These groups have pressured Shell to such a point that it had to readjust their cost cutting measures so as to include this new entity. The game theory would not have been able to fully account for such an issue and this makes the theory very problematic in trying to understand certain business issues. The game theory is therefore not appropriate in understanding economic actors or business entrepreneurs because of the fact that it is founded upon static choices. This tends to reinforce status quo and eventually ignores the fact that human beings have the ability to construct their own paths. This is what has happened in the past ant this is what may happen in the future. (Gul, 2008) Conclusion The game theory is has its own strong points. However, in terms of understanding business scenarios, the theory places to much precedence on the player as an opponent. Additionally, it tends to ignore the fact that human beings have emotions that may hinder them from making rational decisions. Lastly, the game theory has a bias towards reducing the numbers of actors to the least minimum number thus under looking some of the intricate matters involved in macro entities. Reference Don, R. (2008): Game theory - the Stanford encyclopaedia of philosophy; Stringer link Publishers Gintis, H. (2000): Game theory evolving: a problem-centred introduction to modelling strategic behaviour; Princeton University Press Gul, F. (2008): Behavioural economics and game theory; New Palgrave Dictionary of Economics Miller, J. (2003): Game theory at work: how to use game theory to outthink and outmanoeuvre competition; McGraw-Hill Osborne, M. (2004): An introduction to game theory; Oxford University Press Read More