The Art of Strategy: A Game Theorist's Guide to Success in Business and Life

by Avinash K. Dixit

The branch of social science that studies strategic decision making is called game theory.

Strategic thinking starts with your basic skills and considers how best to use them.

The key lesson of game theory is to put yourself in the other player’s shoes.

you have to take into account the objectives and strategies of the other players.

When guessing a number picked at random, the number isn’t trying to hide. You can take the engineer’s mindset and divide the interval in two and do the best possible. But if you are playing a game, then you have to consider how the other player will be acting and how those decisions will influence your strategy.

“Trip to the Gym.”

In the 1986 soccer World Cup final, the Argentine star Diego Maradona did not score a goal, but his passes through a ring of West German defenders led to two Argentine goals. The value of a star cannot be assessed by looking only at his scoring performance; his contribution to his teammates’ performance is crucial, and assist statistics help measure this contribution. In ice hockey, assists and goals are given equal weight for ranking individual performance.

When the follower tacks, so does the leader. The leader imitates the follower even when the follower is clearly pursuing a poor strategy. Why? Because in sailboat racing (unlike ballroom dancing) close doesn’t count; only winning matters. If you have the lead, the surest way to stay ahead is to play monkey see, monkey do.*

There are two ways to move second. You can imitate as soon as the other has revealed his approach (as in sailboat racing) or wait longer until the success or failure of the approach is known (as in computers). The longer wait is more advantageous in business because, unlike in sports, the competition is usually not winner-take-all. As a result, market leaders will not follow the upstarts unless they also believe in the merits of their course.

The perception that you have been excessively greedy may make others less willing to negotiate with you in the future. Or, next time they may be more firm bargainers as they try to recapture some of their perceived losses. On a personal level, an unfair win may spoil business relations, or even personal relations. Indeed, biographer David Schoenbrun faulted de Gaulle’s chauvinism: “In human relations, those who do not love are rarely loved: those who will not be friends end up by having none. De Gaulle’s rejection of friendship thus hurt France.”5 A compromise in the short term may prove a better strategy over the long haul.

Ferdinand de Lesseps was a mildly competent engineer with extraordinary vision and determination. He is famous for building the Suez Canal in what seemed almost impossible conditions. He did not recognize the impossible and thereby accomplished it. Later, he tried using the same technique to build the Panama Canal. It ended in disaster.* Whereas the sands of the Nile yielded to his will, tropical malaria did not. The problem for de Lesseps was that his inflexible personality could not admit defeat even when the battle was lost.

You might think that having more options is always a good thing. But thinking strategically, you can often do better by cutting off options.

How do you get people to do something that is against their interest? Put them in what is known as the prisoners’ dilemma.† According to Buffett:

This situation is called a prisoners’ dilemma because both sides are led to take an action that is against their mutual interest.* In the classic version of the prisoners’ dilemma, the police are separately interrogating two suspects. Each is given an incentive to be the first to confess and a much harsher sentence if he holds out while the other confesses. Thus each finds it advantageous to confess, though they would both do better if each kept quiet.

It is unpredictability that is important when mixing.

It turns out most people fall into predictable patterns.

Every action someone takes tells us something about what he knows, and you should use these inferences along with what you already know to guide your actions.

There are some rules of the game that can help put you on more equal footing. One way to allow trading with lopsided information is to let the less informed party pick which side of the bet to take.

you need to understand the other player’s perspective. You need to consider what they know, what motivates them, and even how they think about you.

George Bernard Shaw’s quip on the golden rule was to not do unto others as you would have them do unto you—their tastes may be different. When thinking strategically, you have to work extra hard to understand the perspective and interactions of all the other players in the game, including ones who may be silent.

That brings us to one last point. You may be thinking you are playing one game, but it is only part of a larger gam...

TWO KINDS OF STRATEGIC INTERACTIONS

game of strategy

The first is sequential,

players make alternat...

The second kind of interaction is simultaneous,

When you find yourself playing a strategic game, you must determine whether the interaction is simultaneous or sequential.

The First Rule of Strategy

The general principle for sequential-move games is that each player should figure out the other players’ future responses and use them in calculating his own best current move. This idea is so important that it is worth codifying into a basic rule of strategic behavior:

RULE 1: Look forward and reas...

Anticipate where your initial decisions will ultimately lead and use this information to ...

DECISION TREES AND GAME TREES

A person making a choice at an earlier point must look ahead, not just to his own future choices but to those of others. He must forecast what the others will do, by putting himself figuratively in their shoes, and thinking as they would think.

In single-person decisions, greater freedom of action can never hurt. But in games, it can hurt because its existence can influence other players’ actions. Conversely, tying your own hands can help.

Two approaches can be used for these. Computer programs are available to construct trees and compute solutions.3 Alternatively, many games of moderate complexity can be solved by the logic of tree analysis, without drawing the tree explicitly.

Starting from any point in the middle of the game where the opponent has played incorrectly, the team with the turn to move can seize the initiative and win.

What seems to be the most damaging criticism comes from the ultimatum game. This is the simplest possible negotiation game: there is just one take-it-or-leave-it offer.

conventional economic theory—that is, each is concerned only with his or her self-interest and can calculate perfectly the optimal strategies to pursue that interest.

neuroeconomics,

Evolution of Altruism and Fairness

people bring many considerations and preferences into their choices besides their own rewards.

“Behavioral game theory extends rationality rather than abandoning it.”10

evolutionary psychology.

Groups that instill norms of fairness and altruism into their members will have less internal conflict than groups consisting of purely selfish individuals. Therefore they will be more successful in taking collective action, such as provision of goods that benefit the whole group and conservation of common resources, and they will spend less effort and resources in internal conflict. As a result, they will do better, both in absolute terms and in competition with groups that do not have similar norms. In other words, some measure of fairness and altruism may have evolutionary survival value.

You should combine the rule of look ahead and reason back with your experience, which guides you in evaluating the intermediate positions reached at the end of your span of forward calculation. Success will come from such synthesis of the science of game theory and the art of playing a specific game, not from either alone.

The problem is that when you try to put yourself in the other players’ shoes, it is hard if not impossible to leave your own shoes behind. You know too much about what you are planning to do in your next move and it is hard to erase that knowledge when you are looking at the game from the other player’s perspective. Indeed, that explains why people don’t play chess (or poker) against themselves. You certainly can’t bluff against yourself or make a surprise attack.

There is no perfect solution to this problem. When you try to put yourself in the other players’ shoes, you have to know what they know and not know what they don’t know. Your objectives have to be their objectives, not what you wish they had as an objective. In practice, firms trying to simulate the moves and counter-moves of a potential business scenario will hire outsiders to play the role of the other players. That way, they can ensure that their game partners don’t know too much. Often the biggest learning comes from seeing the moves that were not anticipated and then understanding what led to that outcome, so that it can be either avoided or promoted.

One of the general morals of this story is that if you have to take some risks, it is often better to do so as quickly as possible. This is obvious to those who play tennis: everyone knows to take more risk on the first serve and hit the second serve more cautiously. That way, if you fail on your first attempt, the game won’t be over. You may still have time to take some other options that can bring you back to or even ahead of where you were. The wisdom of taking risks early applies to most aspects of life, whether it be career choices, investments, or dating.

Prisoners’ Dilemmas and How to Resolve Them

each has a personal incentive to do something that ultimately leads to a result that is bad for everyone when everyone similarly does what his or her personal interest dictates. If one confesses, the other had better confess to avoid the really harsh sentence reserved for recalcitrants; if one holds out, the other can cut himself a much better deal by confessing.