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Why Game Theory Is Important for Business Leaders

Competition in business is a given. In the business environment, "winning" is a matter of securing competitive advantages through effective decision-making, strategy development and execution. Applying game theory can help business leaders consider, analyze and improve the actions they take.

This focus on theory, strategy and decision-making is a feature of In the Emporia State University (ESU) online Master of Business Administration (MBA) degree program the coursework includes game theory and how it can be applied to provide a competitive edge in various industries and situations.

What Is Game Theory?

According to Market Business News (MBN), "Game theory is the study of how and why we make decisions. It is the formal study of conflict and cooperation … where the outcome of one person's decision depends critically on the actions taken by other participants."

Essentially, game theory involves making decisions based on predictions of an opponent's future actions. Thus, game theory informs strategic decision-making in numerous settings, from the sciences to business and politics to war.

How Can Game Theory Help Business Leaders Make Better Decisions?

MBN elaborates on game theory in the context of business environments: "Competition between two companies can be analyzed as a game in which the participants play to achieve a long-term competitive edge, maybe even total domination — monopoly."  

It is a simple concept. A business leader bases managerial decisions and strategy on several factors including their prediction of a competitor's moves and planned responses to those moves. If forecasts are accurate, game theory provides a mathematical framework to analyze the course of action most likely to yield the desired outcomes.

Such preparation helps leaders make informed choices regarding everything from pricing and product launches to target market selection and marketing campaigns. In a way, the concept of "securing a competitive advantage" involves putting game theory into action to produce results.

But game theory in business decision-making generally concerns more than a simple, binary relationship between two competitors' actions. There are often many competitors on the "field" of any industry. Every step taken by a competitor can cause a chain of reactions and events long into the future. When the number of variables goes up, it becomes challenging to predict long-term outcomes accurately.

Plus, a successful business growth strategy often relies on a unique blend of stability, innovation and, at times, disruption. But predicting the impact of innovation and disruption on a company also calls for risk assessments and cost-versus-benefit analyses.

A dynamic game theory approach would also consider unpredictable variables as well, charting likelihoods of outcomes for various scenarios. Then, the strategic leader will be ready with a range of reaction plans.

Like chess players, business leaders apply game theory plans for various scenarios and think many "moves" ahead. They prepare for rapid, preplanned iteration of strategy as needed. This anticipation can help businesses grow while remaining competitive and agile in disruptive, uncertain times.

What Are Some Potential Pitfalls of Game Theory in Business Management?

As with any construct, game theory has pros and cons depending on context and application. For instance, one-dimensional forms of purely competitive game theory can have negative results. Economics professor Avinash Dixit refers to this as a real-world dilemma in an American Experience article on game theory. In a simple example related to business, Professor Dixit views competing stores as victims of a dilemma for undercutting "each other's prices when both would have done better if both had kept their prices high."

This example shows that cooperation in terms of stable price matching would benefit both stores in the long run, keeping profits higher. Considering the long-term outcomes of multiple generations of actions and reactions constitutes a more dynamic form of game theory, which would support cooperation as the best strategy.

Another potential pitfall of basing strategy on game theory is mistaking intuition for accurate prediction. While intuition plays a role in setting strategy and making decisions, the projections need to be reliable. Unfortunately, intuition alone is not always reliable as it is often susceptible to assumption, bias and desired outcomes.

As Professor Dixit explains, "What game theory does is to unify and systematize such intuitions." Data analytics and business intelligence tools can help parse out unfounded intuition from accurate predictive analysis. Combining game theory principles with insight from these tools helps business leaders make informed decisions, driving growth and success through competitive and cooperative strategy.

Learn more about Emporia State University's online MBA program.

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