Last edited 30 Dec 2016

# Game theory and construction

Game theory is the study of mathematical modelling techniques, used across many fields where some degree of strategy is needed. It can be used in construction as an efficient framework for decision-making and dispute resolution.

While it was originally based around zero-sum games – one person’s gains result in other’s losses – game theory today is more commonly used as a broad term for logical decision-making and can be used as a tool for project management.

Game theory was first developed in the 1950s by scientists such as John Nash and John van Neumann.

The reason for game theory’s applicability across many different disciplines is that it is concerned with decision-making among groups of people where the outcome for each person depends on the actions of everyone in the group. Using applied mathematics, predictions can be made regarding an individual’s decision-making strategy, depending on the choices and thinking of the others.

The ‘Prisoner’s Dilemma’ is a classic example of game theory, revealing why two ‘rational’ individuals may not choose to cooperate despite both being aware that to do so appears to be in their best interest.

Two prisoners are held for a burglary. Each prisoner is offered the following deals:

• They will serve a full prison sentence if both confess.
• If one confesses and agrees to testify against the other, they will go free while the other will serve the full sentence.
• If neither prisoner confesses both will share a lesser sentence.

It is in both prisoners’ best interest to share the lesser sentence and not testify against one another. However, neither prisoner can be sure that the other will stay silent. According to game theory therefore, both prisoners will follow their self-interest and confess.

Game theory has also been used in the study of the construction bidding practices. Bidding is undertaken between competing parties, with conflict bringing into play many of the factors that influence the decision of the final bid.

A contractor may raise or lower their price due to a lack of information. The ‘winner’s curse’, usually associated with auctions, refers to a tendency for contractors to offer a price which reduces the prospects of the project being viable for them in terms of profitability. Winner’s curse can be attributed to :

• Inaccurate estimates of project costs.
• New contractors entering a market.
• Minimising losses in case of recession of the industry or wider economy.
• Strong competition within the construction market.
• Differential opportunity costs.
• Winning the bid and then increasing the price through variation orders, claims and so on.

An effective project manager, managing progress and deciding on priorities, will negotiate with a range of different stakeholders and arrive at solutions that are advantageous for the project as a whole.

When entering negotiations, they should consider:

• The issue that has to be solved.
• The parties involved in the issue.
• The parties who will have an impact on the success of the decision taken.
• Whether there are any time or cost issues.
• Whether they should make decisions independently or wait for others to make their decisions.
• Whether mutual gain is possible.
• What their end goals are, and so on.

By looking at the best possible outcomes and working backward from them using game theory, project managers may be able to identify and implement the optimum strategy.