Game theory has obvious uses in competitive analysis and strategy. That being said, I think we’ve only begun to scratch the surface in how much and how deep game theory is used.
Companies have to come up with a strategy where the worst case scenario for them is still acceptably profitable and best case scenario for their competitor is still less than positive.
- Consider a market with two major players- A and B.
- Every action of A to market its product comes with the intention of harboring profits – be it increasing prices to drive profit per unit, or decreasing prices to drive sales volumes or introduction of a new product to capture the untapped market.
- Market being a closed one, A’s gain will mean B’s loss – B is bound to suffer because of any move that A takes to do better in the market. Hence, B responds with a counter campaign.
This is a classic Nash equilibrium situation where any action directed with a particular outcome in mind, drives reaction from competitors and hence gives less than expected (sometimes unexpected) results. Most of the times, B’s reaction to a particular marketing exercise are already anticipated by A’s market intelligence team, and of all the alternatives that are present, one that acceptably meets A’s objectives in the worst case scenario and pushes back B (in short term generally – in long term, market balances out) is accepted.
In marketing, one obvious use of game theory is in signalling.
Suppose there are two firms producing same kind of products but with different qualities. Game theory can help :
- in deciding whether the firm with good quality product should opt for a certification or standard or any other signal to the market.
- in answering whether the signal will help it gain better payoffs (after considering the cost).
- in understanding whether the low quality product firm can bluff or not by sending the same signal. If bluffing is not possible it makes sense for the firm to invest on certification and send the signal.
Another example is of business schools. Business schools send a signal and this helps in branding of the graduates. For this signal to work effectively, game theory can help in deciding the cost (time, money, effort) incurred to send the signal (earn a b school degree) so that only high performers can send the signal and bluffing is not possible by low performers.