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

by Avinash K. Dixit

The essence of brinkmanship is the deliberate creation of risk. This risk should be sufficiently intolerable to your opponent to induce him to eliminate the risk by following your wishes.

With any exercise of brinkmanship, there is always the danger of falling off the brink.

Commitments, threats, and promises will not improve your outcome in a game if they are not credible.

We classify the actions that can enhance the credibility of your unconditional and conditional strategic moves and that can help you practice brinkmanship into eight categories, which are based on three broad principles.

The first principle is to change the payoffs of the game. The idea is to make it in your interest to follow through on your commitment: turn a threat into a warning, a promise into an assurance. This can be done through two broad classes of tactics: Write contracts to back up your resolve. Establish and use a reputation.

Both these tactics make it more costly to break the commitment than to keep it. A second avenue is to change the game by limiting your ability to back out of a commitment. In this category, we consider three possibilities: 3. Cut off communication. 4. Burn bridges behind you. 5. Leave the outcome beyond your control, or even to chance. These two principles can be combined: the available actions and their payoffs can both be changed. If a large commitment is broken down into many smaller ones, then the gain from breaking a little one may be more than offset by the loss of the remaining contract. Thus we have: 6. Move in small steps. A third route is to use others to help you maintain commitment. A ...

(www.stickK.com).

Reputation

Future rivals will remember your past actions and may hear of your past actions in dealing with others.

Sometimes a public declaration of your resolve can work by putting your reputation on the line in a public way.

Cutting Off Communication

Theory often makes it sound as if the various moves being discussed are either 100 percent effective or not at all.

Burning Bridges behind You

Leaving the Outcome beyond Your Control or to Chance

brinkmanship

Moving in Steps

Although two parties may not trust each other when the stakes are large, if the problem of commitment can be reduced to a small enough scale, then the issue of credibility will resolve itself. The threat or promise is broken up into many pieces, and each one is solved separately. Honor among thieves may be restored if they have to trust each other only a little bit at a time.

As with brinkmanship, moving in small steps reduces the size of the threat or promise and correspondingly the scale of commitment. There is just one feature to watch out for. Those who understand strategic thinking will reason forward and look backward, and they will worry about the last step. If you expect to be cheated on the last round, you should break off the relationship one round earlier.

Teamwork

Mandated Negotiating Agents

Someone who tries to stop a train by tying himself to the railroad tracks may get less sympathy than someone else who has been tied there against his will.

UNDERMINING YOUR OPPONENT’S CREDIBILITY

Contracts:

Reputation:

Communication:

Burning Bridges:

Moving in Steps:

Mandated Agents:

I might know that you prefer one outcome over another or that you are lying to me, but if you don’t know that I know that, then that changes the game.*

George Akerlof, whose model of the private used car market illustrated how markets can fail when one party has private information;

The 2007 prize was also for information economics.

Interpreting and Manipulating Information

True story: Our friend, whom we’ll call Sue,

credible signal. This is the cousin of a commitment device.

Sue asked him to get a tattoo, a tattoo with her name. A small, discreet tattoo would be just fine. No one else would ever have to see it.

Why can’t we just rely on others to tell the truth? The answer is obvious: because it might be against their interests.

KING SOLOMON’S DILEMMA

DEVICES FOR MANIPULATING INFORMATION

Actions (including tattoos) speak louder than words. Players should watch what another player does, not what he or she says. And, knowing that the others will interpret actions in this way, each player should in turn try to manipulate actions for their information content.

“prepare a face to meet the faces that you meet.” If you do not recognize that your “face,” or more generally your actions, are being interpreted in this way, you are likely to behave in a way that works to your own disadvantage, often quite seriously so. Therefore the lessons of this chapter are among the most important you will learn in all of game theory.

Strategic game players who possess any special information will try to conceal it if they will be hurt when other players find out the truth. And they will take actions that, when appropriately interpreted, reveal information that works favorably for them. They know that their actions, like their faces, leak information. They will choose actions that promote favorable leakage; such strategies are called signaling. They will act in ways that reduce or eliminate unfavorable leakage; this is signal jamming. It typically consists of mimicking something that is appropriate under different circumstances than the ones at hand.

If you want to elicit information from someone else, you should set up a situation where that person would find it optimal to take one action if the information was of one kind, and another action if it was of another kind; action (or inaction) then reveals the information.* This strategy is called screening. For example, Sue’s request for a tatt...

Your personal characteristics—ability, preferences, intentions—constitute the most important information that you have and others lack. They cannot observe these things, but you can take actions that credibly signal the information to them. Likewise, they will attempt to infer your characteristics from your actions. Once you become aware of this, you will start seeing signals everywhere and will scrutinize your own actions for their signal content.

You believe that things are less likely to go wrong with the car under warranty in the first place. Why?

To answer that, you have to think about the seller’s strategy. The

Actions that are intended to convey a player’s private information to other players are called signals. For a signal to be a credible carrier of a specific item of information, it must be the case that the action is optimal for the player to take if, but only if, he has that specific information.

George Akerlof chose the used car market as the main example in his classic article showing that information asymmetries can lead to market failures.3 To illustrate the issue in the simplest way, suppose there are just two types of used cars: lemons (bad quality) and peaches (good quality). Suppose that the owner of each lemon is willing to sell it for $1,000, whereas each potential buyer is willing to pay $1,500 for a lemon. Suppose the owner of each peach is willing to sell it for $3,000, whereas each potential buyer is willing to pay $4,000 for a peach. If the quality of each car were immediately observable to all parties, then the market would work well. All cars would be traded, lemons selling for a price somewhere between $1,000 and $1,500, and each peach between $3,000 and $4,000. But suppose each seller knows the quality of a car, whereas all that buyers know is that half the cars are lemons and half are peaches. If cars are offered for sale in the same proportion, each buyer would be willing to pay at most An owner who knows his car to be a peach is not willing to sell at this price.* Therefore only lemons will be offered for sale. Buyers, knowing this, would offer at most $1,500. The market for peaches would collapse completely, even though buyers are willing to pay a price for provable peaches that sellers are happy to accept. The Panglossian interpretation of markets, namely that they are the best and most efficient institutions for conduct of economic activity...

Michael Spence’s work for the next conceptual breakthrough, namely how strategic actions can communicate information.*

there are three types of credit card customers, what we will call maxpayers, revolvers, and dead-beats.

Capital One may not be able to identify who the profitable customers are, the nature of its offer ends up being attractive just to the profitable type. The offer screens out the unprofitable types. This is the reverse of the Groucho Marx effect. Here, any customer who accepts your offer is one you want to take.