Game Theory Applied to Long-term Strategic Planning -- New Product Development

Tom Mitchell
President
Open Options Corporation

Niall M. Fraser, Ph.D.
Principal Scientist
Open Options Corporation

Michael Phillips
Strategy Consultant
Open Options Corporation

In strategic planning, the impact of decisions made by external people and organizations such as competitors, suppliers, regulators and customers can be very important. However, assessing these external factors in a comprehensive manner can be very difficult.

Game Theory is the branch of mathematics that allows the formal consideration of the interactions of people and organizations in situations of parallel and conflicting goals. It is a very powerful tool for use in strategic planning. In game theory the various external people or organizations that can affect the success of a strategic plan are called "players".

Any decisions made by an organization are not made in isolation. There is always a dynamic environment that will respond to such decisions and in some cases will anticipate them. Competitors will match product pricing or will introduce better products at cheaper prices. Suppliers might increase raw material costs, customers can switch brand, or regulators can pass new restrictive regulations.

In order to validate any strategic plan, it is necessary to consider both the effect on the other players of the actions taken in the plan, and also effect on the company of actions taken by other players. The feasible future possibilities quickly become very difficult to enumerate and assess, and so a formal game theory process is valuable.

This paper will explain the use of game theory in strategic planning through the presentation of a case involving new product investment:

• A major manufacturer needed guidance on how direct its $1 billion per year research budget over a 15-year planning window.
• Of particular concern was the products the Client should make, given the changing sources and uses of energy.
• The degree of uncertainty over the 15-year time frame was daunting, as well as the breadth of influencing factors.

By attending this presentation, the audience should gain a good appreciation of the value of game theory in strategic planning as well as the knowledge to apply game theory to problems in their own organizations.

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