Making Game Theory Work
Making Game Theory Work
A Practical Guide for Business Leaders
Business leaders are naturally drawn to game theory. They recognize that their own decisions don’t exist in a vacuum and that outcomes are often influenced by the actions of external players—competitors, suppliers, regulators, customers, unions, and partners. The idea that applying game theory could help predict and even influence these actions feels like an obvious improvement over traditional strategic approaches, which tend to assume that external players are static and passive.
The allure is clear. Yet, despite their interest, most leaders don’t know how to use game theory in practice. In business school, their exposure to the subject was often limited to the classic 2x2 model and the Prisoner’s Dilemma. While these simplified models, as David McAdams points out in Game Changer, can offer valuable insights, they don’t capture the full complexity of real-world strategic problems. In practice, most complex real-world scenarios involve 3-7 players and 20-30 strategic options.
Before diving into the process, let’s address a key question: When should game theory be applied? Understanding the motivations and actions of external players is critical in many situations. Techniques like wargaming and scenario analysis are useful for exploring how these factors might affect a company’s strategy. But when the outcome depends on the interaction between your company and external players, game theory becomes essential. It’s simply the best tool when the issues are complex, well-defined, and when outcomes are shaped by the interplay among multiple actors.
For example, complex negotiations are a prime candidate for game theory—whether dealing with suppliers, partners, unions, or regulators. Yet, although negotiation strategy is a well-established field, even experienced negotiators can make costly mistakes:
They fail to fully consider their counterpart’s interests and available options.
They overlook the true value of key levers, both for their company and the other side. In one negotiation, internal experts identified 17 levers as “top five” priorities, a misalignment that could have been disastrous.
They neglect the influence of external players not directly involved in the negotiation. These unseen players can derail a deal if ignored.
Game theory can significantly improve outcomes in both complex strategic challenges—like new market entry and pricing—and more straightforward scenarios, such as the FCC’s spectrum auctions. However, its true value lies in its ability to unravel the intricate actions and reactions of multiple stakeholders, helping companies navigate complexities and avoid common pitfalls.
The Game Theory Process
At its core, game theory predicts how players will behave based on their interests. To build a useful model, you need to answer three fundamental questions:
Who are the players?
What are their options?
What are their preferences?
A successful game theory project begins by getting the right people in the room. This group should include decision-makers, subject matter experts, and those with deep knowledge of the external players. Their involvement not only enhances the accuracy of the model but also increases buy-in for the final recommendations.
The process typically unfolds over two structured sessions. In the first, lasting about 2-3 hours, the facilitator guides the group in identifying the full range of players and strategic levers. The goal is to think broadly, taking a 360-degree view of the situation.
In the second session, which usually lasts 3-4 hours, the group systematically considers what each player— including their own company—wants. Which levers are most important to each player – regardless of whether they control them or want them pulled? This prioritization creates a mental model of the game, revealing insights about the priorities of all parties involved.
The task can seem daunting – ranking 20-30 levers for 3-7 players. For most issues, however, at least some of the group will have a lot of knowledge of the players and what is important to them. Groups quickly get the hang of the task and the facilitator can help. Often, the discussion yields insights about priorities, even for their own company. When there is strong disagreement even after discussion, the analyst can assess the sensitivity of the outcome to the different viewpoints and adjust the findings and recommendations appropriately.
Once the players, options, and preferences are mapped out, game theory predicts which levers will be pulled and which will not—what we call the “Natural Outcome.” This represents the most likely scenario if each player acts according to their preferences, with no unexpected interventions.
But things rarely go perfectly. Sometimes players misjudge the situation, leading to "Danger Outcomes." These risks can help shape strategies to make the company's position more robust or to mitigate potential pitfalls.
The goal of the game theory analysis is to find a "Target Outcome"—one that is both attainable and better for the company than the Natural Outcome. The analysis provides a roadmap of strategic and tactical moves to help the company achieve this result.
Additional analytics on factors like power dynamics and alignment among players help refine the strategy. By considering the uncertainty around preferences and analyzing how other players might approach the game, the company can increase the robustness of its strategy.
Conclusion
Game theory isn't just a theoretical exercise—it’s a powerful tool for navigating complex business challenges. It offers a structured, efficient. data-driven approach to predicting outcomes and improving decision-making. It’s no wonder game theory has a proven track record in improving clarity and driving successful outcomes on even the most complex issues. Why not give it a try?