March 31, 2006

More M.B.A. Programs Embrace Game Theory

Playing games is serious business in a lot of M.B.A. programs.

Game theory -- or the study of incentives -- appears in many disguises in such courses as marketing, finance, accounting and organizational behavior. Game theory is used to examine strategic interactions between players in a market.

"The strongest applications of game theory have come in strategy -- i.e. the science of strategic thinking," says Dan LeClair, an economist and vice president and chief knowledge officer at AACSB International, the Association to Advance Collegiate Schools of Business. "But it's hard to find a course that doesn't incorporate the literature and ideas of game theory."

Methods of teaching vary but often involve playing games in teams or walking students through illustrations, much as a chess handbook diagrams the proper moves on a chessboard.

"Strategic interactions have been around since the beginning of people," says Mr. LeClair. "What's new here is the attempt to provide some structure, particularly a mathematical structure, that helps us understand these behaviors."

The mathematical theory of games was documented by John von Neumann and Oskar Morgenstern in the 1940s and has long been a standard part of economics courses. By the 1970s, faculty in master's of business administration degree programs were discussing how games could be used to teach the practical lessons of business. Only in the 1980s and 1990s did game theory begin appearing in M.B.A. curricula outside of required economics courses and sometimes as a stand-alone elective.

Then, last year, Robert Aumann and Thomas Schelling won the Nobel Prize in economics for their work on game theory, creating greater awareness of the field. Some professors speculate that the Nobel Prize will boost interest in game theory, much as the subject aroused curiosity after the movie "A Beautiful Mind" told the story of John Nash, a Princeton University mathematician and game theorist who won the Nobel Prize in economics in 1994 after fighting schizophrenia.

Mike Shor, an associate professor of economics at the Owen Graduate School of Management of Vanderbilt University in Nashville, Tennessee, regularly teaches game theory in two classes -- one called pricing strategy and another named game theory and business strategy. "I try to make game theory relevant to individuals in business by discarding the heavy assumptions and advanced mathematical tools," says Mr. Shor. Each class session begins with a game that lasts five to 10 minutes.

Mr. Shor requires students to solve four cases and take one exam during his seven-week course. The cases are presented in the form of a memo that leads them to a somewhat obvious conclusion. However, after analyzing the information, the answer to the case is far from obvious.

A popular example that Mr. Shor uses in lectures is the story of how Airbus used brinksmanship with Boeing Co. when Airbus decided to build the A380 superjumbo jet. Airbus announced its plans to build the jet and Boeing immediately said it would do the same. If both makers of airplanes had gone ahead with the project, the market would have been split and neither company could have made a profit. Airbus called Boeing's bluff, however, and began the project in earnest. About the time Airbus unveiled the plane, Boeing brushed aside the move and said it had calculated that such an aircraft could never be profitable. The statement seemed an admission that Boeing never intended to build the aircraft.

"The key is to differentiate between a commitment and a bluff," says Mr. Shor.

Thomas Buerkle, who teaches personnel economics at Goethe University in Frankfurt and general economics at the University of Applied Sciences in Frankfurt, uses bargaining theory to discuss labor strikes and cooperative game theory as a way to explain why labor contracts should be long term.

He says that both employees and companies have two choices when interacting: cooperation or defection. If an employee has a one-year contract and shows up on the last day of work not knowing whether the contract has been extended, she will not invest full energy in the job. Knowing this, the company doesn't give the employee any work to do on her second-to-last day. Realizing the whole contract might be scuttled, the employee doesn't dedicate herself fully on the third day before the contract ends. And so on.

"If the date of the end of a relationship is known, no one cooperates," says Mr. Buerkle. "Longer-term contracts still come to an end but do a better job ensuring cooperation for a company because during the relationship no party can be sure when the contract really ends."

Vanderbilt's Mr. Shor runs gametheory.net³, a Web site for educators, students and others who are interested in the subject. The site links users to prepared classroom materials, simulations and other related material. He considers it a sort of "support group" for academics who want to make game theory relevant to business and other applications and present the material in a useful way.

"Sometimes game theory is mistakenly viewed as the study of conflict, particularly with the literature on zero-sum games in which I win and you lose," he says. "But, in business, one of the most important contributions of game theory is to help us understand how both parties can win. That's a very fundamental contribution that game theory has to make to business."

Although the value of teaching game theory has been widely accepted by practitioners, as evidenced by its wide application in so many types of M.B.A. courses, the method still has its opponents. The most widely voiced criticism is that game theory assumes people are rational and know what they want in a given situation, while real life hardly mirrors this scenario. Another assumption is that people are always out to benefit themselves, never thinking altruistically and never interested in cooperation.