It’s tough being a manager; so many decisions. But here’s a blog that will improve management decision making. Most decisions that managers make are complex multi-round affairs. They often involve making one decision, and then waiting to see what someone else will do before making another. Examples abound: in manager-employee relationships; in employee – customer scenarios; or in buyer – supplier issues.
Decisions can be aided by understanding game-theory. The important measure is the pay-off for each party. Games are often zero-sum – someone wins and someone looses. But if compromise can be reached, both parties win. Here’s how it works.
Two drivers are racing towards a single-track bridge. Neither wants to give way – both are in a hurry and want to be first over. They must both make a decision at the same time. Do they keep going and try to win, or do they give in and lose?
How do they decide what to do? By understanding the basic principles of game theory, conceptual models can be used to understand complex problems in order to predict what actions others will take.
This blog considers two models and then shows how they can be used in real-world examples.
This game of chicken (above) has serious consequences if both drivers choose to keep going. The drivers must decide what action to take in a split second, without knowledge of what the other driver (or ‘player’) will do.
There are actually four choices in the above scenario. Lets consider them.
The worst-case scenario is that both drivers continue straight on. This has severe consequences (or ‘payoffs’), certainly injury and possible death. It does however prove they are strong-willed. To swerve would show weakness.
Both drivers prefer a zero-sum game where the other swerves and they win – particularly if they’re both men! There are however two options where they tie, one of which unfortunately risks their lives.
The decision making process is complex and split second decisions must be made by each driver without knowledge of what the other will do.
A second decision-making model is knows as The Prisoners’ Dilemma. As with the above example it’s a one shot game. The person has to make a decision without the knowledge of what the other person will do.
Bill and Ernie have been arrested for stealing a car. They are told that they will each serve two years in prison for car theft. The police believe that they have both also been involved in a bank robbery, but they have no evidence of this.
Bill and Ernie are held in separate rooms and told that if they confess to the robbery they will serve a total of three years for both crimes. They are also told that if one confesses and the other doesn’t, that person will serve one year in prison for assisting the police whilst the other will serve ten years. So, how does this look on the decision making model.
In this game the best outcome for Bill and Ernie is to deny that they were involved in the robbery. They will then service two years in prison.
But what if Bill confesses and Ernie doesn’t? Bill will serve one year in prison and Ernie will service ten years. Likewise, if Ernie confesses and Bill remains silent then Bill will serve ten years and Ernie only one.
In order to remove the possibility of serving ten years in prison the best option for each is to confess since neither can be certain that the other hasn’t reached the same conclusion. By confessing they will serve one year if the other person remains silent. If they both confess they will each serve three years.
These examples are interesting, but the real power of game theory as a decision-making tool comes into its own when considering more complex issues.
When engaged in decision-making, parties will act independently and rationally based on their own interests. As demonstrated, this does not always deliver a result that provides the optimum for both parties. To minimise impact, each player considers their actions based on their understanding of the other’s intent. There are many factors that come into play including mutual co-operation based on trust. Trust is built over the months and years preceding the game. Often trust is weak. Often the solution that requires the trust of the other party is ignored, since it leads to a solution that is high risk if one party defaults.
The game theory lens provides a model allowing players to consider options before acting. No decision is a two-choice decision. There are four options based on the two decisions that a player can make.
The game theory models illustrate the outcomes possible based on assumptions. Whether, of course, these initial assumptions are correct is a different story.
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