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No Playing Around: Reflections on Game Theory as Serious Business

May 2000

One of the most important developments in business over the past 25 years has been the rise of game theory. And one of the central figures in the creation of that concept has been Robert Wilson, Atholl McBean Professor of Economics, whose specialty has been designing ingenious new formats for auctions, such as the one used by the State of California in 1998 to privatize utilities.

“I applaud Bob as one of the great research leaders here at Stanford over the last 30 years,” said economics professor David Kreps during a discussion of “Game Theory and Management,” held on May 19 in conjunction with Stanford’s 75th anniversary celebration.

Noting Wilson’s influence in making Stanford a major center of game theory development, Kreps, who is the Paul E. Holden Professor of Economics, placed the work of Stanford faculty and PhD students in the larger context of important game theory research that took place at business schools all over the country beginning in the mid-1970s. While the words “game theory” could hardly be found in curricula two decades ago, Kreps said, by 1985 they were ubiquitous among not only academics but also economists, who adopted the concept as a powerful means of analyzing business situations that “price theory just couldn’t touch.”

John McMillan, professor of international management, talked about Robert Wilson’s use of game theory in designing the Federal Communications Commission auction of spectrum rights for wireless communications in the early 1990s. He described the new auction format Wilson devised — named the “simultaneous ascending auction” — which allowed for all licenses to be offered for sale at the same time via computer. The design was particularly effective, McMillan noted, because it kept the process moving in a timely manner and prevented overbidding.

Panelist John Roberts, Jonathan B. Lovelace Professor of Economics, said one of the key tenets in using game theory to develop business strategy is to “put yourself in the other party’s shoes and think about what they need and how their beliefs are going to be affected by your actions. Assume not that they want to kill you or be your friend, but that they want to thrive for themselves.”

He described the efforts of one major corporation to do “game theoretic” modeling of their markets to predict how increased buyer power and increased entry would affect their revenues. Among other examples he cited was the case of Intel, which used game theoretical thinking to deliberately create a competitor as a means of committing themselves to treat customers well.

Jeremy Bulow, Richard A. Stepp Professor of Economics currently serving as chief economist of the Bureau of Economics of the Federal Trade Commission, discussed how game theory has influenced government policy in anti-trust cases. Noting that anti-trust investigations hinge on whether a firm is charging less than its average variable costs, he said that game theory has become indispensable in helping the FTC tease out such information. Bulow cited examples in which game theory has been called upon to help investigators determine whether airlines are engaging in predatory pricing. He also discussed topics that arise in high-tech antitrust cases, such as switching costs, bundling, contracting issues, vertical acquisitions, and divestitures.

By Marguerite Rigoglioso