Applied Game Theory: Flipkart vs Amazon
Decision-making is hard.
But why?
Because there are multiple parameters, lack of information and not knowing the outcome.
But do we have a formula for humans to make decisions similar to what we have developed for machines?
Maybe we have. Some call it intuition, some call it framework and some call it Theory.
Game theory is about situations where more than one participants are part of decision making process.
It studies situations where two or more participants are involved for a reward or punishment which we call a Game. It can not predict human behavior with 100% accuracy but yes it can give you some really good insight.
Flipkart vs Amazon
Amazon’s Prime Day and Flipkart's Big Billion Day sale gives these companies the most business compared to any other short time duration. Buyers, sellers, internal teams and other middle teams have some sleepless nights.
The prime day came and went, it’s Flipkart’s time to shine.
Both of these companies use multiple marketing channels like Twitter, Facebook, newspaper and more to make their sale as successful as possible.
So, let’s think about a hypothetical situation.
Both of these company’s analysts have come to a conclusion that 1st August is the best day to announce the sale date.
Confusion is that they are not sure if they should go for a full front-page newspaper ad or not?
Whoever publish ads, wins 90% customers over the competitor if the competitor doesn’t follow the same strategy, as both of these platforms and their offerings are almost identical.
But of course, these ads cost money and running them will cut your profits.
Let’s assume that the front-page newspaper ads cost 1 lakh/day and customers can give a total profit of 10 Lakhs which will be divided equally. So 5 Lakhs for each company if neither of them runs an ad.
Half of the money on advertisement go waste, trouble is you don’t know which half.
What if both of them publish ads? Well, then, your ads will cancel each other out. You’ll still get a 5 Lakhs profit, same as if neither of you had run ads.
But in this case, you’ll both be poorer as a result of your ad spending.
Actual profit = Sales profit — ad cost = 5 lakhs — 1 lakh = 4 Lakhs.
If amazon publishes an ad and Flipkart doesn’t, then amazon has 90% of customers which gives them a profit of 8 lakhs ( 9 lakhs sale profit — 1 lakh ad cost) and Flipkart's profit will be 1 lakh. Vice-versa.
Let’s put this in the table:-
The above table is the payoff matrix, which lists the players, the actions open to each player, and the payoffs that each player will get for every possible combination of all the players’ actions.
Both of these companies know putting an ad on paper will give them an edge over competitors but only if the competitor doesn’t. No matter what *you* do, *he* will be better served by running ads.
So, in this situation, if two of these are rational, they’ll both end up running ads.
Analyzing situations like this with cross-dependent payoffs is what “game theory” is all about. Every “game” in game theory has 3 defining characteristics:
1) The “Players” who play the game,
2) The “Actions” that each player can take, and
3) The “Payoffs” that each player gets from the game.
In our game we have two players (a duopoly) with 2 actions, to run an ad or not. Games can have multiple players and multiple actions.
Once we have the payoff matrix, the next step is to analyze it and figure out how the game will unfold.
This is where “Nash Equilibrium” comes in.
Nash Equilibrium
John Nash proposed it and discovered many of its properties, won a Nobel prize for it in 1994.
In a Nash Equilibrium, *every* player’s chosen action is the optimal response to the actions chosen by the other players or once the players reach a Nash Equilibrium, *no* player has an incentive to change their chosen action.
Why would they? Their current choice is already optimal. This is why it’s called an “equilibrium”. Nobody has an incentive to depart from it.
Dominant Strategy
One player’s loss can be a win for another. Game theory suggests that in a situation where one player’s loss is another one’s win, then players should think about minimizing their maximum loss.
Decisions are simultaneous, which means decisions taken by both parties are at the same time and neither of the players knows the decision of another player. So, to win a game, players have to take a dominant strategy.
The dominant strategy has the best payoff no matter what other player chooses. Its equilibrium is reached when each player chooses their own dominant strategy which is nash equilibrium.
You can now relate this with the ‘Prisoner’s Dilemma’ example and if you don’t, watch it here.
What is the dilemma in our example?
If these both companies run ads, they make a profit of 4 Lakhs but if they don’t they’ll make a profit of 5 lakhs.
So by running an ad you are losing a profit of 1 Lakh and yet, the outcome where neither of you runs ads is *not* a Nash Equilibrium.
The moment one of you decides not to run ads, the other has all the more incentive to run them.
So, this is a unique case of a duopoly game.
Other examples of duopoly are Zomato — Swiggy, Byju’s — Unacademy, Ola-Uber, AWS — GCP and more.
Conclusion
Game theory is a field where we study social interactions, decisions and logic behind them.
Nash equilibrium is about achieving an optimum result. Action taken by a player to achieve that result can or can not be the best action or judgment of decision. When you are competing with each other, the best option is to take action that benefits you the most, no matter what everyone else decided to do.
