Game Theory

Management > Crisis Management > Lectures > Independent Research > Game Theory > Nash equilibrium > Business Nash Equilibrium > Strictly dominant strategies > SDS for companies > IEDS > Minimax > Backward induction

Backward induction

Backward induction is where you make decisions based on future rational play.

For example:

In a market place an incumbent firm has a relative monopoly. An entrant seeks to enter the market, but both need to analyse the situation to decide their next moves. If the incumbent decides to accommodate the entrant, it will lose some of its market share to the latter, but will not lose profits and the competition may mean further innovations will be made and benefits may be had for both companies.

Alternatively, the incumbent could fight by lowering its prices, which would force the entrant from the market, but harm its own profits. This would be a negative result for both parties. If the entrant thinks the incumbent will fight, it will not enter the market, meaning the incumbent gets to keep its profits and the entrant do not lose or gain anything.

By analysing possible scenarios, it would be irrational for the incumbent to decide to fight, as this decision would be too far the decision tree - there would be no-one to fight because the entrant would have decided not to enter if it knew the incumbent was going to fight.

In a crisis situation, managers can eliminate irrational decisions by looking at possible future scenarios and working backwards to the present situation in order to determine the next course of action.

Forward induction