Game Theory Concepts Useful in Life

Set up win/win situations

In the game of Scotland Yard, 5 detectives have to capture a criminal on the run. The detectives work together such as “You block that route, and I’ll block this one.” This is an example of a win/win situation or a positive-sum game. 2 + 2 becomes 5. Or, as the MBAs call it, synergy. This is growing the pie.

A win/lose situation or a zero-sum game is where one side’s win has to be balanced by the other’s loss. There’s no net gain, only a transfer. 2 + 2 becomes 4. This is dividing the pie.

A lose/lose situation or a negative-sum game is where there’s a net loss: 2 + 2 = 3. This is taking a significant piece of the pie and throwing it in the trash and then trying to divide the rest.

Play positive-sum games. Such games incentivise the person you’re playing with to help you succeed, because then he succeeds, too. He becomes your partner, not your opponent. On the other hand, if you’re in a zero- or a negative-sum game, the person you’re playing with is incented to act against you. He becomes your opponent. In addition to yielding poor results, such games suck to play, and hurt your reputation and your ethics.

Life is a repeated game

In game theory, there are two types of games: a single-shot game and an iterated game. Some people look at life as a single-shot game: they take advantage of others, whether at work or in personal life. They win the battle, but leave behind a trail of enemies, losing the war. Instead, look at life as an iterated game. There will be another round, and the people who played with you this round will remember whether you played fairly and reciprocate in the next round.

Overcome the prisoner’s dilemma

In the prisoner’s dilemma, the two prisoners didn’t trust each other, and so ended up with a suboptimal outcome. This is not merely an intellectual exercise. It’s a directive to us to create a situation of trust in our dealings.

Let me illustrate how I do it in my advisory. I turn away prospective clients who treat me with distrust, such as by trying to take advantage of me or evading questions. Of course, one must live the values one expects from others, so I try to be transparent and trusting towards the client. The clients who make it through this filter result in more successful projects.

This brings us to dependence, independence and interdependence, as The 7 Habits of Highly Effective People explains:

We begin our lives dependent physically (others have to do things for us), intellectually (others have to think for us) and emotionally (we link our happiness to others’ approval of us). Babies are vulnerable — anyone can hurt them.

Over time, we graduate to independence, where we don’t let others’ incompetence or ill intentions hurt us. This lets us achieve far beyond anything we could as a child. Independence is a great achievement.

However, there’s a limit to what we can achieve single-handedly. When we hit this limit, it’s time to graduate to interdependence. It does involve going back to vulnerability, to giving up the independence what we worked so hard for 2-3 decades to achieve. But, in exchange, we get to achieve things a risk-averse person can’t. What got us here won’t get us there. People who are caught by the prisoner’s dilemma are stuck at this middle level of independence. Those who overcome it graduate to interdependence¹.

Tit for tat

People think of tit for tat as a petty reaction, but it’s actually a valid strategy in game theory that discourages people from taking advantage of you. Is the previous example, the client refused to pay (tit) and I threatened to terminate the contract (tat). Tit for tat sets a minimum standard of behavior. If the other party fails to adhere to these, there will be consequences. The tat deters people from doing it again. It’s like the law, but at a personal rather than societal level.

Sometimes the best move is not to play

I turn away clients who insist on me executing a project in a way that produces suboptimal outcomes, because it will result in dissatisfaction on my side, dissatisfaction from the client’s side, potentially a dispute or a demand for money back, and bad reputation for me. It won’t result in a testimonial or a case study, or me growing in my skills. Don’t play games that have been rigged against you. To do this, you must first be smart enough to recognise such a game.

Credible commitment

A credible commitment or a costly signal is when you make a commitment with a penalty against yourself. For example, as a consultant, I guarantee results. In the unlikely event that the results aren’t achieved because of a deficiency on my side, I do whatever it takes to set things right, whether redoing the work, giving them a partial refund, or even a full refund if I feel that’s the right resolution. This gives confidence to the other party.

1. Interdependence requires you to have clear criteria about whom to be interdependent with and how to structure the relationship. I have 6 criteria, and if the client or project fails even one, I reject them.

Interdependence needn’t be all or nothing. You can be interdependent in some ways (e.g., the success of the project) but not in others (e.g., insisting on all cash rather than equity). You can pick and choose the aspects in which to be interdependent.