The second approach is to look where incentives are poorly designed, and then correct the problem. Barry Nalebuff brings up the example of Blockbuster Video. When it was founded, the company bought taped copies of movies at $99 a pop from the studios; this meant Blockbuster had to rent out each tape 50 times to recover costs. The result was a shortage of stock, leading to dissatisfied customers who often could not find the movie they wanted. “How do you correct that incentive problem? How do you allow Blockbuster to have lots of tapes?” Nalebuff asks. The answer: “Pay per play, or revenue sharing.” Blockbuster negotiated a deal in which it pays only $10 per movie, but shares $1 per rental with the studios. “Changing that incentive allowed them to switch to guaranteed-in-stock, no late fees, much higher customer satisfaction, and much higher profits,” Nalebuff says. “That switch saved their business. It may not save them from video-on-demand, but as they say, seven fat years are good preparation for seven lean years.”
Turning things upside down is the third technique. Nalebuff can point to countless small shifts, like the banana trick, that can often make big differences. Do you put coffee in your milk, or milk in your coffee? If you do the former, you know the milk gets mixed automatically as the coffee is added. So what? “Dunkin’ Donuts made the switch at its outlets,” Nalebuff notes. “It is able to get rid of countless plastic stirrers and save money.” On a grander scale, Priceline.com took the power to set airline ticket and hotel prices away from the sellers and gave that power to the buyers, building a $1+ billion company in the process.
The fourth Nalebuff technique is asking where else a product or an idea could work. Someone else has surely thought of your idea before you. Has the idea worked in other industries, other countries? What can you learn from other people’s investments? As an example, Nalebuff holds up a Spin Pop. The brainchild of two postal workers, the Spin Pop is a lollipop that spins on its motorized base when you push a button. The two inventors of the motor-powered candy sold it for $15 million — a pretty good outcome. John Osher, who headed Cap Candy, the company that bought the Spin Pop, figured there was more that could be done with it. After walking the aisles of Wal-Mart for inspiration, Osher saw the expensive electric toothbrushes and decided to create a $5 spinning toothbrush using Spin Pop’s motor. Osher later sold it to Procter & Gamble for $475 million, and today P&G is using the same motor to power yet another product, the Dawn Power Dish Brush, which sold in the tens of millions in 2006. “The success in every case was based on finding the right problem that their existing answer had already solved,” says Nalebuff.
“Barry is able to use game theory to quickly dissect the tactics that a particular business uses in the marketplace, and is able to reveal the underlying strategies and motivations for these tactics,” says Howard Weissman, a former Warner-Lambert executive with whom Nalebuff worked on the launch of a diabetes drug. “Working with Barry and his unique approach allows business managers like myself to either preempt a competitor’s next move or at the very least respond to competitors in a way that is beneficial to one’s own business.”
Lightly Sweetened Valuations
Honest Tea has been the one place where Barry Nalebuff has explicitly put all his thinking about game theory into practice. The idea for the company emerged after years of teaching Coke versus Pepsi to his students and ruing the dearth of not-too-sweet options on the market. “I was stuck for 10 years by not having the right product,” Nalebuff says. “I was stalled at mixing orange juice with club soda, or cranberry juice with club soda, but I knew there was a market to serve adults.”