Game Theory Basics: How Companies Reason About Each Other

It earns its place in this pillar because the market-structures article left a question open: in oligopolies, where a handful of firms watch each other, what determines whether they fight or coexist? Game theory supplies the vocabulary — dilemmas, equilibria, repeated games, credible commitments — that turns "it depends on strategy" into reasoning an investor can actually follow. Concept-level treatment per the spec: four ideas, each carrying real analytical weight, none requiring mathematics.

The prisoner's dilemma — and why price wars happen to rational people

The famous setup: two parties would each be better off cooperating, but each is individually better off defecting whatever the other does — so rational play lands both in the outcome both wanted to avoid. Translated into business: two rival firms would both earn well holding prices high, but each earns more by undercutting whether or not the rival does — so both cut, and margins collapse for everyone. This is the structural explanation of price wars: not stupidity or malice, but a payoff structure in which individual rationality produces collective damage. The concept generalises across the investing landscape: advertising arms races (both spend heavily, shares barely move), capacity booms (each producer expands rationally into the glut that ruins all), and bank runs (each depositor rationally withdraws, collapsing the bank none wanted collapsed) share the same skeleton. A Nash equilibrium — the theory's central concept, stated accessibly — is any configuration where no player can improve by changing strategy alone: the dilemma's mutual defection is one, which is exactly the problem — equilibria are stable, not necessarily good, and escaping a bad one requires changing the game rather than exhorting the players.

Repeated games, commitment, and moving first

Three refinements do most of the practical work. Repetition changes everything: the dilemma's grim logic holds for one-shot encounters, but firms meet in the market every quarter, indefinitely — and in repeated games, cooperation can be sustained by the shadow of the future: defect today and the rival retaliates tomorrow, so restraint becomes individually rational. This is why some oligopolies maintain pricing discipline for decades without any agreement — each independently concluding that starting a war costs more than it wins — and the legal line from the structures article bears repeating: such independent parallel restraint is lawful strategic reasoning, while communicating or agreeing about it is a cartel; the boundary is precisely what competition authorities litigate. Discipline is also fragile by the same logic: a shrinking market, a desperate player, or an entrant with nothing to lose shortens everyone's shadow of the future, which is why price wars cluster in downturns and around disruptive entries. Credible commitment: promises change behaviour only when breaking them is visibly costly — a firm that builds massive capacity ahead of demand is committing to fight for share (the investment is sunk; retreat is now the expensive option), which can deter entry more effectively than any statement; central banks' obsession with credibility, from the central-bank profile, is the same concept in policy dress. Moving first is not automatically winning: first movers gain where their advantage compounds (networks, standards, learning curves); fast followers win where pioneers pay the education costs and later entrants copy the answer key cheaply — the honest evidence supports both patterns, sorted by whether the underlying moat machinery rewards being early or being right.