Why startups need to be good at game theory

Here is a quick question from a GMAT test (taken by MBA applicants).

Which of the following is the correct answer ?

a. 4π sq. inches
b. 8π sq. inches
c. 16 sq. inches
d. 16π sq. inches
e. 32π sq. inches

Don't scroll down to look for the answer.

Give it two minutes... try to think and answer ?

It's just the kind of regular multi-choice question that MBA applicants regularly answer. No big deal.

Oh! Wait... the question is missing!

Okay, that's definitely an issue. But I think you should still try to figure out the answer.

Building a startup is somewhat like answering this question. You are trying to figure out the answers without really knowing the question.

There are many approaches that one could take, to figure out the right answer. The most common way is to take a quick survey.

"Hey, do you think ecommerce is hot?"

"Wow! Whatsapp sold big! Do you think we should build a chatting app? We will just make it anonymous.."

Surveys are easy. We do them over coffee and over beer, with our friends. We also assumed a much simpler question (in place of the question that we do not know) with survey compatible yes / no answer options.

A second way is to always pick answer option (a). You just pick the first option that comes your way. That's also referred to as the priming effect. If your first job is in the logistics sector, the chances that you do a logistics startup in comparison to any other kind of startup are much higher. Your first job has primed you to continue to work in the same domain. People inherently like consistency and building a startup in the domain you have already been working in, helps maintain that consistency for you.

But the right way for startups to answer the unknown question is to apply game theory.

A startup engages with users, customers (those who pay and not necessarily the user, e.g. advertisers on Facebook) and other companies competing with the startup for a share of the market and even the government, market regulators are the players that a startup engages with. Game Theory dictates that you first try to understand the motivations and objectives of other players and understand the strategies they will adopt, to define your answering strategy.

Your answers are the combined set of all the things that you can do to run your startup.

You may not know the exact question to ask but to choose between the answers, start applying game theory to win the game against or along side other players. Note that the best games always have a feasible win-win strategy. In case of customers create value for them to earn revenue, and in case of competitors, jointly grow the overall market.

So let's come back to that GMAT question.

What is the objective of the questioner? She wants the people who really understand the problem to get the answer right and those who do not to get it wrong.

We can almost immediately rule out the answer 16 sq. inches since it stands out very differently angainst the other answers and is unlikely to cause confusion to those who understand the question only partly.

So the viable answers seem like the area of a circle, which is measured as πr2. Which makes it likely that 4π sq. inches (r=2) or 16π sq. inches (r=4) as likely answers. The common mistakes people will make is if they believe that the formula of the area of a circle is 2πr or it is 2πr2 or it is πr.

In the case with r=2 we come up with the answer as 4π sq. inches both if we believe the correct forumla to be πr2 or 2πr. So if r=2 the question will not be able to capture this formula mistake by the answerer. However with r=4 we will come with answers as 16π sq. inches (formula = πr2) or 8π sq. inches (formula = 2πr), or 32π sq. inches (formula = 2πr2) which match up with the answer options given. Thus by applying game theory we have figured out the correct answer (16π sq. inches) even if we do not know the exact question.

That's what you got to do for your startup !

Credit: Game Theory question example borrowed from The Art of Strategy