GAME THEORY AND

BUSINESS STRATEGY
How Game Theory can Structure our Thinking on
Business Strategy
A repertoire of action

Conflict Collusion

Competition Collaboration

Co-creation
 Using game theory to shape strategy

According to Brandenburger and Nalebuff

(1995), game theory:
Provides a systematic way to understand the
behavior of players in situations where their
fortunes are interdependent (p. 57)
Successful business strategy is about shaping the
game you play, not just playing the game you find
(p. 58)
Key Insight: Allocentrism concerned with
the interests of others or seeing from
others point of view, e.g. using your
understanding of their response to your initial
action to shape your first move
Knowing the game
Game theory includes a wide variety of games
with various players, strategies and pay-offs
Typically used to explain and predict human
behaviour, including behaviour of firms and
consumers

The prisoners dilemma is probably the best

known game studied in game theory - a non zero-
sum game of two players and two strategies:
Cooperation or defection
 Prisoners dilemma in the newspaper industry

Wall Street Journal

No charge Charge
(Defect) (Collaborate)

2 1
No charge
(Defect)

2 6
New York
Times

6 4
Charge
(Cooperate) 1 4
 Prisoners dilemma in the newspaper industry

Wall Street Journal

No charge Charge
(Defect) (Collaborate)

For New York Times No charge or

No charge defection is dominant strategy
(Defect)

2 6
New York
Times

Charge
(Cooperate) 1 4
 Prisoners dilemma in the newspaper industry

Wall Street Journal

No charge Charge
(Defect) (Collaborate)

2 1
No charge
(Defect)

2 6
New York
Times

6 4
Charge
(Cooperate) 1 4
 Prisoners dilemma in the newspaper industry

Wall Street Journal

No charge Charge
(Defect) (Collaborate)

2 1
No charge
(Defect)
For Wall Street Journal No charge or
defection is also dominant strategy
New York
Times

6 4
Charge
(Cooperate)
 Prisoners dilemma in the newspaper industry

Wall Street Journal

No charge Charge
(Defect) (Collaborate)

2 1
No charge
(Defect)

2 6
New York
Times

6 4
Charge
(Cooperate) 1 4
 Implications
Prisoners dilemma shows that rational
strategies do not necessarily lead to optimal
outcomes

Collaboration usually requires trust and

experience
 Co-opetition: Value Net
Customers

Substitutors Company Complementors

Suppliers
Competition AND Cooperation
The Value Net
The Organizations Value Net (p. 60) has 4 Players
Customers: Provide revenue
Suppliers: Provide resources such as raw materials and
labor
Substitutors:
Type 1:alternative players from whom customers can purchase
products/services (e.g., Coke/Pepsi)
Type 2: Organizations that compete for the same raw materials
are also substitutors
Complementors: players from whom customers buy
complementary products (or to whom suppliers sell
complementary resources)
Hardware and software are complementors
Examples from the past
 Changing the game: the PARTS model

Five elements of the game that can be changed:

1. Changing the Players (add, subtract, role
change)
2. Changing the Added Values (what each
player brings to the game, can be raised and
lowered)
3. Changing the Rules (limits to possible
reactions to any course of action; can be altered if
you have the power)
4. Changing the Tactics (moves to change
perceptions)
5. Changing the Scope (setting the boundaries
of the game)
1. Changing the Players
By adding another player (HSC), Coke/
Pepsi were able to reduce the power of
the existing supplier (Monsanto)

By paying to create cheap hardware,

3DO increased the attractiveness of its
own software
2. Changing the Added Value
Raise your Added Value or Lower the Value
added by Others
Raise your added value: Creation of TWA
comfort Class; GM Card
Lower the value added by others: reduce
retailer power by reducing supply of a highly
valued product; reduce complementor power
by doing work in-house; reduce supplier
power by using generic technology (Nintendo
example)
3. Changing the Rules
Rules determine how a game is played by
limiting the possible reactions to any course of
action.
Look forward and reason backward.

Potential competitor responses to new entrant:

Accommodation or Retaliation
Challenge: How do we create accommodation
by incumbent as opposed to retaliation?
n Kiwi Airlines (stayed small)
4. Changing Perceptions
Either reduce the fog (eliminate
uncertainty) or thicken the fog (create
uncertainty)
Daily News vs. New York Post
(Murdoch) pricing example
NYP wanted 50 cents, DN did not
match, so NYP cut to 25 cents. Threat
of 25 cents made DN match NYPs 50
cent price.
5. Changing the Scope

Changing the Scope: can expand or

restrict the game
Nintendo had lead in 8-bit game, so Sega

came to dominate the 16-bit game

Creating and Capturing Value in the Value
Net: Exercise

Go into teams
Choose a company whose business model is familiar
(e.g. Coca-Cola, Apple, Wal-Mart)
Map out its value net
Identify at least 3 actions based on the PARTS model
that in your view will enable the organization to increase
value generation and capture. Try to include both win-
win and win-lose actions.
Some teams will be asked to make short presentations
of their discussions
Value Net for Coca Cola

Customers: ?

Complementors:
Substitutors: Coke McDonalds,
Pepsi, ? Wal-Mart, ?

Suppliers:
NutraSweet,
Sugarcane producers,
Water suppliers