The Ultimatum Game

Why running your business like there is no tomorrow might just mean there isn't

Let’s play a game.

You pick heads or tails, and I will flip a coin. If you win, you get £100. If you lose, I get it (Ok, it was mine in the first place, but let’s gloss over that for now!).

Now it gets interesting. The winner, who won the £100, has to split the money with the loser. The winner can suggest a split (£90/£10, say, or £50/£50) and it is up to the loser to agree or disagree with that allocation. If the winner makes a suggestion, and the loser agrees with it then the money is split accordingly and (presumably) everyone is happy.

If the winner suggests a split, however, and the loser does not agree with it, then the whole £100 is taken away from both of us and thrown on the fire.

This game is a stalwart of experimentation into the economic discipline known as “game theory” which seeks to explain how people make complex decisions in the real world where we are all impacted by each other’s choices.

This particular experiment (known as the “Ultimatum game”) caused a real stir when experimenters first began to play with it, because it appears to show a very counter-intuitive thing.

Cold economic logic suggests that if I win the £100 and have to suggest a split, I should offer you a split of £99 to me and £1 to you. After all, the £1 you are getting is better than the zero that you will get if you reject my offer and the money is thrown on the fire, yes? OK, it might seem a bit of a miserly offer but surely we can rely on people acting in their own best interests?

Well, no.

It turns out (and this is an experiment that has been run many thousands of times in every corner of the world) that it doesn’t work that way. If I offer you only a measly £1 out of the £100 available, very often you will reject it as being “simply unfair”. In anticipation of that, when the game is played the offer made is usually much more generous – often very close to the “fair” 50:50 allocation.

There is an enormous amount of academic research from both economists and social psychologists attempting to explain why the cold-hearted but rational outcome does not happen, and why instead we tend to play a fairer game than we need to. Issues of brain chemistry, evolutionary biology and complex mathematical calculations have all been brought into play.

There is, however, a simpler explanation, and one which is critical to any of us in business. Although I described our game with the coin toss and the £100 as a single experiment we would do together, our relationship is bigger than that. In a real commercial situation we might know each other and want to work or do business together for a long time.

The same equations which show that the right thing to do when you play the Ultimatum game is to “screw over” your opponent by offering them £1 change completely when you take this into account. If the only interaction we are ever going to have is to play this game once then that strategy might be correct, but once you take into account that we live in the real world and will do other business together it is no longer rational for the winner of the coin toss to maximise their short term advantage.

The real lesson from our game, therefore, is that as consumers and business owners we are all part of a wider economy and that our actions towards each other are governed not just by short term economics but by the fact that it is a small world out there – we will run into each other again, we will do business again, and I’d rather store up some goodwill in my relationship with you for the future than win a short term battle but leave a grumpy adversary out there seeking revenge.

The technical term for experiments like the Ultimatum game when they are designed to be played only once by people who don’t know each other and will never see each other again is the “One-shot game”.  The initially baffling results of the Ultimatum game, which so confused economists, simply tell us a truth about the world and about our business lives which we already, in our hearts, know to be true.

Life is not a one-shot game. Nor is business.

Of all businesses, the ones which least resemble the dry rationality of the one-shot game are consumer businesses. The retailer who takes back a malfunctioning product without question and provides a full replacement is not optimising the value on that individual transaction – indeed they may be destroying all the profit they made on the sale in the first place. What they are doing, however, is investing in that relationship with that customer. The pay-off from that investment is in the future – the extra business, the positive word of mouth all of which accumulate into a strong brand and a set of loyal customers and advocates.

Consumer businesses become great when they treat their customers like there is a future, and like they want that customer to come back in the future. Businesses which try to optimise today’s profit by taking advantage of any opportunity they can to make money at their consumers’ expense do not thrive. Like the unwitting player of the Ultimatum game, they are surprised and disappointed when it turns out that they really do reap what they sow.