Inspiration vs Manipulation

Game Theory and Startup Ecosystem

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Game Theory dictates that you first try to understand the motivations and objectives of other players and understand the strategies they will adopt to define your answering strategy. A startup engages with users, customers, and other companies, competing with them for a share of the market. Even the government and market regulators are players that a startup engages with. In this article, we will discuss how game theory and startup ecosystem are interrelated.

Negotiation with VCs

Imagine a scenario where founders and investors are negotiating a deal. This could happen in a cooperative manner where they do a fair deal, benefiting both parties equally (a non-zero-sum game) or become noncooperative and try to exploit and get a better deal for themselves at the expense of the other (a zero-sum game). A zero-sum game ends in a lower valuation or zero funding for a startup. Now, The Nash Equilibrium for the scenario occurs when both companies value themselves below true value. After initial negotiations, the next set of decisions would be taken on prior experience, and therefore strategies would be adjusted accordingly. There is a strategy in game theory, namely “tit for tat”, which clearly explains this type of situation.

The relationship between venture capitalists (VC) and startups is very unique and unlike any other co-dependent network. Most startups experience failures which often starts with the crumbling relationship between these entities. Which leads to the question: what factors contribute to a successful relationship between founders and VC that results in funding for a startup? Prisoner’s Dilemma has the answer.

Prisoner’s Dilemma is a situation where individual decision-makers always have an incentive to choose in a way that creates a less than optimal outcome for the individuals as a group.

Observing Prisoner’s Dilemma

Prisoner’s dilemma can work as a conceptual framework to investigate this relationship. In the context of startups and VC’s, prison sentences would be the profits/benefits received by both entities. (here low points depict high returns)

Pay off matrix between Startup and Venture Capitalist

When VCs and Founders mutually defect

First, let’s observe what happens when both entrepreneurs and VC’s ‘mutually defect’. This can occur when an entrepreneur becomes aware of new opportunities that have a higher probability of success like competing offers, new ideas, etc. and the VC’s are constantly looking to maximize their financial return, which incentivizes defecting to end the relationship leaving both with 5 points. In this instance, ‘defecting’ would mean disallowing financial support. In the case of entrepreneurs defecting while VC’s remain steadfast in the relationship, we see that withholding technical details, critical information about the startup (full disclosure is often necessary for cooperation to occur) may serve as a short term strategy that benefits the entrepreneur but hurts the VC. On the other hand, if the VC does not provide enough capital or show confidence in the team afterwards and pressurize the startup, that would hurt the startup.

When they co-operate

To get the maximum profit i.e, (1, 1) points, VC and startup have to cooperate. To cooperate, Communication is key. Having a vision, being able to dazzle people with your idea is just as essential to a good relationship as the idea itself. That is, the probability of a cooperative relationship rises with the frequency of their communication. The probability of a successful relationship increases when there is perceived power equality between entrepreneurs and VC’s.

How to scale business

We have talked about how to get funding once you have the idea and the team, but it is also important for a company to make sales in order to survive in a highly competitive market. Let’s see how one can do that.

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In-game theory, there are two types of games:-

1. Finite Game: a game played for the purpose of ending play consistent with static rules with known players only.
2. Infinite Game: a game played for the purpose of continuing play, there are changeable rules and unknown players also.

Business: Not a Finite Game

In business terms, the concept and game of business have existed longer than any business and will continue long after business nowadays cease to exist. The problem here is the number of companies that are playing a finite game: they are playing to be the best and to achieve certain goals in terms of money, but they always get frustrated by the company that has an amazing vision. In the long term, the company with a stronger vision will always win and the other will always run out of business, one way or another. The former company would apply the following rules to win:-

1. Price — they play the price game, but they do so because they know it’s effective. Drop your prices low enough and people will buy from you. However, it can come at a tremendous cost and can create a significant dilemma for the company. One cannot debate that dropping the price is not a legitimate way of driving business; the challenge is staying profitable. It works, but at what cost?
2. Promotions — Around the 1950s, General Motors was one of the largest automotive industries. By 1990, GM faced an onslaught of competition from other countries’ industries, and they turned to the advertisement. They offered cash back incentives between $500 and $7000 for those who bought their products. For a long time, the promotions worked brilliantly and its sales were high, but in the long term, incentives only helped to erode GM’s margins and pushed them behind.
3. Fear — You may have heard “Every thirty six-seconds, someone dies of a heart attack”- by a local cardiologist, and “before it’s too late” by the insurance industry. You get manipulated by this. When fear is employed, facts are incidental. This emotion cannot be quickly wiped away with facts and figures.
4. Aspirations — Marketers often talks about the importance of being aspirational, offering someone something they desire to achieve like “Six steps to a happier life”, “six easy steps to losing weight”, “buy one if you want to crack JEE” etc. Actually these works. But does it matter in the long term?
5. Innovation — In 2004, Motorola launched RAZR mobile phones with new features such as an internal antenna which was 13.99mm thin. Millions of people bought it. Even a Prime Minister or two was seen talking on one. It was in fact a revolutionary’s success. But then after four years, Zander (the then CEO of Motorola) was forced out. The stock traded at 50% of the average value since the launch of RAZR. Real innovation changes the course of industries or even societies like lightbulbs, microwave ovens etc. These are true innovations that changed how we do business or live our lives. So RAZR was not an innovation. Adding a camera to a mobile is not an innovation- for example. We can say RAZR was successfully designed. Novelty can drive sales, the RAZR proved it but the impact does not last.

So, what works in an infinite game of business?

Inspire vs Manipulate

We have seen that Manipulations lead to transactions, not loyalty. It would work fine in a finite game.

There are few leaders who chose to inspire rather than manipulate in order to motivate people. They all do it in the same way. They think, act and communicate to all. A company formed on the true purpose or cause of why any company does what they do(a “why”) is the answer to why some companies achieve high while others cannot.

It offers clear insight as to how Apple is able to innovate in so many diverse industries and never lose its ability to do so. It explains why people tattoo Harley-Davidson logos on their bodies. The concept of “why” not only explains achievement, leadership, product development, and sales but also explains the loyalty of customers to a company.

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Business is an infinite game so we need to have loyalty and trust in our customers, employees and stakeholders. A founder should know why he started what he started in the first place. In order to win or to get funds in this context, one should cooperate. So, a leader needs to inspire and cooperate rather than manipulate and defect.

References

• Sinek, Simon The Infinite Game(2018), Start With Why(2009).
• Carse, James P. (1987). Finite and Infinite Games.
• https://medium.com/futursticvc/the-evolutionary-game-theory-of-a-startup-ecosystem-and-why-it-matters-for-founders-b402c0069a1c
• https://www.scirp.org/journal/paperinformation.aspx?paperid=70363
• Zhang, W. Y. (2012). Game Theory and Information Economics. Shanghai: Shanghai People’s Publishing House.
• https://www.researchgate.net/publication/312010544_A_behavioural_game_theory_perspective_on_the_collaboration_between_innovative_and_entrepreneurial_firms
• https://www.investopedia.com/articles/investing/110513/utilizing-prisoners-dilemma-business-and-economy.asp