Game theory and business simulations can be useful tools for mid-market CFOs to analyze strategies, uncover weaknesses in assumptions, and encourage strategic thinking. Simulations allow participants to experience the complex interactions between decisions and outcomes in a low-risk environment. Common applications include strategic planning sessions, M&A analysis, and process improvement initiatives.

1. Agenda Game Theory is a tool used by governments, businesses and non- profit organizations to analyze and plan strategy and tactics Mid-market CFOs can use game theory to uncover weaknesses in their assumptions and do better SWOT analysis. Simulations can take the form of CFO-led strategy reviews – for example, at retreats with executives and/or board members

2. Game Theory is a Dynamic Approach to Decision Making Game theory attempts to model behavior in strategic situations It aims to simulate the fact that an individual's or organization’s success depends in large part on how their choices interact with the choices that others make in response Game theory simulates an interactive situation with at least one other person that requires you to put yourself in the other person's shoes For example: How will a competitor react if I did this versus that? Will a competitor understand my real intent? Will I mis-communicate my intent—or will he misunderstand it? While initially developed to analyze situations in which one player does better at the other's expense (zero sum games such as war), it has been expanded to address a wide class of interactions

3. Game Theory is a Dynamic Approach to Decision Making (cont) When you have 4 or 5 players in an inter-dependent situation and each may or may not take 4 actions, that can lead mathematically to many outcomes—game theory seeks to uncover scenarios you may not anticipate and the options you need to deal with them Business applications of game theory seek to get managers and others thinking about competition and customers in ways that they wouldn’t otherwise. The value of simulations lays in the interaction and decision making that happens among the various players as they each apply their own set of values and learning experiences to a common objective. ~ Wharton School of Business Game theory helps to define alternative options that arise from the intersection of thought, people and process Game theory provides a risk-free way to test different interactions of experience and intuition

4. A Common Example of Game Theory The Prisoners Dilemma Illustrates that a single course of action has different outcomes depending on what the other party do There are 2 prisoners Each has the choice to remain silent or to betray the other prisoner They aren’t allowed to communicate What Prisoner A Chooses To Do What Prisoner B Chooses To Do What Happens To Prisoner A What Happens To Prisoner B Remains Silent Remains Silent Serves 6 months Serves 6 months Remains Silent Betrays Prisoner A Serves 10 years Goes free Betrays Prisoner B Remains Silent Goes free Serves 10 years Betrays Prisoner B Betrays Prisoner A Serves 5 years Serves 5 years

5. Learning By Doing “ Learning by doing ” is the best way to learn. In business simulation exercises, participants confront the options in a tangible manner - they get to see and touch the way business operates. Experiential learning leaves the participant with a mental matrix for retaining information and applying it in the future.” ~ Jack Stack Game theory requires that we use both right side and left side brain activity (analysis and intuition) The multi-dimensional interaction among peers requires participants to take a new look at familiar issues and uncover potential answers that might never have been considered otherwise. Edgar Dale, a renowned educational psychologist, says that simulated experiences generate as high as a 90 percent information retention rate . In comparison, traditional teaching techniques such as lectures result in only 10 percent rétention.

6. War Games The following are typical inter-dependent, global political issues modeled by war games: Could it have started a new war? How would Japan react? Would the U.S. hold in check or support Japan? How strong was North Korea’s relationship with China? What if this was all a smoke screen to build up their ability to sell nuclear arms? Countries have applied war games to develop strategy—and to understand how to keep their competitors and enemies off balance with feints and deception For example, North Korea threats/miscued missile firings—an example of using war games and game theory to manipulate other countries

7. War Games Offer the Same Benefits for Business Game theory offers a way for companies to : Address a systemic issue quickly and effectively Uncover weaknesses and discover creative solutions Rethink assumptions about how participants think and who gets a say in the decision process Develop new strategies Engage more executives in buying into change faster Develop and test a SWOT analysis Review their strengths, weaknesses, opportunities and threats – and those of its competitors “ The proper application of game theory and business simulation using an evolved model proves most effective at delivering repeatable and sustainable results time after time.” ~ Fortune Magazine Article Feb 2008 – Game Theory

8. A Way to Ensure that You Ask the Right Questions Asking the right questions that could get to the root of disappointing operating ratios might include: questions about processes, products, systems, staffing and more that can lead to necessary and innovative decisions and actions. Proper training gets action leaders asking the right questions. With simulations people become less hesitant to ask questions and seek solutions that may have otherwise been overlooked – or have been afraid to ask. Games and the game environment remove these and put all players on a level field of engagement , where all questions are valid and a wide range of answers are considered.

9. Uses Of Game Theory For Mid Market CFOs Applications used by CFOs run the gamut from Rehearsals, Computer Models and Table Top Simulations Simulations involve engaging the CFO, CEO and other executives and Board members to think like someone else about: Business Plans Acquisitions Reorganization The CEO and Board of Directors are prime candidates for strategic planning using game theory to: Encourage interaction Stretch thinking Create spontaneity that stimulates creativity Increase team work Expedite buy in Cost reduction initiatives Process Changes

10. Polling Question Polling Questions: Which of the following in NOT a goal of simulations? 1. Anticipate scenarios you hadn’t previously considered. 2. Think outside the box. 3. Question basic assumptions. 4. Create a detailed action plan for the next 6 months.

11. For Example: A Cost Containment Scenario Most boards would applaud an announcement regarding cost containment However, few would be able to define their role in making this a reality A simulation session on cost containment might involve board members simulating the success or failure of such an initiative This helps participants to engage in the challenges such an initiative involves—so they can see the issues , challenges and ways to overcome them

12. Example: Create An Expanded View Of Management Options The Israeli telecom market undergoes a transformation of its infrastructure to wireless Four Carriers will compete One carrier (Bezeq) used simulations and game theory to prepare for the up- coming deregulation The company held a Board retreat to focus on what their strategy should be in the deregulated environment A consultant worked for two weeks with management to understand the board objectives and issues The simulation was designed to address alternative strategy scenarios Because the company was facing discontinuous change , there was a need to stimulate out of the box thinking Six hours of simulation play used disparate combinations of situations and solutions to illustrate the need to develop a workable strategy in view of the fact that long distance prices were about to drop.

13. Example: Create An Expanded View Of Management Options (cont) The facilitator suggested a “What If:” scenario: what if long distance revenue were to be reduced from $1+/ min. to less than 20 cents /min.? In the market side of the simulation the time to prepare new products for market was reduced significantly with each round—requiring that decisions be made faster The simulation presented a hypothesis that demand could grow while prices fell—got participants out of the assumptions they’d been locked into The game play led participants to be more open to new industry realities, which they’d previously been reluctant to face The more open to possibilities they became the more creative their solutions became and the more risk they were willing to put into the model The company now has 50% share of the wireless market in Israel

14. Case Study #2: Robert Express Roberts Express was a mid cap logistics company that was struggling with its IT The CIO and CFO supported an upgrade of IT but the board resisted, not seeing how it would enhance customer value The company hired an outside consultant to assist them in modeling the problem in the format of a table-top board game simulation. The case for IT was hard to make on hard numbers: instead it was based on the “soft” benefits of improved customer relations, faster response times to inquiries, and better information about package location--but the advantage still wasn’t clear to the Board Board members engaged in a two day retreat. One day was devoted to a business simulation where the new IT platform was made available to only 1 of 4 teams With this advantage the team that had a simulated IT platform outperformed the other teams by a large margin. That helped the Board make the decision in favor of going ahead with the IT upgrade.

15. Case Study #3: A Distribution Company In the mid 90s XYZ Company was looking at a new paradigm Cost of traditional customer acquisition was $800 per customer. Web based customer acquisition was only $65 per customer. The Board had a hard time seeing the opportunity Web was new technology. Board had long history with family business in traditional marketing. Board members were not technology-literate: only 1 of 8 had a home computer. No understanding why would anyone would buy anything from the Internet After a few hours of the simulation the Board realized the advantages of Web-based shopping. They saw the competitive thrust. They were carefully coached through a new experience that resulted in a new thought process. They were able to see both sides of their decision process

16. Case Study #4: A Contract Manufacturer A contract manufacturer of circuit boards experienced quality problems—their products were not meeting customer specifications A simulation modeled the impact on their financials of product defects: How much rework added to their cost Any defects on a production run for a large client like Boeing could lead to the immediate loss of the account Simulations incorporated client rejections into the game and penalized the players for poor performance – but did it non-confrontationally – through market pressure and rules of engagement As a result of the simulation, personnel were trained on the consequences of low first pass yield. Within 45 days the metric was righted: production employees understood the issue from a new point of view and had developed a solution that made sense.

17. Polling Question Polling Questions: A simulation can be particularly helpful when a Board is balking at a decision that hinges on “soft” decision criteria?: 1) Yes 2) No

18. CFOs Alternative Approaches Simulations often use board games The incentive to win the game leads us to use both left brain (intelligence, reason) and right brain (intuition) and to drop long-held assumptions Can allow brain to work in ways it doesn’t usually For example, money maps are a visual game theory application that allow complex financial issues to be visualized and discussed in a compelling manner

19. A Simulation Board Game: Income/Outcome Income / Outcome is a board simulation that applies game theory. Simulates starting a business, building up a balance sheet and going to market Results of each round show impact of decision made on the balance sheet and P&L Highlights unintended consequences of decisions Particularly good at showing managers with a “silo” mentality the impact of what’s done in other parts of the company Allows players to “buy” information such as how long it will take for materials be become obsolescent Tactical chips and accounting procedures enhance thought process

20. Game Plan for Change is a table top simulation designed to ignite growth through transformation. Distinctive in its directed design: requires you to follow a logical, structured process, for example in pursuing a cost containment program Emphasis is on how steps are related Requires visioning up front to focus on your objectives and how you plan to get there May move players from one table to another to simulate someone leaving the company Another Simulation Board Game: Game Plan For Change

21. Rehearsal Simulations These are story-based A story or situation is defined that will address a challenge indirectly (or at least less confrontationally) than with traditional analysis Define group into 3, each with its own role For example: A simulation with a Board about how management should try to change the Board’s mind on an issue A simulation of how a company that’s an acquisition target should tell the board what it needs to know about them A simulation where participants model the thought processes of people they are trying to influence Well suited to issues where the decision criteria are judgmental rather than data-driven

22. Polling Question Polling Questions: Which of the following in NOT part of the simulation process? 1. Divide up into teams. 2. Compete to win. 3. Explore personality conflicts on your team. 4. Understand the economic impact of decisions you made.

23. Plan Using outside facilitator helps to “peel the onion” to reveal the core issues Define the objectives and issues Identify the “positional” mindsets you want to challenge Consider change of venue i.e. a retreat--to reinforce different mindset Define the rules of engagement Time required 1 – 2 weeks in prep. Create roles, materials and script The “tie-back” or review section of the simulation reviews and analyzes each team’s decision Intended to produce the “aha:” teams understand the ramifications of what they did in the game for making actual decisions Look at the results and understand impact of the decisions that the winning team made For example, t he team that won had the best market research and therefore knew first of falling prices and increased demand Facilitator creates and executes the game so as to question assumptions and produce new avenues of thinking Overview of the Simulation Set up teams Define goal Goal is version of the company’s real goal For example, if goal is to adopt Lean Manufacturing then Just In Time inventory is incorporated into the scenario Each team creates plans and runs them on the game board May change assumptions, composition of teams Teams compete to achieve their goal Cross functional teams get different approaches from different perspectives Do It Review / “ Tie-Back”

24. Follow up Questions? Jack Howe [email_address] www.drumbeatproductions.com 972-462-0243 469-387-1489