From the 1950s through the 1970s, game theorists became increasingly abstract and mathematical, basing their conclusions on equations rather than real experience. Barry Nalebuff set out to reverse that trend and reconnect game theory to the real world. Although it is a widely accepted approach now, extending game theory to business required an intellectual leap. As Nalebuff explains, there are two reasons for that. The first is the original emphasis on “zero-sum” games: For someone to succeed in poker, football, chess, or even submarine warfare, someone else has to lose. “In business, your success doesn’t require others to fail,” he says. The second reason is that there are no explicitly defined rules in business. Indeed, nothing defines the boundaries of a “game,” or even whether the same game is being played by all competitors. And that’s where both the peril and the potential lie. “In business, you can work incredibly hard and your efforts won’t be rewarded if you are playing the wrong game,” Nalebuff says. “But you also have the opportunity to change the game, rather than just play it. Success comes from playing the right game.”
Nalebuff bases many of his ideas on the thinking of Nobel Prize winners William Vickrey and James Mirrlees (published in the late 1940s and mid-1970s, respectively). Their work illuminated how business and government leaders can make decisions on such matters as contracts and taxation even when they’re working with incomplete information. They looked at how different incentives would affect the outcome of decisions. Mirrlees’s work on optimal income taxation led him to change his political views — from the belief that the government should tax the rich heavily to help the poor to the belief that, because taxes affect every individual’s incentive to earn, the optimal rate for everyone should be just 20 percent. Vickrey’s work in “congestion pricing” suggested that pricing on toll roads and commuter transportation should rise during rush hour; this approach has become common for electrical utilities and airlines. (See “Lights! Water! Motion!” s+b, Spring 2007).
According to Nalebuff, in a globalized business environment with instant communication and therefore near-limitless options, game theory provides a way for corporate leaders to consistently make better choices. “Because the world is changing so fast, we can’t count on learning by doing or experience,” he says. “By the time we have moved up that learning curve, we are in a new game. And in the activity of shaping that game, we need to have tools that predict what it is that we are creating.”
But Barry Nalebuff hit a pothole in the late 1980s when he tried to teach game theory. “The students weren’t seeing how it was directly applicable to business,” he says. The 1991 book Thinking Strategically, which Nalebuff wrote with Princeton economist Avinash Dixit, was his response, and a well-received effort to bring game theory solidly into the real world. But Nalebuff wanted to take his ideas further. “I realized Thinking Strategically was sort of like Apollo 13, a successful failure,” he says. Co-opetition, written in 1996 with NYU economist Adam Brandenburger (when both were at Harvard), was a further step, synthesizing research in and out of the classroom to apply game theory to business.
The Game Changer’s Reward
Then, while consulting to Fortune 500 companies in the mid-1990s, Nalebuff developed his method for applying game theory in business decisions. The process begins with writing down and categorizing all the elements of a game: the players, the rules (e.g., laws and government regulations), people’s perceptions, the boundaries of the game (the market), and the linkages among all the elements. With that level of detail in hand, the player then spells out the consequences of a change to any of the elements. The approach helps CEOs make better strategic moves by offering a more complete picture of the consequences of their decisions. More importantly, says Nalebuff, it can help leaders understand the games of their industry well enough to reframe the business. “‘Philosophers have only interpreted the world. The point, however, is to change it,’” Nalebuff says. “Karl Marx said that, and I am probably one of the few professors who still quote Marx, but he had a point: The action is in changing games rather than playing games.”