Volume 2, Number 1

Game theory is garnering a lot more notice these days. Although an appreciation of its potential value from a management strategy perspective did not take hold until the 1970s, interest has grown considerably since then.

For instance, three game theorists won the Nobel Memorial Prize in Economic Sciences in 1994. Attention was spurred further a few years ago by the Federal Communications Commission's well-publicized auction of radio spectrum bandwidth, a process in which game theory was utilized in both auction design and bidding. And several management consulting firms now boast practices devoted exclusively to broadening its understanding and application.

Through Thick and Thin The demand for steel in today's marketplace is chiefly for what is produced in sheet form. Its production traditionally involves casting molten metal into slabs eight- to ten-inches thick and then gradually rolling them thinner, a costly and time-consuming process. In 1983, however, a method was developed that enabled producers to cast slabs only one- to two-inches thick, thereby substantially reducing the amount of rolling required. America's largest steel maker, U.S. Steel, faced with a need to modernize one of its slab-casting plants, decided against using the new thin-slab technology, noting that despite its advantages, no other firm had adopted it. Moreover, the new technique would have required the company to close its nearby rolling mill and build another one adjacent to the new casting facility. Enter minimill Nucor. A small, American, niche-market steelmaker, Nucor yearned to enter the lucrative sheet-steel market and viewed thin-slab casting, with its lower production costs, as its entry card. Nucor's gamble paid off big-time, allowing it to rapidly capture a significant share of the sheet-steel market. Applying game-theoretic models to this scenario, Ghemawat illustrates in Games Businesses Play that it is possible to quantify, and thereby account for, many of the incentive factors that motivated the actions and reactions of key industry players. According to Ghemawat, market entry by an "outsider" was predictable; so were the decisions of "insiders" not to adopt the new technology.

In his book Games Businesses Play: Cases and Models, published by MIT Press, HBS professor Pankaj Ghemawat explains the potential uses and limitations of game theory within the realm of the business strategist. Ghemawat's research uniquely melds game-theoretic concepts with analytical rather than traditional descriptive case studies to examine a diverse set of strategic decision-making situations. His findings reveal much about the usefulness and practicality of game theory as a tool for strategic business planners.

According to Ghemawat, "Game theory is basically the study of intelligent decision-making in situations where your payoffs depend not just on what you do but on what others do." Its practical application occurred as early as World War II, he explains, when the British were astonished by their success in applying the concepts of game theory to submarine warfare. Since then, it has been used in an array of areas, including economics, politics, and law.

While game theory has already gained a solid following among industrial organization economists, business strategists continue to debate its usefulness in their field because of a limited amount of relevant empirical research. In addition, it still suffers from a general lack of awareness among managers. Ghemawat helps resolve these shortcomings in his book by showing the use of game theory in a series of business dilemmas described in detailed longitudinal case studies that span diverse industries. "Cases have long been central to management education," he says, "but they have been used less frequently as an integral part of business research. In fact, they provide an excellent means of confronting game theory with the real world."

The cases that form the centerpiece of Ghemawat's book focus on a number of major corporations, including Allied Chemical, British Satellite Broadcasting, DuPont, General Electric, and Nucor. As he explains, "Each of the cases is paired with a customized game-theoretic model in a way that covers a wide array of commitment decisions, from short-run commitments such as price levels to longer-run ones such as capacity expansion and reduction, product and process innovation, and battles for market share. The match between case outcomes and model predictions is then analyzed both quantitatively and qualitatively."

Ghemawat comes to the conclusion that game-theoretic analysis of incentives can help strategists explain the patterns of interaction in strategic situations involving small numbers of players as well as differences in efficiency among alternative courses of action. Reciprocally, the detailed analysis of cases can benefit game theory by providing examples of its effects at work by highlighting competitive variables that deserve additional study and, more broadly, by suggesting ways to elaborate and modify existing theories.

"As this body of research points out," Ghemawat says, "game theory fits nicely into the larger fabric of strategic management. It supplements the traditional analysis of competitive interactions, which tends to focus on competitors' behavioral predispositions, with analyses of competitors' incentives in a way that can be extraordinarily powerful."

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