Menu
Editor’s Note: This is the 14th book review we are publishing as part of our Get Paid to Read contest. Last week, we published Active Value Investing by Vitaliy Katsenelson which was reviewed by Ruth Pelchat.
You can explore the rest of the reviews we’ve published in the Reading List section here.
This week, my friend Sanjay Narang, a product and strategy professional with over 15 years of experience at multiple Fortune 500 companies, reviews The Art of Strategy by by Avinash K. Dixit and Barry J. Nalebuff.
The Art of Strategy, which was first published in 2008, is a good read for anyone who is interested in learning about game theory, negotiation and decision-making in business situations. In personal life, things are decided with emotions and not necessarily through strategy or business tactics and I would not recommend the adoption of these strategies in personal interactions.
This 14-chapter book has many business case studies and primarily discusses developing thought processes to deal with competition or challenging business conditions. For the investing audience, strategy is hugely important to balance risk/reward as well as allocating to either growth vs. value by adopting a barbell approach and the use of diversification.This book doesn’t provide insights related to the world of investing and finance.
The Art of Strategy is divided into three sections. The first chapter deals with 10 different situations in which multiple strategies are used in everyday life. I was not aware until I read this book that Warren Buffett wrote an op-ed (The Billionaire’s Buyout Plan in NY times) in Sep 2000 promoting campaign finance reform, raising the limit on individual contributions from $1,000 to $5,000 and banning all other contributions from corporations, unions or PACs. He knew both political parties would never support such a bill and highlighted the absurdity of claims that money doesn’t influence congressional votes.
The second chapter discusses the power of backward reasoning (chess strategy of looking forward and reasoning backward) and provides case studies from the reality TV show Survivor, a scenario from soccer covering how a striker and goalie think of the penalty kick shot and the tale of quarterback Tom Osborne (1984 Orange Bowl) making a win vs. tie decision in a game. One of the learnings from this chapter is to take risks early and apply that thinking to most aspects of life. Even if you fail in your first attempt, the game won’t be over. In many situations you learn better by watching others play versus learning on your own.
The third chapter of The Art of Strategy deals with the prisoners’ dilemma problem and how to resolve it. There are various examples and case studies but they are not relevant for an investing audience. I learned that a lot of results in real life situations are the result of a confidence game. Everyone works together and life is good, or everyone looks out for themselves resulting in nasty and unpleasant outcomes.
Part 1 of the book ends with a discussion of the Nash equilibrium (combining conflict and cooperation). Look for an equilibrium, in which each player’s action is the best response to the others. In the absence of equilibrium, any systematic behavior will be exploited by one’s rival leading to mixing of plays.
Part 2 of the book covers choice and chance, strategic moves and making strategies credible. In this section, the authors explain how game theory is not applicable to all situations and how logic and rational thinking help uncover optimal solutions. Another type of strategy is how a company can best compete with other companies, by setting prices that will maximize profitability.
In 2001 and 2005, the Nobel prize was won for information economics and how the power of having information helps parties get better outcomes. They discussed why some groups of individuals, organizations and countries succeed in promoting cooperation while others suffer from conflict.
Part 3 of The Art of Strategy deals with voting rights, auctions, incentives and manipulating information. The book explores voting systems to allow for multiple voting preferences. Various vote-tallying systems could take this data and come up with a fairer assessment of the most-preferred candidate. The book goes into some detail in considering the different outcomes of the 2002 presidential race (Gore vs. Bush vs. Nader). The book describes various approaches for political negotiations, incentives and threats from unions. But a threat is only good if it is credible.
The book goes into auctions, its various forms and how people bid based on emotion or excitement. The mother of all auctions was the sale of spectrum for cell phone licenses. These are multi-billion-dollar complicated auctions that allowed participants to simultaneously bid on several different licenses. The book discusses strategies of Fuji Films and Kodak to win market share in Japan and the United States. The key takeaway is that if you don’t like the game you are playing, look for a larger game.
Towards the end of the book certain exercises are provided. One example discussed how to make a good impression on a first date and assess the sincerity and quality of the other person. I wonder if people intuitively think of game theory in signaling and screening during a first date.
In the end, game theory is not an exact science. It is both an art and a science. The Art of Strategy may not be perfect in day-to-day interactions as you don’t always have complete information about the situation or the other people you’re interacting with. However, after you understand the concepts, it will help you see conflicts and decisions in a different light. For my investor friends, The Art of Strategy explores counter intuitive thinking, which is the mainstay of contrarian investors.