The game theory originated in the late 1920s by Neumann and Morgenstern achieved a wide acceptability with the publication of their book ‘Theory of Games and Economic Behaviour’ in 1944. In the theory of games, the success of the party tends to be at the cost of the others. Each player in the game wants to win by outwitting other players.
Thus, the different players are in a rivalrous relationship or in conflict. Each player in the game is an autonomous decision-making unit, which may even be a group of individuals. We may think of simple two player game or more elaborate N-player game. As the number of players increase in the game, the game theory solution becomes complex.
“Survival is tougher than entry”. This is an apt statement for the modern business. Fierce competition coupled with lack of information, makes it strategically important for the business firms to correctly assess the behaviour and the reaction of the rival firms.
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Each firm faces the basic question as to how to maximise profit, when it is competing against a number of competitors (in some cases almost identical to itself). Game theory is specifically answering this question. It is a technique, which is used by managers to formulate strategies to reach their goal, taking into account the likely actions of the competing firms.
The more accurately, the business firm is able to assess the rival’s action, more successful will be his managerial decision. For this, he should not only be able to see competitive situation from his point of view. But, he should also be able to put himself in his rival’s position to analyse the situation and decide on the optimal decision. This calls for interactive and strategic thinking, which is the central theme of game theory.
Take an example, micro-soft (provider of the operating system and Intel), and the world leader in manufacturing the computer chip, decides to go for a joint venture. Suppose, each one of them has to invest $ 8 million for the research and developmental work.
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The research and development is so specific that it has no use outside the joint venture project. If the product is launched successfully, each of them will earn $ 2 million annually, but, if one of them backs out, the other partner will suffer heavy losses.
The risk associated with the project might prompt either or both of them to back out. The managers of both the companies should form such a contract so that both the firms keep their promises.
Take another example. In the wake of privatisation of the domestic airlines services, suppose besides Indian airlines, there are two other competitors in the field. All the three are competing for attracting the passengers on a lucrative Mumbai-Delhi commercially busy route.
To begin with, all of them will be charging identical fare, say, Rs. 3000 for one way ticket. This can be the starting point for a price war to increase their market share. To do that, each airline has to decide on the number of scheduled flights, the number of days along with the time of the flight, in such a way that it is able to outweigh the other airline.
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However, all airlines will not be able to increase their market share, since total passenger market is more or less stable. So, some one’s gain in the market share will be at the cost of someone else. If you are a manager of one of these airlines, you would like to evaluate plan of action, so that you are able to increase your market share.
In pursuing these kinds of decisions, one has to logically analyse each step and its consequences so as to form strategies to counter the consequences like we do in games of chess, poker or war games. Hence, the name game theory is an apt one.