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Game Theory: An Application in Organisational Behaviour

What is Game Theory?

Game Theory is a mathematical concept that was made popular by actor, Russell Crowe, in the hit film “A Beautiful Mind”. Some of us might have even studied this particularly interesting theory while in school. While some of us may even be practicing and/or applying it right now at work without us knowing. It is a theory that can hide it conspicuous head in the everyday things that we do, from strategic planning to even the making of simple daily choices. So what exactly is Game Theory?

A Game Theory can be defined as a means of analysing strategic actions that, more often than not, result from the consideration of the expected behaviour of others; or simply, the decisions that is made by one, taking into account the response from a would-be affected party by one’s decision. This sounds a little confusing but many of the current global economic policies and even between rival companies, game theories have often been used to make effective, calculated decisions. A game, in economics, is defined as a situation whereby rules, strategies and payoffs are involved for parties to make beneficial decisions. In this context, of course, “beneficial” is subjective. Why? Let’s take a look at the following example.

The Prisoners’ Dilemma

This classic illustration has been widely used as a simple yet effective explanation of game theory.

Once upon a time, there were 2 thieves who were caught while trying to steal a car. The Judge decides to sentence them to a 2-year jail term each. However, the Prosecutor suspects that these men were also responsible for an unsolved bank robbery some years back but he lacks concrete evidence that can tie the men to the case. The Prosecutor then devised a plan with the Judge, which he hopes would make the thieves confess to their previous crime.

The Prosecutor first places the 2 prisoners in separate rooms so that they cannot communicate with each other. Each is told that they are suspected of an earlier crime and are also told the following:

  1. If each confesses to the robbery, each will get a 3-year jail sentence.
  2. If 1 person confesses and the other does not, the one who confessed will get only a 1-year sentence while the other will serve 10 years in jail.
  3. If neither of them confess then each will only be convicted for the car theft and will be sentenced to jail for 2 years.

If you are one of the prisoners, what would you do?

The payoff matrix is as shown:

The Prisoners’ Dilemma

Now if I were any of these prisoners, I would be either trying to maximise gain for myself independent of my accomplice’s decision or I would have to make my decision based on how much I trust him. Do I anticipate him to deny so that I can confess and enjoy the shortest of the jail terms? But what if he confesses and I confess as well and my jail term increases to 3 years? So in that case, shall I deny and hope that he denies as well so that we both need only to serve 2 years in jail? But what if he confesses and now I get a 10-year sentence?! Tricky, isn’t it? Hence, the Prisoners’ Dilemma.

The optimum solution to this problem is actually to find its equilibrium. The equilibrium in a game is also known as the Nash equilibrium, named after John Forbes Nash (the character portrayed by Russell Crowe in the movie). This balance occurs when one takes the best possible action given the action of the other party and vice versa. In this example, a dominant strategy exists for each prisoner. This means that in this dilemma, no matter what the other prisoner decides, one would choose to confess because it is the best course of action. Thus, the equilibrium of the prisoners’ dilemma is that each prisoner confesses.

I know what you’re thinking. Why shouldn’t the equilibrium be the situation if each prisoner denies? If so, both would only serve a 2-year jail sentence compared to a 3-year one right? Take note that the Nash equilibrium is not achieved with actions that would generate the best payoff. Remember the prisoners are kept in separate rooms and trust is an issue here because if I trust that my accomplice would deny along with me, but if he doesn’t, then I am in for a decade behind bars.

This game model is essentially a non-zero sum game, which means that a gain by one player does not necessarily cause a loss in another player. In other words, win-win scenarios exist. On the other hand, there are also zero- sum games, whereby a player gains at the equal expense of other players. An example would be Poker. If I win with a good hand, then I would gain all bets that the other party has made at the table. So with all these jargon and explanations on an economic theory, what does it have to do with organisational behaviour?

Internal Strife

Game theories have been used extensively to study the behaviours of companies in an oligopoly. An oligopoly is a market or industry that is dominated by a few firms. More often than not, the price strategies of these firms are heavily influenced by that of rival firms. An obvious example would be the local petroleum market that is dominated by the likes of Shell and Caltex. Ever noticed that when one of these companies decides to lower its price of petrol, the rest would follow suit? However, the reverse would never happen. Why would any company in an oligopoly be in the right mind to raise prices? Would its rivals follow suit? However, you can try working out a payoff matrix for a hypothetical scenario and you would be able to appreciate the effectiveness of a game theory.

Although several other real-world applications exist, another of a game theory’s application is present as well. One that does not involve comparison between firms but it is one that can help explain the rise of conflicts within an organisation.

Have you ever heard or even witness business functions of an organisation “backstabbing” one another? Maybe it could be the sales department having constant arguments and disagreements with the production department? Maybe it could also be a case whereby the management fails to work in line with its ground staff? Maybe with an understanding of game theory, “rival” functions within any organisation can learn that such conflicts arise from familiar roots.

Let’s say we have a scenario where the product development department and the marketing department of a fictitious organisation are at loggerheads which each other. The product people are in charge of creating new products while the marketing folks are responsible for selling whatever the product people came up with. However, perhaps due to some misunderstandings and accusations between the two, relationships start to break down and internal strife ensues. The situation gradually escalates to a point whereby both teams must make a decision on whether, they want to cooperate or refuse cooperation with each other. Cooperation here can refer to information- sharing, effective communication etc. Hence the following scenarios, with regards to probable effects each decision has on the organisation’s performance as a whole, might just turn out.

  1. If both departments choose to cooperate, each department would contribute $5 million in revenue to the company directly and/or indirectly.
  2. If one department chooses to cooperate and the other does not, the department that chooses to cooperate would add $7 million to the company’s coffers, while the other contributes $1 million to the organisation, whether directly and/or indirectly.
  3. If both departments choose not to cooperate then each will contribute nothing to the company.
The payoff matrix is as follows:

Internal Strife

So in this case, what do you think is the Nash equilibrium? In terms of game theory, the Nash equilibrium in this situation would, of course, be the point when both departments cooperate. This is so because no matter what choices that the other department makes, one would choose to cooperate in order to maximise one’s gains. In addition, the organisation benefits from the highest total revenue with mutual cooperation, as compared with the rest of the other scenarios. However, would this be the dominant strategy for both departments?

In theory, any business functions within the same organisation would decide to cooperate to avoid conflict and at the same time, generate win-win results. However, how often have we witness Scenario D as the eventual outcome? Simply because Scenario B and C, more often than not, do not exist in the real world because the fact is we live in a “tit-for-tat” society. Scenario D is what I would call the Organisational Disequilibrium.

Firstly, any CEO would tell you that in situations like this, the product development department has to learn to co-exist and collaborate with their marketing counterparts because these two key departments are interdependent with each other. However, if one department refuses to cooperate, do you think the resulting party would not follow suit? Assuming ceteris paribus (all things remaining the same), any person would retaliate in response to hostility towards him or her. Eventually, a “bloodbath” begins, leaving both parties crippled, whilst generating negative results.

Why then do teams degenerate to such a state? We will find the answers in the deeper roots of such organisational relationships. These answers lie with two very tenuous components in relationship-building and you can find them in my earlier pages. The words are highlighted and I’m sure you can spot them. Got them?

The two critical factors that determine any positive relationships are:

  1. Communication and
  2. Trust

In the Prisoners’ Dilemma, communication was cut off between both prisoners and thus, trust became an issue. This setting then led us to the Nash equilibrium of when both prisoners confess. In the product/marketing analogy, wouldn’t communication be readily available to allow both departments to produce win-win results? Strange isn’t it? In today’s organisational environment, with the widespread availability of communication technologies and processes, why should communication be of any concern? Why, even with communication, our product and marketing teams would still end up in Scenario D?

What Is Communication?

First of all, let us define communication. According to Dictionary.com, the word “communication” is defined as the imparting or interchange of thoughts, opinions, or information by speech, writing, or signs. However, do you think that communication would be more of an “interchange” instead of an “imparting”? In this case, is sending an e-mail message or posting a notice a form of communication? Is holding an “informative” meeting a form of communication? The answer: no. These are mere forms of notification. Why? Let us take a look at the following model that illustrates the Communication Cycle.

What Is Communication?

Effective communication entails a sender to transmit a clear message for a recipient to understand and not just be heard. Upon receiving the message, the intended recipient would be able to acknowledge the message and/or provide feedback, if need be, back to the sender. Nonetheless, if you agree with me on this specific definition, how many of us do practice effective communication?

Sometimes? All the time? None at all? But how important is communication in an organisation? This next case study will demonstrate the significance of organisational communication.

Case Study: The Re-birth Of Continental Airlines

The following details, in the early 2000s, the profile of Continental Airlines – A passenger airline company that was one of the best in America and the world.

  • No. 1 U.S.-based Airline
Nikkei Business Magazine survey (December 2003)
  • Best Transatlantic Airline
2001 OAG Airline of the Year Awards (February 2001)
  • Top International Airline
National Airline Quality Rating Study (April 2000)
  • Best Executive/Business Class
OAG Airline of the Year Awards (2003, 2004, 2005, 2006)
  • Best U.S. Airline for Business Travel
SmartMoney (February 2000)
  • No. 1 On-time Performance in 2000
U.S. Department of Transportation
  • No. 1 Most Admired Airline
FORTUNE magazine (March 2006)

The following details the profile of Continental Airlines till 1994.

  • Experienced 10 changes in leadership in 10 years.
  • Went through bankruptcy proceedings twice.
  • Has not made a profit in 10 years.
  • Customers were shunning the airline.
  • Arrival and departure times were very unpredictable and as the then CEO commented, that their planes “came and went as they happened to”.
  • According to the Department of Transportation, Continental Airlines was ranked last among the country’s 10 biggest airlines.
  • The company received almost 3 times as many complaints as the industry average and more than 30% more complaints than the ninth- placed airline.
During these trying times, Continental Airlines was undoubtedly THE worst airline in the whole of America. With abysmal morale, non-existent cooperation among employees and a barrel full of lies from the management, the company was in total chaos. As then CEO, Gordon Bethune, once remarked that it was “a company with a lousy product, angry employees, low wages, and a history of ineffective management.”

Faced with an organisation in dire straits, Bethune knew he had to radically change the company culture and communication was the key to Continental’s survival and revival. He knew that positive, healthy interaction was vital in turning things around and interestingly, the first thing that Bethune did was to open up the executive offices to all employees.

In the past, the twentieth-storey office for Continental’s top management in Houston was like a fortress. Its doors were shut from prying eyes as surveillance cameras prowled the place like tigers searching for a prey. No one could enter this area without a security pass and this was not exactly the most inviting place to be for any employee. However, in a symbolic gesture, Bethune literally opened the once-locked doors to the entire company. Thereafter, open houses were organised for employees in order for employee-management barriers to be broken and thus allowed trust to, once again, be built.

Nonetheless, the road to restoration was not always a smooth-riding one. However, Continental’s leaders kept up with their regular meetings with their people, as views were aired and shared. Honesty and patience were a priority as the management revealed everything to its employees, good news or bad. Bulletin boards were also put up in every employee area that displayed the company’s ratings for the previous year, as assessed by the Department of Transportation; and daily company news updates. Additional forms of communication were also put in place, including monthly and quarterly employee newsletter which were mailed to each employee’s house and even 800-number hotlines for any employee to enquire about anything from anywhere in the world. Bethune’s communication policy was simple: “Unless it’s dangerous and illegal for us to share it, we share it.”

As weeks become months, slowly but gradually, Continental finally began to function as a team. In the year that Bethune took over the reins of CEO, 1994, the company lost US$204 million. By the end of the next year, Continental posted a profit of US$202 million. Subsequently, for the next half a decade, Continental posted twenty-four consecutive profitable quarters in a time when their competitors struggled to remain afloat.

An Afterword

People often ask, “Why is there a need for teamwork?” “Why can’t we focus just on ourselves and generate higher returns?” “Everyone wants to win and for every winner, there will be a loser, isn’t it?” As human beings, even as employees within a company, we often assume that we are constantly being engaged in zero-sum games, when in fact non-zero sum games exist and these should be the mode of operation in order to maximise gains, both individually and organisationally.

But for a beneficial equilibrium to be achieved, communication is critical. In fact, effective communication must be present for a borderless team to function well. If the management of Continental Airlines still persisted with a strict top-down approach with information flowing through a one-way route, it could not have turn things around so quickly. If communication barriers are erected, distrust will permeate through every member, every department; and if trust becomes an issue, then the organisation will, without a sliver of doubt, slip into a chaotic disequilibrium, fueled by retaliation.

Thus, in order to for you to digest this lengthy article easily, just remember the following three pointers:

  1. For every hostile action, there will be an equal (sometimes more) and opposite retaliation.
  2. Communication builds trust and trust builds successful organisations.
  3. Do not forget Points (1) and (2)

So being “nice” does have its bottom-line benefits as niceness begets niceness as hostility begets hostility; and if in doubt check with the Game Theory.

Michael Parkin, (1993), “Economics (Second Edition)”, Addison-Wesley Publshing Company [13 March 2008]

John C. Maxwell, (2001), “The 17 Indisputable Laws of Teamwork”, Nelson Business [18 March 2008]

Continental Airlines, (2008), About Continental > Company Profile >Awards. Available from: http://www.continental.com/web/en- US/content/company/profile/awards.aspx

Article by Andy Pan, the Director of Training at Right Impact

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