Business leaders do no better than their political peers. They spend fortunes doing financial analyses of their expected gains and losses from this or that deal, but they spend virtually nothing analyzing how their counterparts on the other side of the table think about their own gains and losses. The result: companies have a good idea how much a business is worth to them before they try to buy it, but they don’t know how much they need to pay for it. In my experience, they often pay far too much, or, to look at the other side of the coin, they sell for much less than the buyer was prepared to pay. Too bad for their shareholders.
How can anyone make prudent choices without first thinking through how others will see those choices and react to them? Yet that is how most big decisions are made, blind to anyone else’s point of view. Plowing ahead without much thought to what motivates our rivals, whether in business or in government, is a surefire way to make a mess of things, leaving us to muddle through at best, our hopes pinned to shortsighted decisions.
Decision making is the last frontier in which science has been locked out of government and business. We live in a high-tech age with archaic guesswork guiding life and death decisions. The time for peering into tea leaves or reading astrological charts should be long over. We should leave entertaining divinations to storefront psychics and open the door to science as the new basis for the big decisions of our time.
Curious about how this can be done? The chapters to follow explain how precise predictions can be made. We will see, through illustrative examples from the worlds of national security and business and everyday life, that the problems of war and peace, mergers and acquisitions, litigation, legislation, and regulation—and just about anything else that does not rely on the hidden hand of market forces—can be reliably predicted.
We will see ways to use science, mathematics, and, in particular, the power of game theory to sort out behavior and improve the future. I hope to share with you this cutting-edge world of thought, whose potential, to many, may seem to verge on the mystical. But there is no mystery or mysticism in good prediction. To demonstrate this for you, I will suggest, in Chapter One, how a modest amount of strategic reasoning can help you save hundreds and maybe thousands of dollars the next time you buy a car.
1
WHAT WILL IT TAKE TO PUT YOU IN THIS CAR TODAY?
“GAME THEORY” IS a fancy label for a pretty simple idea: that people do what they believe is in their best interest. That means they pay attention to how others might react if they choose to do one thing or another. Those “others” are anyone believed to be a prospective supporter or opponent. Looking at how their interests intersect or collide is basic to assessing potential outcomes of decision making. To get a good grip on what people are likely to do requires first approximating what they believe about the situation and what they want to get out of it. By estimating carefully people’s wants and beliefs, anyone can make a reliable forecast of what each and every one of them will do. And if you can predict what will happen, then you can also predict what will happen if you alter what people believe about a situation. This is, in short, how we can use the same logic both for prediction and for engineering the future.
I’ll provide a more detailed examination of game theory in the next two chapters, but first, as promised, let me illustrate what I’m talking about with the example of how best to buy a new car.
A new car purchase is a costly bargaining experience for most of us because most of us are bad at it. A little strategic reasoning can go a long way to improve the experience. If you follow the ideas here, you will not only have a happier time buying a car, you’ll also pay a lot less money.
New cars are mostly bought in one of two ways. Most of us go to a dealership, test-drive a vehicle, maybe fall in love with it, and engage in a most unpleasant negotiation over the price. A smaller number of us hate that experience enough that we buy cars through the Internet. This usually means getting price bids from a few local dealers and then going to one of them to get the car. That’s slightly better, but there’s yet a better way to buy cars that I urge you to try.
What’s wrong with the most popular means of car shopping? Pretty much everything. To start with, you, the buyer, invest your time, and probably the time of some family members as well, at a car dealership. The salesperson knows that few people enjoy dealing with them. They know that they rate near the bottom of anybody’s scale of occupational trustworthiness. (The
Being there is what game theorists call a “costly signal.” It’s a costly signal because your expenditure of time and energy announces that you want to buy, that there’s a good chance you’ll buy from the dealership you’re visiting rather than go elsewhere, and, especially if you have kids with you, that you want to get out of there as quickly as possible. That first step, then,
Now as it happens, costly signals are usually good things for you. They show you’re serious about what you are saying and doing. That can give you credibility, as we will see in later chapters. Unfortunately, costly signals can have just the opposite effect when you’re a shopper. They announce your eagerness to buy, and that makes it tough to get a good deal.
The situation was bad enough when you walked in the dealership door, but it only gets worse once a conversation begins. Although you’ve probably done homework online and know something about the invoice price of the car you want, there’s a great deal you don’t know that the dealer does know. When you say you want a gray car, or a blue one, or yellow, you don’t know whether you’ve picked the hottest color in the greatest demand or a color that hardly anyone wants. You may not even know that there can be a price difference of many hundreds of dollars between choosing, say, red or yellow because the dealer treats that choice just the way options are treated—as one more place to pile on costs. You don’t know enough about the local supply and demand to have a good retort when Pat, the salesperson, tells you the vehicle you want is in short supply. Translation: The invoice price on the Internet? Forget it—that’s not going to happen for the car you want. Score another point for the dealer, and still none for you.
As anyone who’s ever bought a new car knows, Pat will almost certainly ask you, “What will it take to put you in this car today?” Now you’re cornered. If you name a really low price, Pat, who has been playing up to you, looks hurt or loses interest, or maybe even becomes just a little rude. Control of the discussion is now fully out of your hands. You feel bad about the lowball offer, you want to establish your good faith, and so you come back with a number close to what you’re actually prepared to pay because you want to keep the conversation going. So Pat has gotten you to put a credible price on the table. Now, after praising the offer, Pat announces that this is a price that can be taken to the sales manager for approval. This is when the price gets jacked up a little bit more to close the deal. Rather than worrying about what the sales manager will say as you sit at Pat’s desk, sipping dishwater-thin
