How many fish would you take?
A common “game” explored by game theory is called the tragedy of the commons. Watch the short video: “What is the tragedy of the commons?” (TedEd)

Game theory: modeling complex situations

These kinds of situations where multiple “players” make decisions that are interdependent: one person or entity’s decision affects the outcomes and decisions of others involved. The study of such dynamic decision-making scenarios is called game theory. Game theory is often a core element of risk management, operations management, and decision science programs in business schools.

Game theory is “the theory of decision-making and leads to an analysis of the interactions and decision-making processes of rational players in order to understand the behavior and strategies of individuals or companies in economic systems (von Neumann & Morgenstern).”

Game theory is a way of modeling and using computational techniques to determine optimal solutions in complex relationships with competing interests.

An exploration of game theory through the context of sustainability can reveal the unique and powerful role enterprise risk management can play in advancing positive social and environmental impact.

Playing Games with the Environment

Risk managers and their game theoretic thinking can unlock tough environmental trade-off decisions. Consider water and all the various parties involved for example. By 2050, half the world population will live in water scarce regions and today’s these shortages already cost $4.5b per year in Central Asia alone (The Economist).

If a firm uses water and also discharges treated water, there are internal facilities managers, process engineers, accountants and auditors, and external water authority officers, government regulators and community groups, just to name a few. Each of these groups have a different set of motives, incentives and desired outcomes when it comes to water.

Let’s look in greater depth at another example….that of launching new sustainable products.

Game Theory in Action: Creating the Decision Table and Determining the Optimal Solution

The “decision table” below is an illustrative example for how game theory models are designed.

Game theory models can become highly complex and involve advanced statistical models but the basic game theory model is the same and includes the elements below (which are represented in the table below)

• • players – what individuals or groups or companies are involved?
  • objectives – what do they want? what incentives or motives are at work?
  • options – what are the possible decisions for the firm?
  • actions – what are the possible reactions off the players to the firm’s decision
  • probabilities – what are the calculated probabilities of various outcomes? (based usually on primary and secondary research–surveys, interviews, desktop research, etc.)

As you can see, the “decision table” brings a rigorous and data-driven model to a complex sustainability strategy decision involving multiple parties with competing interests. 

Our aim here was to demonstrate the importance of game theory and how scenarios are modeled to identify risks and opportunities. The next steps of determining probabilities and calculating the optimal answer. You can see an example of how such calculations are done with an example involving the loss of key personnel. 

What Game Theory Has to Offer Sustainability

Sustainability is about managing the often competing, sometimes cooperating interests of multiple parties. The optimal choice has to consider not only the perspective of each party but also how each will react to the choices of the others involved. Because of this complexity, game theory, and the risk managers who use it to build computational and statistical models, can make an important contribution to identifying optimal solutions to sustainability challenges from climate change to circular economy to the protection of rainforests.

Game theory and the enterprise risk managers who use it effectively can uniquely offer the following to sustainability strategy:

• a step-by-step process for analyzing and modeling sustainability-related strategic decisions in a way that accounts for relevant risks and opportunities
• data-driven decision making that optimizes financial, social and environmental impacts
• careful consideration of the “players” involved in a sustainability decision scenario and an understanding of what motivates each of them
• an understanding that the optimal action to address the identified risks considers the perspectives of all parties involved

Risk management is about anticipating what might happen and making informed decisions, therefore we must consider how others will react. Scenarios where multiple parties make interdependent decisions is where game theory can play an important role. Increasingly, these decisions in business involve careful consideration of social and environmental impact–which invites even more “players” to the game.

We can make assumptions about how people and organizations will react without considering motives, incentives, and objectives.

Game Theory is an important tool for informed decision-making to manage risks and improve financial, social and environmental performance.