Nash Equilibrium in business and the consulting world: how is it applicable?
Welcome to The Management Consultant, a newsletter about the game of consulting written by a long-time player.
If you’re not a subscriber, sign up and get interesting content on how to improve at management consulting delivered to you for free (on an irregular schedule 😅)
Have you ever wondered why two fast-food joints or gas stations often pop up close to each other and then there's nothing for miles?
At first, it might seem nonsensical.
Wouldn't a business attract more customers if it were far away from the competition?
The solution to this mystery lies in Game Theory, specifically in a concept called the Nash Equilibrium.
To understand better what I'm talking about, let's walk through an example.
There are two ice cream vendors, Seller A and Seller B, along a one-kilometer beach.
Both aim to sell the most ice creams. On the first day, they set up their stands in the middle of the beach, with Seller A on one side and Seller B on the other. This way, each of them serves about half of the beachgoers.
It's a fair distribution.
However, one day Seller B decides they want an edge.
So, the next morning, they place their stand in the center of the beach. As a result, they attract more customers, around 62.5%, leaving Seller A with only 37.5%.
Faced with this, Seller A also moves towards the center the following day. Now, both of them are back to evenly splitting the customers.
Neither can change position without giving customers to the other.
This situation represents the Nash Equilibrium in game theory, named after the mathematician John Nash.
John Nash’s work significantly impacted the fields of mathematics, economics, and game theory. Born on June 13, 1928, in Bluefield, West Virginia, Nash made substantial contributions in the field of differential geometry and partial differential equations. However, he is perhaps best known for his work in game theory, which earned him the Nobel Prize in Economics in 1994. His story was famously depicted in the 2001 movie A Beautiful Mind, based on his biography by Sylvia Nasar.
Nash’s groundbreaking contribution, known as the Nash Equilibrium, provides a concept of stability and strategy in non-cooperative games, like in the example we are analyzing today.
A Nash Equilibrium occurs when no one can benefit from changing their tactic alone; if changes are necessary, they must involve all participants.
In the mentioned example, both ice cream vendors are now in the center of the beach, because moving would mean losing customers.
As you can imagine, this theory doesn't just concern ice cream vendors.
It's the reason why many shops, restaurants, and gas stations choose locations near their rivals.
Proximity to competitors implies more potential customers, and moving away could result in losing that clientele.
So, even though it might seem odd at first, opening a business next to a competitor can turn out to be a shrewd choice.
The next time you spot two competing stores side by side, remember it's not a mere coincidence. They're applying this fundamental principle of game theory. It's all part of the business game, where sometimes the winning strategy is to stay close to competitors.
A business-context example
But game theory and the Nash equilibrium don't just relate to how close shops are set up.
Game theory delves into the behaviors of participants, whether they're individuals or businesses, as they engage strategically and competitively. This is achieved by analyzing and assessing the results of possible actions, observing how participants respond and adjust based on real-world consequences. Within a Nash equilibrium, you “satisfaction” doesn't necessarily arise from agreeing with your adversary's strategy; instead, it arises from how good you feel with your own chosen response, considering the strategy they have opted for.
Let's discuss a second example, relevant for all of us who spend our lives in corporates.
Hello 👋 one quick ask before you keep reading.
If you are new to this newsletter, please subscribe: it’s free… and interesting ✔
If you are already subscribed, please share it: don’t be selfish! 🤗
Imagine you have two skilled employees, Rick and Sam, who are both vying for two open positions within the company: Business Architect and Senior Business Consultant. Their qualifications and experience are on par with each other.
In this game, there's a strategic decision to be made by both Rick and Sam. They can either both apply for the Business Architect position, or one can apply for Business Architect while the other applies for Senior Business Consultant.
The Nash Equilibrium comes into play when Rick's best option is to apply for Business Architect if Sam is applying for Senior Business Consultant, and vice versa.
This makes sense because, somehow, they are avoiding direct competition for the same role, increasing their chances of at least one of them getting a promotion. If they both apply for Business Architect, there's a risk that neither of them might get the position, as the Consulting Partner might decide to bring in someone external.
Rick and Sam are making choices that take into account each other's potential decisions, resulting in a scenario where neither has an incentive to unilaterally change their choice given the other's choice. It's a situation of stability based on strategic decision-making and mutual considerations.
More food for thought
By now, you should have a grasp of how this powerful mathematical concept is actually impacting our lives much more than we think!
Some more scenarios I thought of, that are noteworthy in business, and specifically apply to the world of consulting:
Salary Negotiations: in situations where employees negotiate salaries with their employers, there can be a Nash Equilibrium when both parties find a compromise that satisfies their respective needs. If the employee asks for too much, they might not get the job, and if the employer offers too little, the employee might decline the offer.
Skill Specialization: consultants often need to decide on their areas of expertise. This can involve a Nash Equilibrium when colleagues choose to specialize in different areas to avoid direct competition and potentially strengthen the team's capabilities. Your boss will enjoy having a formed team where members complement each other's capabilities.
Competing for Projects: within a firm, consultants always compete to join high-profile projects or align themselves to specific functions/service lines. A Nash Equilibrium can arise when individuals strategically choose engagements to maximize their contributions, their chances of success and probability for promotion, without overloading themselves.
Job Mobility: when considering switching jobs or companies, employees might evaluate the equilibrium between their current role's benefits and the potential gains from moving. This includes factors like compensation, work-life balance, growth prospects, and the overall work environment. Life is about compromise, as we discussed in this post.
You get the idea…
To close today's conversation, the takeaway is that the Nash Equilibrium helps us understand how individuals navigate complex decisions within their careers to optimize outcomes.
It takes into account their own choices while anticipating the choices of others involved, creating a balance between competition and cooperation that is commonly seen in professional settings.