An Information Technology Example

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Game theory provides a promising approach to understanding strategic problems of all sorts, and the simplicity and power of the Prisoners' Dilemma and similar examples make them a natural starting point. But there will often be complications we must consider in a more complex and realistic application. Let's see how we might move from a simpler to a more realistic game model in a real-world example of strategic thinking: choosing an information system.

For this example, the players will be a company considering the choice of a new internal e-mail or intranet system, and a supplier who is considering producing it. The two choices are to install a technically advanced or a more proven system with less functionality. We'll assume that the more advanced system really does supply a lot more functionality, so that the payoffs to the two players, net of the user's payment to the supplier, are as shown in Table A-1.

Table A-1

Although it looks a lot like the Prisoners' Dilemma at first glance, this is a more complicated game. We'll take several complications in turn:

• Looking at it carefully, we see that there this game has no dominated strategies. The best strategy for each participant depends on the strategy chosen by the other participant. Thus, we need a new concept of game-equilibrium, that will allow for that complication. When there are no dominant strategies, we often use an equilibrium conception called the Nash Equilibrium, named after Nobel Memorial Laureate John Nash. The Nash Equilibrium is a pretty simple idea: we have a Nash Equilibrium if each participant chooses the best strategy, given the strategy chosen by the other participant. In the example, if the user opts for the advanced system, then it is best for the supplier to do that too. So (Advanced, Advanced) is a Nash-equilibrium. But, hold on here! If the user chooses the proven system, it's best for the supplier to do that too. There are two Nash Equilibria! Which one will be chosen? It may seem easy enough to opt for the advanced system which is better all around, but if each participant believes that the other will stick with the proven system -- being a bit of a stick in the mud, perhaps -- then it will be best for each player to choose the proven system -- and each will be right in assuming that the other one is a stick in the mud! This is a danger typical of a class of games called coordination games -- and what we have learned is that the choice of compatible standards is a coordination game.
• We have assumed that the payoffs are known and certain. In the real world, every strategic decision is risky -- and a decision for the advanced system is likely to be riskier than a decision for the proven system. Thus, we would have to take into account the players' subjective attitudes toward risk, their risk aversion, to make the example fully realistic. We won't attempt to do that in this example, but we must keep it in mind.
• The example assumes that payoffs are measured in money. Thus, we are not only leaving risk aversion out of the picture, but also any other subjective rewards and penalties that cannot be measured in money. Economists have ways of measuring subjective rewards in money terms -- and sometimes they work -- but, again, we are going to skip over that problem and assume that all rewards and penalties are measured in money and are transferable from the user to the supplier and vice versa.
• Real choices of information systems are likely to involve more than two players, at least in the long run -- the user may choose among several suppliers, and suppliers may have many customers. That makes the coordination problem harder to solve. Suppose, for example, that "beta" is the advanced system and "VHS" is the proven system, and suppose that about 90% of the market uses "VHS." Then "VHS" may take over the market from "beta" even though "beta" is the better system. Many economists, game theorists and others believe this is a main reason why certain technical standards gain dominance. (This is being written on a Macintosh computer. Can you think of any other possible examples like the beta vs. VHS example?)
• On the other hand, the user and the supplier don't have to just sit back and wait to see what the other person does -- they can sit down and talk it out, and commit themselves to a contract. In fact, they have to do so, because the amount of payment from the user to the supplier -- a strategic decision we have ignored until now -- also has to be agreed upon. In other words, unlike the Prisoners' Dilemma, this is a cooperative game, not a noncooperative game. On the one hand, that will make the problem of coordinating standards easier, at least in the short run. On the other hand, Cooperative games call for a different approach to solution.

Roger A. McCain