Game Theory and the Retailers’s dilemma

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As Christmas approaches a number of retailers, whether they realize it or not, will participate in a game of “Prisoner’s Dilemma”. They will have to decide whether to hold their nerve and their prices until after the main holiday season, when traditionally the ‘sales’ period starts, or whether to introduce discounts before Christmas in an effort to hit top-line targets and steal a march on competition. The decision they take has to take account of what they think their competitors will do. If every retailer holds their nerve everyone will enjoy a higher bottom line, if everyone launches their ‘sales’ early everyone loses (except the consumer) because it is a zero sum game. But if one retailer moves ahead of the others they win relative to their competitors.

This kind of strategic decision is inter-dependant – the outcome depends on the actions or inaction of others –  and is the basis of Game Theory developed in the 1940’s by Neumann and Morgenstern for economics. In 1950 Flood and Dresher developed the example of the prisoner’s dilemma to illustrate the use of Game Theory. You can read the full version of this in Wiki but the basic idea is that 2 prisoners are held in separate cells accused of a crime. If both confess they get a 5 years sentence. If neither confess they get 6 months. If one betrays the other he goes free and the other guy gets 10 years. On the assumption that less prison time is better and there is no honour among thieves it is better for both to choose to confess. If the game is repeated eventually people can figure out that it is better to ‘co-operate’ and stay silent.

In 1995 Harvard Business Review carried an article by Brandenburger and Nalebuff (crazy names, crazy guys) which tried to re-launch the use of Game Theory in business strategy since so many business decisions have outcomes that depend on the decisions of others – like the prisoners dilemma. There don’t seem to be many takers for this very mathematical branch of business science. Decisions are discussed taking into account opinions on what competitors may or may not do, but it is rare for this to involve the kind of complex matrices and algorithms advanced by the purest disciples of Game Theory.

So you can expect the ‘sales’ to start early this year as every retailer takes the pre-emptive retaliation route. The retailers and their shareholders will lose out, consumers will win and no-one will learn. When the Prisoner’s Dilemma scenario was tried out among a sample of ‘ordinary people’ 40% took the ‘say nothing’ option. In other words they assumed that everyone realizes it is better to co-operate. Suckers.

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