Game theory and Human Resource Management

“When thinking strategically, you have to work extra hard to understand the perspective and interactions of all the other players in the game, including ones who may be silent. That brings us to the last point. You may be thinking you are playing one game, but it is only a part of a larger game. There is always a larger game.” – Dixit & Nalebuff in The Art of Strategy

Companies have gone through a very difficult period that could arguably be likened to a ‘perfect storm’ as many industries struggled to create sustainable growth because of, say, increasing and aggressive labour unrest as well as fractures between unions and labour. HR professionals will need to to sort these issues in unconventional ways and become key players in delivering on primary business objectives. Game theory is an approach which, if used correctly, will lead to better problem-solving approaches and significantly increase the likelihood of success.

Game theory delineates how individual players make decisions when they are aware that their actions affect each other and when each individual has the same realization. Game theory has been applied extensively in the field of economics and many other areas of social sciences, but has made few contributions to the area of human resource management. The games this theory potentially applies to are vast and range from chess to child rearing, from leadership to managing takeovers, developing turnaround strategies or implementing change interventions, and from advertising to politics.

Strategic thinking using game theory in a business or leadership sense starts with an ability to understand the basic principles behind “human nature and behaviour”, and then know how to utilize this knowledge in a manner that influences positive win-win outcomes. Game theory will enable organizations and managers to better comprehend and hence, effectively manage their team members during difficult times. John Nash, who made fundamental contributions to game theory, believed that the best solution is when we consider what is best for the individual (zero-sum), and the group.

How is game theory useful in HR?

Game theory is incredibly effective in analyzing problems, defining the ‘right’ solutions for different contexts (both strategically and tactically), expediting effective decision-making and, importantly, getting things done and getting good ideas implemented.

Game theory is technically a branch of applied mathematics that has been adopted for use in economic analysis. In economics, the central feature of game theory is that it provides a formal modeling approach for decision-makers to explore a variety of interactions among economic agents and their potential outcomes. Such a modeling process can be important for decision makers in HRD for considering their investments and their potential returns.

Game theory is an approach that allows organizations to understand:

  • Causes of problems
  • Manifestation of problems(scenario planning)
  • Which 20% to focus on in order to get the 80% benefit
  • Decisions and solutions to adopt
  • How confident we can be that the reactions from our key stakeholders (employees, labour, shareholders, management, communities and government) will be positive because of our strategic or tactical actions/decisions?

Analysis and Examples:

Firm employee interaction as a dynamic game

Decision of the firm Employee’s Actions
Act Cooperatively Act Opportunistically
Adopt HRD Initiatives 7.5, 7.5 0, 15
Do not adopt HRD Initiatives 5, 0 NA

As an illustration, suppose the firm must invest $5 on an HRD initiative that has the potential of providing $15 in enhanced productivity of the employee. In a cooperative environment, both the employee and the firm may decide to share the excess productivity of $15 evenly making it worthwhile for both. However, with opportunistic behavior, the employee may decide to switch jobs with the potential of appropriating the entire $15 in economic rent for himself or herself, leaving the employer with an expenditure of $5 which brought no returns. Faced with this prospect, the firm may decide to not invest in the HRD initiative and save the $5.

A firm expends resources in HRD initiatives in the hopes of creating a more valuable (productive) work force. Once an employee has decided to participate in an HRD initiative, he or she has the opportunity to behave cooperatively or opportunistically. Cooperative behaviour will manifest in higher productivity from the employee where the economic rents from the HRD investment are shared by the employee and the firm. However, opportunistic behaviour by the employee may result in the employee marketing his or her newly enhanced expertise to other firms who did not make any investment in the HRD initiative. As such, the employee could extol the entire economic rent generated by the firm’s HRD initiative. Of course, the hiring firm may negotiate some of the extra rents away from the employee in the hiring process. In any event, if the employee sees an opportunity to obtain a greater portion of the extra rent generated, he or she may still have an incentive to switch jobs. Such opportunism may reduce the incentive for firms to invest in HRD initiatives in a static environment.

As an employee’s opportunistic behaviour becomes known among potential employers, he or she may be unable to repeat such opportunistic behavior over future iterations. Future employers may insist on safeguards such as bonding agreements before investing in HRD initiatives for such employees. As such, the value of future HRD initiatives may be limited for an employee with questionable reputation, and the added value from switching jobs may eventually disappear. Applying these notions, one may develop a dynamic strategy where in an infinitely repeated game; the dominant strategy may well be co-operation.

Wage bargaining (Collective bargaining):

Say, a labour union declares a strike demanding higher wages. The labour union is unaware of the exact profit made by the company. Hence it is a case of imperfect information. (Even if the firm divulges its profit, there is no reason why the union would believe because the firm has an incentive to understate its profit thereby requesting a lower wage.) In such a situation there are many things that come into play.

1. The firm may not know how long the union can hold its stand. The firm however, knows the cost of replacing the experienced labour force.
2. The union may not know how long the firm can hold its stand before giving into the union’s demand.
3. Is the firm holding out and not settling to pay higher wages an indicator of the fact that the firm cannot afford to pay higher wages (it will result in huge losses for the firm and hence it has nothing to lose in its current stand) or is the firm trying to bluff the union into believing the same? In other words, is the signal valid?
4. Say if there is a condition that when a strike goes unresolved for more than ‘x’ weeks, an arbitrator gets involved. Now, there is at least one more uncertainty – what would the arbitrator do. If the arbitrator’s decision would be favorable to either of the parties, there is an incentive for that party to wait out.

Using all the information that each party believes to be true, it can come up with an acceptable range of wages. If the ranges overlap, a strike can be avoided! Else the game will be a protracted one with more signals and ultimatums.

What underlies game theory principles?

It is important to understand that because the dynamics of human behaviour are relatively well understood, it is possible – with enough information – to predict or anticipate individual responses to interactions or decisions. Some decisions or interactions are clear cut and solutions are relatively easy to identify and implement, but increasingly managers are faced with challenges that are potentially open-ended and not responsive to generic interventions. However, managers are very responsive to interventions that target and positively impact their specific problems. Game theory enables us to identify these in a scientific way.

Game theory principles are also based on the realities of human behaviour, which people won’t express externally, but these do drive decisions and strategies, for example:

  • People aren’t always selfless in their actions and decisions and so will not always do things that are in the best interests of their employees or the organization. It is human nature to act in ways that protect their best interests and drive their own agendas.
  • Over time, any individual typically demonstrates consistent behaviour patterns in response to problems or making decisions. Finding patterns in behaviour, understanding internal political dynamics, and knowing the motivations of an individual/key decision maker will enable you to use foresight in developing responses to scenarios, which scientifically increases the potential for effective collaboration and buy-in to ideas and solutions.

Finally, some of these change management questions with reference to GROW model will be useful in digging deeper-

grow

Limitations

These methodologies are not without their shortcomings which need to be considered during the strategy development process.  Firstly, game theory assumes the players act rationally and in their self-interest.  We know that as humans, this is not always the case.  Secondly, Game Theory assumes that players act strategically and consider the competitive responses of their actions.  Again, our experience tells us that not every manager thinks within a strategic context.  In reality, most companies often do not have enough knowledge of their own payoffs let alone those of their competition. Finally, Game Theory is most effective when managers understand the expected positive and negatives payoffs of each of their actions.

(Sources- Quora, Blogs, HR Pulse, research papers and summary of the book- The art of strategy )

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About Mukesh Bhavsar

Mukesh has done BE Civil from Mumbai University and MA Political Science from IGNOU. He is currently pursuing masters in HR Management from Tata Institute of Social Sciences (TISS). He has worked for a couple of NGOs in India and UK. He has also written for some newspapers and magazines on different social issues. He was one of the 20 volunteers of India-UK Global Xchange program in 2011. Mukesh is interested in entrepreneurship, writing, social work, travelling, and photography. Follow him on twitter- https://twitter.com/mukeshbhavsar88
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