Understanding The Game

Why Game Theory is one of the most critical concepts in business

Thinking through the game theory of a business deal is absolutely critical regardless of if you are working on a cofounding partnership, business development agreement, or new client.

In college, I was involved in a tiny pro audio consulting partnership that we called Terra Sound. We helped bars, churches, and small studios by installing and configuring their sound systems. Before my partner and I decided to join forces, we both independently were doing this type of work different markets.

My partner and I both worked in the pro audio department of Sam Ash Music in Las Vegas which meant that we could sell someone a sound system and ask them if they needed help with installation. About a third of the time we asked question this the buyer would need help so we would funnel the work through the company. We were good friends and had consistent business so things started off well.

Over time, however, the the partnership began to unravel for reasons I didn’t fully understand.

Years later, and after going through what can only be described as various painful business situations, I found myself thinking about Terra Sound. It wasn’t until I started reading more about the game theorists “John Nash” and “Bruce Bueno de Mesquita” that it became in clear why the business my friend and I put together fell apart.

In “The Predictioneer’s Game” Mesquita explains how Leopold II was deemed as “Builder King” in Belgium, yet in Congo he was a Tyrant that ruled through corruption and brutality. Mesquita then went on to explain that the likely cause of this was the governmental system that existed in Belgium. It required that for Leopold to keep power he needed to act as a gracious civil servant. Leopold was a smart man so he acted according to what he thought was optimal for himself while taking into account the choices and actions of his constituents. This concept is what is known as the “Nash Equilibrium” and is one of the major contributions that the economist John Nash, who was portrayed by Russle Crowe in “A Beautiful Mind”, made to the field of Game Theory.

In the Congo, however, there was no incentive structure to keep Leopold in check, thus he “extracted” the natural resources from the country to fuel his personal fortune through the use of a mercenary army.

Game theory basics and the Nash Equilibrium

When my partner and I setup the Terra Sound partnership we thought that 1 + 1 would equal 2. Meaning that together we would be able to do more work which meant more money for the both of us. We were, after all, friends who serviced different markets and respected each others ability. The problem came in that each of us could source leads and execute contracts on our own. Worse, it was more profitable in the short run to do our own solo contracts. This meant that each time a call came in for service, the pressure to do the contract on our own acted as sandpaper which ultimately eroded the partnership to nothing.

Yes 1 + 1 did equal 2, but in this case it didn’t matter.

I realize now that what we needed something that would keep us together and acting in alignment. For Leopold this was the Belgium power structure, but we needed 1 + 1 needed to equal 3. This could have been accomplished by having some mismatch in skills, knowledge or resources that together would create an amplification in the outcome. This amplification is a concept that I think of as “tension”, which is something that is always required among business partners to keep them aligned. Without it, things have a tendency to drift.

A useful thought experiment to explore tension in business deal is by imagining if one partner were to be hit by a bus. How dismal the aftermath would be for the deal — not to mention the loss of a friend. If the answer is “we would survive and thrive just fine” there isn’t any tension in the partnership.

This is a two way street. Whenever evaluating a potential partnership, long and hard consideration needs to be given to whats in the union for all parties. Just like my partner and I did when setting up Terra Sound many people don’t consider the deal from all angles before committing.

Personally, if I don’t see clearly understand the value that I can provide, and the value a prospect thinks/knows I can provide, I don’t do a deal because I want to ensure that there is tension to keep everyone marching in the same direction. This means that sometimes I miss out on some seemingly good opportunities, but as Sun Tsu said:

“He will win who knows when to fight and when not to fight.”

I have found that understanding this distinction is one of the most important concepts in business and Game Theory is a useful framework in recognizing when to take up arms.

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