Barry Nalebuff on Business and Game Theory's "Prisoners Dilemma"
Barry Nalebuff is the Milton Steinbach Professor of Management at the Yale School of Management. Professor Nalebuff has written on a wide variety of subjects ranging from strategy to pricing, bidding to bargaining, and innovation to incentives. He is an expert on game theory and has written extensively on its application for managers. His most recent book, The Art of Strategy, is an update of the best-selling Thinking Strategically, which explains the fundamentals of game theory using real world examples.
Professor Nalebuff's work on strategy focuses on the fundamental duality in business—the conflict between cooperating to create a pie and competing to divide it up—which he presents in Co-opetition. His book, Why Not?, focuses on providing a framework for problem solving and ingenuity. His work on product bundling was featured in the European Union's investigation of the proposed GE-Honeywell merger.
Question: How does game theory work in the business world?
Barry Nalebuff: The starting place is to appreciate what the larger game is. And that we’re often focused on competitive strategy, but actually there are many players that you have to appreciate your role with, not just competitors, but what’s the opposite of competitor, and that’s something you may call a complementer [sic], somebody who makes your goods and services more valuable, rather than less valuable.
Think about the relationship between Intel and Microsoft. They are not competing with each other. For customers, Microsoft without Intel isn’t worth much, and Intel without Microsoft isn’t worth much.
What’s interesting about that game is that there also in a little bit of a Prisoner’s Dilemma, but the opposite way that we normally think of. We normally imagine companies are worried about their rivals undercutting them and stealing market share, but here the problem for Intel and Microsoft is each of them is charging too high a price, not too little a price. So think about what cooperation means in a Prisoners Dilemma, nobody confesses, or in a cartel we all agree to keep our prices high.
But if Coke wants Pepsi to charge a lot and Pepsi wants Coke to charge a lot, but from Intel and Microsoft’s perspective, Intel wants Microsoft to be cheap because that stimulates the sales of computers. And Microsoft wants Intel to be less expensive. If they were to get together and agree on pricing, what would they do? They will actually lower their prices because I’m willing to lower my price if you lower yours because you’re lowering your price helps me, and I’m willing to lower my price in response. And so the collusive outcome in the case of complements actually is lower prices, more sales, higher profits and happier customers.
Question: How do contemporary businesses utilize game theory?
Barry Nalebuff: Normally to fold your cards reminded me of an example on the card business.
I think Hallmark [or] American Greeting Cards had done the study which convinced them that in-store printing of greeting cards was a disaster. That ultimately the cards weren’t very successful, it was too time consuming, it just wasn’t going to work.
They could have just folded their cards and walked away, if you like, but they actually left the impression of this was the best thing since sliced white bread, and they created that impression in the market to the point where American Greeting Cards decided to really run with it big time, and preempt them, and that let American Greeting Cards down to dead end.
There is another great example in the battle between Sky TV and British Satellite Broadcasting. This is not that different in the United States from our satellite radio; where there are two companies in the UK competing to see who is going to be the satellite TV broadcaster.
And the UK, it’s a big country but it’s not that big, there’s room for one, and so the question is, who is going to be the one company left standing at the end of the day? On one side was Murdoch, who was bringing the equivalent of Baywatch and shows that people like. And the other was the British Satellite Broadcasting, the BBC; this one is the establishment version, which was better funded, had more highfalutin content and the Her Royal Majesty’s approval.
And both of them were losing gobs and might literally billions of pounds while they are in the market. So the question is, how I can I convince the other side that I’m going to be the one who makes this?
And what Murdoch did was instead of selling satellite dishes, he started to lease them. Now the problem with selling the dish is that if you are the customer and you buy the wrong dish, well, you look like an idiot because you’re putting all these money, you had to explain to your spouse why you got this big planter in your yard now that you’ll be humiliated with the rest of your life.
But if you lease it, and the company goes belly up, that’s their problem, not yours.
And so in this standard’s world, remember we have a Blue Ray and HD DVD, customers sit there paralyzed. They won’t go one way or the other. And Murdoch helped them make that decision even in the face of uncertainty by saying, I’ll take that risk, you don’t have to worry about it and that display of confidence is really what a lot customers to go to his side and, ultimately, is what lead the other side to [keep].
Question: You’ve written, “People cooperate to create a pie, then compete to divide it.” Explain this concept.
Barry Nalebuff: When Avinash [K Dixit] and I wrote our first book, “Thinking Strategically,” the world is a little bit more dog eat dog, or at least we saw it that way. As a result, we were focused on the competitiveness side of things.
But it turns out that strategies and game theory applies just as much to creating cooperative outcomes as it does to thinking about ways be the other parties. Of course, when you are working on a cooperative outcome, you also care about how much you are going to capture, so my goal is not to create value or create pie [that others believe] is to create things that I will get. So how can I work together to do something that will benefit both of us, but will in particular benefit me?
And that could be in the case of the Prisoner’s Dilemma, coming up to think about cooperation. It can be finding ways to structure partnerships that give all of us the right incentives.
And so game theory has focused too much on the zero sum, or beating others, as opposed to the how do you make the marriage or the business partnership successful and long lasting.
Recorded on: Oct 2, 2008
Barry Nalebuff shares his thoughts on cooperation and competition in the business world.
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