Strategic Business Management and Game Theory: the Theory of Games Into the Business - Research Paper Example

 In the last three decades, game theory has been appropriated to an increasing number of practical issues: from antitrust examination to financial policies; from auction proposals to forming incentives; and from battles on exclusive rights to argumentative resolutions. Today, the integration of the theory of games into business management theory provides the most innovative approach in the evaluation and implementation of business resolutions. The focus of game theory in strategic business management encompasses the particular issues of market rivalry, maximum profits, negotiations, tactical maneuvers, competitive auctions and the “balance of power” amid the company, its consumers and its suppliers (“Business Management Theory and Concept,” no date). How is it played? There are five elements in the game theory, namely: (1) the players or decision-makers; (2) on-hand strategies of each player; (3) set of rules governing the players’ actions; (4) the consequences of the players’ choices; and (5) the payoffs amassed by each player. The players take actions in agreement with a certain set of rules. This game presumes that each player will follow the strategy that will yield maximum long-term profits. Some games may be a “winner-take-all” wherein only one business emerges as the winner; some games with players having common interests, however, may require cooperative strategies to attain the highest possible payoffs (Smith, 2010). An easy version of the game theory that is most commonly used by companies worldwide and centers on the outlook of competition is the “prisoners’ dilemma.” This game is a crisis between two prisoners wherein their destinies are dependent on whether one or both of them confess or remain silent concerning a suspected crime. Prisoners’ dilemma has effective applications to business. Every competing company has the alternative to either agree to the consented fundamental pricing arrangement or to cheat by introducing a price cut-off plan. Although some companies may have the mutual interest of cooperating rather than competing, pursuing self-interest by cheating on a collusive agreement may be worse for both companies. This scenario is quite basic in a prisoners’ dilemma. A thorough examination of decisions has manipulated the universal business atmosphere and is essential in forming conformity transactions (Pinkasovitch, 2010). To illustrate a perfect example of prisoners’ dilemma, here is the case of two cola giants: Coca-Cola and Pepsi. Both firms must choose a pricing tactic. With the combined market power of both firms, each firm gains high profits when they both raise the cola price. However, if one firm decides on deception by lowering its cola price, the rival’s customers will automatically switch to the cheaper cola, hence, a bigger income for the cheater. Cheating, which is the foremost strategy of every business in the pursuit of a bigger policy interest can be damaging for both companies. In some cases, companies are better off when they cooperate (Dixit & Nalebuff, 1991). Narrowed to its fundamentals, game theory is an instrument for realizing the effect of judgment on both rival companies. Before the introduction of game theory, assumptions were made that behaviors of rival firms do not affect each other. However, today, game theorists dispute that in order to survive in the modern business world, each player has to map an approach based on how other competitors may react and behave (Shor, 2008). John Roberts, the Jonathan B. Lovelace Professor of Economics at the School, says "One of the messages that game theory gives you is that you need to forecast accurately the beliefs, the expectations, and the behavior of other parties with whom you're interdependent in terms of profits and payoffs" (Buell, 2010). Game theory assists companies in working out schemes on how to deal with emerging competitors and how to discourage market invasion (Frary, 2009). It is fundamental to know who are actively playing the game. Unpredicted outcomes may likely occur even in the slightest alteration in the number of players. The case of two sugar-free sweetener firms and two soft drink companies best illustrates this theory. NutraSweet is a low-calorie sweetener used in Diet Coke and Diet Pepsi. In the 1980s, Holland Sweetener Company attempted to fracture the monopoly of NutraSweet in America’s sugar-free market. NutraSweet, in order to protect its dominant position in the market, agreed with Coca Cola and Pepsi to a price cut-off. Consequently, Holland Sweetener, as an emerging threat was removed. When rivalry between two players becomes advantageous to third parties, there is a possibility for the winner to share its profits. To all intents and purposes, Holland Sweetener surrendered its share of the gains, thereby unexpectedly helping the two cola giants to succeed (Shor, 2008). A sure technique to victory is a firm’s indispensability. In the late 1980s, Nintendo dominated the video-games business by limiting all software developers to creating only five games each and keeping retail stores on short rations. The brilliant strategy of hooking its consumers, plus the short supply of Nintendo games gave way to the success of the company. Consumers were willing to purchase games even at a much higher cost. (Shor, 2008). On the other hand, the mighty IBM which was incompatible in the computer world stockpiled its problems when it decided to enter the personal computer market and permitted Microsoft and Intel to expand the interior processing unit and software. Because of this, imitations of the IBM computers emerged in the market. The Intel chip and MS-DOS operating system came out at an equally good quality and a much cheaper cost than the IBM (Bowen & Fagan, 1993). Although more companies are using the game theory, there are some that are hesitant to discuss details as to how they play the game. Others may not even confess that they use game theory in honing their business strategies. Decision analyst, Frank Koch of the oil pioneer Chevron admits, "Game theory is our secret strategic weapon." Koch openly conferred how game theory predicts reactions of foreign governments and retaliations of competitors when Chevron goes on board intercontinental ventures. "It reveals the win-win and gives you the ability to more easily play out where things might lead," he declares (Rappeport, 2008). One sensible use of game theory, according to Brandenburger and Nalebuff, is to aid firms in deciding when it is safe to compete and when it is time to cooperate. This process is called “coopetition.” Some products, as viewed by consumers, are requisites to one another, for example, hotdogs and mustards; Microsoft and Intel (Shor, 2008). Sometimes, for rival firms to maintain making high profits, it is more reasonable to cooperate by merging ideas or avoiding price wars through conspired price plans (Frary, 2009). “Co-branding” is an accord of strategic coopetition between two concurrently competing and cooperating businesses for achieving viable gains through “operational synergy.” This strategy of game play constitutes two different non-competing firms that can possibly share dedicated customers by mutual integration of brand icon, status and integrity in the market where customers seem to have harmonized partialities and joint routines. The global introduction of the ‘Nike + iPod Sport Kit’ product from two of the world’s famous brands, Nike and Apple, proved the successful implementation of game theory in the strategic coopetition of both non-rival firms, although not in identical quantities at a global stratum (Rodrigues, 2009). Criticisms on Game Theory While some companies may attest to the effectiveness of the game theory, some experts remain doubtful on the theory's success in the “real world.” Critics argue that the theory is in conflict with natural human behavior. The presumption that all game partakers will behave based on reason is counterfactual to the reality that general psychological partialities on economics can undoubtedly create unreasonable decisions (Rappeport, 2008). "Game theory assumes rationally maximizing competitors, who understand everything that you're doing and what they can do," says John Horn, a business consultant at McKinsey. "That's not how people actually behave," he added. Horn articulates that in game theory, human nature is given extra unnecessary recognition. The newest study on competitive behavior revealed that business firms overlook impending actions by rivals, depending reflexively on unstable basis such as the news media and annual reports. When these companies are faced with emerging threats, they respond instinctively by mainly centering on future maximum profits and market allocations (Rappeport, 2008). In the book, “Economics and the Theory of Games,” it was noted that game theory may have failed due to this rationale: some games are solvable and some are not; and those that are solvable are at times presented with countless solutions that are mostly improbable. In some games, it is only natural that theorists may not provide clear-cut resolutions. This does not mean that the applied game theory is due to fail. Even the most experienced game theorists could not constantly give an instant, single balanced solution in this multifaceted illogical world (Bacharach, 1976). Another criticism against game theory is that the theory twists a person’s outlook of humanity, as one of egotistical relations. On the other hand, game theory singlehandedly “has no moral content, makes no moral recommendations, is ethically neutral.” It examines but not suggests egotism (Aumann, 1987). Because game theory is mathematical, the majority of its detractors claim that the theory is rather insufficient to verify scientifically since almost all decisions of game players are incalculable as experiments. Furthermore, the theory becomes unreliable as those matters are inaccurately perceived. More often than not, in game theory, competitors are presumed to be knowledgeable about unforeseen events and that they have taken these events into consideration. While it is nonetheless risky to make computations on the possibilities, it is likewise very complicated to restructure those (Gintis, 2000). Conclusion The main concern with game theory is that it is obligatory to formulate assumptions. However, reducing these assumptions into its simplest forms cannot be performed with accuracy. There is always an invariable tradeoff relating to practicality and solution. Although game theory applications can precisely illustrate the decisions of the competing firm, still, it is impossible even with the most innovative computer to measure it. Some presumptions made lack flexibility to be applied in real-life situations. Given a certain situation when a business entity is confronted with the most challenging tactical decisions, game theory supposes that the options regarded before tactical resolutions were made are stationary. This set-up is not what really transpires in the real world. A compromise and conformity between two competing firms have to be met to effectively realize the feasibility of certain decisions. The nature of game theory may overlook solutions that are out of the ordinary or innovative. Sometimes, decisions made do not follow rationality. Mostly, these decisions actually came from peripheral aspects that have favored the company and not from conscious resolutions of the game player. Game theory sometimes puts too much importance on competition. The success of a business does not have to be based on the rival’s failure. It does not have to be a win-lose game between two competing firms. Rivals may sometimes be better off when they cooperate. References Aumann, R. J. (1987). The New Palgrave: A Dictionary of Economics. Vol. 2. Ed. Eatwell, J., Milgate, M. & Newman, P. Macmillan, London: England Bacharach, M. (1976). Economics and the Theory of Games. Macmillan, London: England Bowen, D. & Fagan, M. (1993). System failure that brought down IBM: Technological Change overtook the computer giant and now its culture needs to change. The Independent News and Media Limited. Retrieved 30 April 2010 from: http://www.independent.co.uk/news/business/system-failure-that-brought-down -ibm-technological-change-overtook-the-computer-giant-and-now-its-culture-needs- to-change-david-bowen-and-mary-fagan-report-1480526.html Buell, B. (2010). Game Theory: A New Tool for Economists. Stanford Graduate School of Business. Retrieved 30 April 2010 from: http://www.gsb.stanford.edu/news/research/econ_gametheory.shtml Business Management Theory and Concept. (no date). Economy Watch. Retrieved 30 April 2010 from: http://www.economywatch.com/business/business-management-theory.html Dixit, A. & Nalebuff, B. (1991). Thinking Strategically: A Comparative Edge in Business, Politics and Everyday Life. New York: W.W. Norton. Frary, M. (2009). Game Theory Keeps Serious Company in the Real World. Times Online. Retrieved 30 April 2010 from: http://business.timesonline.co.uk/tol/business/related_reports/business_solutions /article5792397.ece Gintis, H. (2000): Game theory evolving: a problem-centered introduction to modeling strategic behavior. Princeton University Press Pinkasovitch, A. (2010). Why is Game Theory Useful in Business? Investopedia. Retrieved 30 April 2010 from: http://www. investopedia.com/ask/answers/09/game-theory-business.asp Rappeport, A. (2008). Game Theory Versus Practice. CFO Publishing. Retrieved 30 April 2010 from: http://www.cfo.com/article.cfm/11700044/c_2984335/?f=archives Rodrigues, F. (2009). Strategic Coopetition of Global Brands: A Game Theory Approach To ‘Nike + iPod Sport Kit’ Co-branding. Munich Personal RePEc Archive. Retrieved 30 April 2010 from: http://www. mpra.ub.uni-muenchen.de/16146/ Shor, M. (2008). Game Theory Readings. Owen Vanderbilt. Retrieved 30 April 2010 from http://www2.owen.vanderbilt.edu/mike.shor/courses/game- theory/docs/ lecture01/Economist.html Smith, S. (2010). Game Theory. Beyond Intractability. Eds. Guy Burgess and Heidi Burgess. 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