This is part three of Breaking Down Corporate Strategy, a three-part series of articles where I explore the components of corporate strategy, the factors that steer its development, as well as a side discussion of game theory and its interesting relation with corporate strategy. Read Part One here.
This is the final article in our three-part series, Breaking Down Corporate Strategy. So far, we’ve discussed what corporate strategy is, what it isn’t, and most importantly, what drives it. In the first article, I mentioned that corporate strategy is dependent on the market landscape — that makes sense. We want to develop a strategy that takes into consideration the various external business factors to mitigate risk and improve the odds of capitalizing on market opportunities.
However, the relation of a company’s corporate strategy with its surroundings goes a lot deeper and finds its roots in an extremely famous behavioral economies phenomenon called Game Theory.
What Is Game Theory?
Chances are you’ve already aware but if you need a refresher, game theory, at its core, is the study of calculating outcomes. It has most likely existed in various forms and names throughout human history but it became its own field of study in the 1950s.
While calling it the “study of calculating outcomes” is apt, it’s also a gross oversimplification. Game theory is closely related to other fields including mathematics, economics, social sciences, and to a certain extent, psychology. It has found major applications in business strategy, biology, computer science, political science, and many other fields you may not expect.
However, we’re interested in game theory’s application in behavioral economics — as the science of knowing what other people (companies) will do. Business schools all over the world introduce students and future managers to the concept through thought exercises such as the prisoner’s dilemma or the ultimatum game.
But it’s important to understand that game theory is a lot more dependent on computer-based mathematical models than ever before. Game theory may be a mental exercise in our day-to-day lives and in the boardroom to a certain extent, but for most enterprise-level applications, game theory is not something that can be done inside your brain on a whim to find answers.
An Example of Game Theory
Game theory is a field of applied mathematics using complex mathematical models and formulae to reliably find answers to real-world problems. There are more than a dozen different “games” with hundreds of rules that mimic the conditions found in the real world.
For instance, a common assumption in economics is that we’re studying a “rational being” but companies often make seemingly “irrational” decisions because they are not playing by the same rules as we are. These types of games are called asymmetric games and one of the most popular versions of this game is called the Ultimatum Game.
In essence, the Ultimatum Game pits two individuals, the Proposer, and the Responder, in a situation where they must split a set amount of prize money. However, the money will only be distributed if the Responder accepts the Proposer’s offer. Traditional economics dictate that the Responder would be a rational being who would always accept the offer because they would get something at no cost.
But you and I both know that if the Proposer made a ridiculous offer, such as a 99:1 split, the Responder would very likely say no. And because this game involves different strategies for each player, finding a fair offer (or equilibrium) is more complicated than you might think.
Corporate strategists deal with similar situations all the time. For instance, a team of corporate strategists will share their views on how the market (competitors) would react to a new product. Finding the right pricing strategy, in particular, is very important. Most firms want to avoid a price war and so they’ll try to find a price equilibrium that doesn’t force everyone into a price war.
Game Theory and Corporate Strategists
One of the unwritten job requirements of a corporate strategist is to predict what other companies in the market will do. What many don’t realize is that this is just as much about mathematics as it is about psychology (if not more). Most corporate scenarios can be defined in terms of a “game” with set rules and possible outcomes. A corporate strategist’s job is to first identify both the rules and outcomes for each competitor and then evaluate the likelihood of each outcome.
Like in a game of chess, we’re anticipating our opponent’s move and playing accordingly. And like in a game of chess, we also consider that the opponent is the same thing — making corporate strategy a dance between firms, of sorts. Tango, perhaps.
