Sunday, July 12, 2020

Game Theory-Decision Making and an American/Chinese New Market Example

Game theory has been known as an effective decision making tool in business, government, biology and in the military. It is a mathematical method of understanding possible outcomes based on the decisions of other members within a system. The theory has its advantages in terms of helping decision making but there are limitations and thus it should be used as a support but not necessarily supplant decision making. The brain is still the most powerful processing system for abstracts, contingencies and opportunities.

Game Theory as a Support

Game theory may help us make decisions but can't supplant good judgement. However, without such systems the "gut" feeling and intuition can damage the rational thinking process. Thus, strategic leaders should us such system to help themselves thing through potential alternatives. Using a rational system helps round out and provide more insight into there thinking strategies and systems.

That same finding was found ,

 "is perfect because different situations or problems within the organization have to be handled in different unique ways. The bottom line is that game theory can be used very effectively as a tool for decision making whether in political, psychological, economical, personal or business setting. However, this should not be used as a substitute for good judgment in strategic decision-making; it is just an enabler in critical thinking. Game theory only sheds a light on why businesses behave the way they do and why they go for specific strategies available through transparency."

How Game Theory Works

The theory started in 1944 by Von Neumann and economist Oskar Morgenstern who published a beautiful book called "Theory of Games and Economic Behavior". The theory helps people make choices by evaluating options and "pay off" based on the movement of players. To formalize thinking and create some quantitative level it is often placed into something called the "pay off matrix". Such a matrix is simply X and Y (many more levels as players enter and leave the game). 

The matrix helps us to factor in information we know about the market and the competition to determine which is the best approach. The "pay off" is based on what someone expects to make or not make in each of the scenarios. As the market changes and you make choices there are changes within your position and pay off of available options. No one truly wins until the last player is in checkmate sort of speak. 

Marketing and Product Lines as an Example

Let us assume that an American Company conducted a market analysis and plans to earn $25 million if they enter and manufacturing in a Chinese market. A Chinese Company is currently earning $5 million with a sub par product that doesn't capture market demand well. (This is only an example). If the Chinese company adapts to the change and uses the new acquired technology gained legally or illegally from the American company they could find themselves in 3 years to have parity of $15 million to $15 million as manufacturing and marketing come into full speed.

The game changes as the scenario changes. If the Chinese company solicits the government to place more regulations on the American company through restricting supplies, labor requirements, requiring Chinese vendors, location adjustment, higher taxes, etc....the Chinese Company will earn $20 million and the U.S Company position will be reduced to $10.  Parity is now lost.....

It there are other changes it may dwindle the competitive example of the American company and if there is theft they may end up loosing more than if they didn't invest in the market at all. Thus, the rational choice may be to not manufacture in China and try and sell products manufactured in the U.S. and sold into China.

This is only an example often discussed in the news but could apply to many different nations. 

Errors in Projection Creep In

There are some assumptions that each player is looking for a rational pay off. The key term is that rationality is the main point and based on what vantage point each of the players use. We sometimes assume that people are rational and we know that isn't always the case. With one understanding in the free market system companies compete against each other and therefore different rational assumptions will be made than if we were dealing with two different major political systems with different rational assumptions (Capitalism vs. Communism).

As an example, if the goal of the company is primarily to make a nation stronger and only secondary to make a profit that would change the assumptions of what decisions are likely to occur under different scenarios. Thus.....rationality is often bounded by culture, creed and political system that would impact the way the matrix is created. It furthermore increased the need for international trade to be functioning off of similar economic assumptions and basic universal value systems.

Such large scale matrix can be extremely in depth and complex. Something like the prisoners dilemma may be easy to understand but something like complex international business or national conflict could be much more difficult. As the contingencies grow so does the matrix and also the potential for miscalculation. We must make some assumptions such as how much capital a company has, labor resources, skill level of managers, government policies, etc... etc... etc... the more complex the game the more likely there will be errors in the projections. (...not only my grammar and spelling)

Good Decision Making and Game Theory

There are two ways to sort of look at rational choice. On one side we can use a rational system such as Game Theory, Scientific Method, Legal Logic, other Logos, etc... to determine what the best course of action. On the other side we can use our thinking and gut feeling (which is sometimes based in rationality and sometimes in emotion) to determine what the best course of action could be. My suggestion is that you use a little of both....Listen to your gut and experience as well as a formal decision making system like Game Theory to help you make decisions. Often go back and adjust your matrix and new factors way in (i.e. culture wars, tariffs, etc...)

Askikomurwa, V. & Mohaisen, M. (2015). Game theory and business intelligence in strategic business decisions-A review. Proceedings of 5 th ISERD International Conference, Bangkok, Thailand, 17 th June 2015, ISBN: 978-93-85465-36-9

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