Game theory: A business application

Game theory is a mathematical and economic framework that predicts and analyzes the behaviour of rational individuals or groups in strategic situations where the outcome depends on the choices of all the involved parties.

Game theory attempts to predict the way that two or more parties will act in a given situation. Scenarios like “the prisoner’s dilemma,” “the centipede game,” and “the dictator game” are used by economists, political analysts, and businesses to figure out the most likely course of action. Game theory has branched out to encompass many other business disciplines. From optimal marketing campaign strategies to waging war decisions, ideal auction tactics, and voting styles, game theory has become a valuable tool for businesses.

One application of game theory in business is in the airline industry. Airlines use game theory to determine the best pricing strategy for their flights. They use a technique called “yield management” to maximize revenue by charging different prices for the same seat depending on the time of day, the day of the week, and the season.

Another application of game theory in business is in the field of strategic management. Game theory can be used to analyze the behaviour of competitors and to develop strategies that will give a company a competitive advantage.

Other application includes:

• Political Science: Game theory is used to study political campaigns, voting and legislative behaviour.
• Psychology: Game theory has also been used to study human behaviour in social situations, including altruism, cooperation, and conflict.
• Finance: Game theory is used in finance to analyse the interaction between different market participants.
• Biology and ecology: Game theory is used in biology and ecology to model the behaviour of animals and their interactions with each other and their environment.

Overall, game theory is an important tool for analysing and understanding strategic interactions, and it has many applications in various fields.

A business application of Games Theory can be seen in the story below.

Once upon a time, there were two coffee shops located next to each other in Lekki phase one. Both shops sold high-quality coffee, and both had a loyal customer base. One day, one of the coffee shops decided to lower their prices in order to try to steal customers from their competition. 

Unknown to them, the neighbouring (second) coffee shop had also been considering a price reduction. However, the second coffee shop was familiar with game theory concepts, they knew that a “price war” would harm both businesses.

Using game theory analysis, the second coffee shop decided not to lower their prices and instead they decided to focus on differentiating their product by offering unique flavours such as Caramel , Toffee , Vanilla, Chocolate, Hazelnut etc and hosting events. Over time, customers began to recognize the value the second coffee shop offered, and the first coffee shop lost many of its customers. 

In the end, the second coffee shop won the game by applying game theory to pricing strategy, which allowed them to successfully differentiate its product and increase its customer base without initiating a price war.