Game Theory and Product Strategy

Or: It’s all fun and games until someone loses an eyeball

Nir Soffer

http://www.linkedin.com/in/nirsoffer@TheNirEast

Game Theory and Strategy

It’s all fun and games until someone loses an eyeball

What?

• A primer on basic game theory concepts– Very basic– No math!– If you know a lot about Game Theory already, you

may get bored• A discussion on applying game theoretic

concepts to product strategy

Why?

• I think Game Theory is Fun!• Interesting perspective on behavior of both

people and firms• Analytical toolset for competitive scenarios

Who?

• Israeli, permitted to live in Austin by his cat• Student of Behavior and Business• GTM Consultant for multiple startups• Previously in PdM and Strategist in Dell and a

variety of software development roles• First time ProductCamp Presenter!• Very, very bad at making slides pretty.

Agenda

• What is Game Theory?• A Few Games and Business Analogies– Rock, Paper, Scissors:

• Zero-sum, symmetric game

– Prisoner’s Dilemma:• Pricing, market entry, volume• Iterated Prisoner’s Dilemma: TFT• Collusion/Cooperation in IPD – cartels

– Chicken and the Value of Commitments• Investment, market entry

What is Game Theory?

• You are playing Rock Paper Scissors. Which do you choose?

• You sell a product that is very similar to your competitor. Do you:– Price low to steal his customers?– Price the same?– Price higher?

• You need to invest in a factory to create your product

Types of Games

• Sequential vs. Simultaneous– Sequential: Chess, Checkers, Tic-Tac-Toe

• Solvable• Game tree solution

– Simultaneous: Rock Paper Scissors• Solvable• Equilibria solutions• Most business problems are simultaneous (or very close

to it) rather than sequential

• Our focus will be simultaneous, 2 player games

Brain Teaser – Cut the Cake

• Two twin brothers have gotten a cake from their parents for their birthday.

• What is the best way for them to split it so they are both happy?

Rock, Paper, Scissors

This is a gameRock Paper Scissors

Rock 0 , 0 0 , 1 1 , 0

Paper 1 , -1 0 , 0 0 , 1

Scissors -1, 1 1 , 0 0 , 0

So how do I read it?• The first number in each

pair is the payout for the row player – the second is for the column

So, who cares?• This is a boring game – but

it’s here as an example for more interesting ones

• Still – interesting to note:– Symmetric– Zero Sum

Rock, Paper, Scissors

Rock Paper Scissors

Rock 0 , 0 0 , 1 1 , 0

Paper 1 , -1 0 , 0 0 , 1

Scissors -1, 1 1 , 0 0 , 0

So, again, I ask, who cares?• RPS is a classic example for

a zero sum, symmetric game– Zero sum: Winning is done at

the expense of the loser– Symmetric: Identical options

with identical payoffs exist to all players

Let’s Play!

Find a partner – and play Rock, Paper, Scissors!

Rock Paper Scissors

Rock 0 , 0 0 , 1 1 , 0

Paper 1 , -1 0 , 0 0 , 1

Scissors -1, 1 1 , 0 0 , 0

What have we learned?

• Does RPS have much in common with real business problems?

• What’s the best strategy for playing RPS?

Prisoner’s Dilemma

• A classic!• Probably most famous game in Game Theory• We are going to spend some time here, so get

comfy

So, what’s the big deal?(positive payoffs are desirable)

Shut up

Snitch!

Shut up

3 , 3 0 , 5

Snitch! 5 , 0 1 , 1

• Two burglars are busted and put in separate rooms

• Police interrogate and promise the first one to snitch a deal

• Now, things get interesting.

• What would you do?

Equilibrium(positive payoffs are desirable)

Shut up

Snitch!

Shut up

3 , 3 0 , 5

Snitch! 5 , 0 1 , 1

• The problem should be clear

• Everyone would be better off shutting up – but each individual would rather snitch

• Therefore, the Nash Equilibrium (and therefore the result of the game if played by rational, payoff maximizing players) is the sub optimal bottom right corner

What does PD apply to?

• Can you think of any real life scenario in which PD applies to?

A ton of them!

• Pricing/Promotions: We are selling a similar product; should I price low (and then steal share) or high?– http://www.businessweek.com/articles/2013-11-19/

best-buy-and-the-holiday-retail-prisoners-dilemma• “Feature Wars”• In fact, most non-zero sum games in which

cooperation yields more benefits than competing can be modeled like a PD game

So what do we do?

• The bad news: The solution to a standard, “pure” Prisoner’s Dilemma game is always mutual defection. Sorry. It’s a cruel world.

• The good news: Reality is infinitely more complex; there are factors we can explore and ways to “change the game”– IPD– Collusion (don’t do that!)– Change the Game

Let’s try something

• Pick your gaming partner• Play the game!

(positive payoffs are desirable)

Shut up

Snitch!

Shut up

3 , 3 0 , 5

Snitch! 5 , 0 1 , 1

Show of Hands

• Who picked snitching? Why?• Who picked shutting up? Why?

And now, a Twist!

• Play the game again. • And again.• And again.• Until I tell you to stop.

Iterated Prisoner’s Dilemma

• An interesting result emerges when playing PD multiple times. Why?

• What if I told you that you had exactly 100 turns to play?

• Strategies: TFT, TF2TT• Axelrod’s Successful Strategy:– Clear– Provocable– Nice– Forgiving

CollusionCareful! I’m not a lawyer, but usually, this is illegal

Excerpt from Cramton & Schwartz 2002 – see table 1 at http://drum.lib.umd.edu/bitstream/1903/7061/1/cramton-schwartz-collusive-bidding.pdf

(can’t put table here for copyright reasons)

Change the Game

• What are other options to change the game?• What if you locked the loot from the burglary

with two keys?• Examples from a Product Strategy perspective:– Differentiation– Consortiums (pooled standard ownership)– Punitive clauses in contracts– Price matching clauses (retroactive ones as well) – Most favored customer clauses

Last One! Chicken!Swerve Drive

on!

Swerve Lose, Lose

Lose , Win

Drive on!

Win , Lose

Splat! , Splat!

• Anti-cooperation game• What are business

analogies?• How can you win?

Some interesting questions if we have time left

• You need to bid on ad keywords. Are you better off having keywords that are identical, or different from your competition?

• Do you think it’s better to ape your competitors features or remove them entirely?

• When you build a store location – would you rather build it next to your competitor, or somewhere else?

Thank you!

Backup

Further Reading

• Art of Strategy: Dixit & Nalebuff• Evolution of Cooperation: Axelrod• Prisoner’s Dilemma: Poundstone