The prisoner dilemma

Do you raise contract prices to cover extra costs or cut them to win volume back? The answers may be dictated by the decisions being made by your rivals

“As soon as aviation will resume its activities difficult choices will bedevil managers and decision makers. With regard to ground service providers (GSPs) some touchy issues will be:
• Shall we stick to our contractual obligations even if the contracts are no longer commercially viable?
• Are our SLAs still realistic?
• Shall we wait if and when our customers approach us or shall we cancel contracts unliterally?
• How do we handle unpaid invoices that are overdue?
• Shall we urge airports to set up pools for equipment, office-space and even staff to reduce cost? If such pools are established, will we participate?
• Shall we lower training requirements and postpone refresher courses?
• What staff levels should we apply?
• Shall we change contracts of employment thereby reducing wage levels significantly or shall we strive to increase prices to cover cost even if contracts could be lost?

The list is by no means complete, but covers some of the burning issues that will have to be decided in the next couple of weeks. The most pressing questions will be:
1. Shall we do it on our own irrespective of what others do or shall we wait and see what the others are doing?
2. Shall we do it alone or shall we do it only if everybody is doing the same?

To answer the last two questions managers and key-decision makers enter the field of game theory. Game theory is the study of mathematical models of strategic interaction between rational decision makers. Games are played in very different formats and we are more often than not indifferent to this fact. We believe that it is our decisions that matter. In fact, the outcome of these games is more influenced by what the other players decide. The decision process will not come to an end as long as there is no equilibrium achieved, where no one is able to improve their situation by changing their strategy to play. In economics this is called ‘Nash equilibrium’. For example, if every ramp handler at a certain airport agrees on pooling ground support equipment, as this is commercially sensible for all participants then a stable situation can be reached where everybody uses the pool and saves cost. As long as one or the other service provider thinks that it is better not to take part in pooling or if they think that the rules are against their interest then there will be competing strategies as far as number or quality of GSE is concerned. This could lead to congested parking spaces at the ramp or shortcuts in maintenance.
If a market reaches a Nash equilibrium it is considered to be a stable market. This is due to the fact that every outcome depends on the decisions of the various players, ie. market participants. The ground handling services market is a good example where this kind of stability has not yet been achieved. In ground handling the GSPs so far have not found common ground in their approach to reach any form of market equilibrium. The result is an ever deteriorating price level as there are still many providers that are prepared to offer services at marginal cost. As a matter of fact this has left many GSPs with empty pockets. In the current situation their economic survival is in jeopardy as many GSPs are highly leveraged with unhealthy equity bases. To answer all the questions raised above leads to situations that mirror the so-called prisoner’s dilemma. In it, two delinquents are offered the same deal. If both confess to their crime, they each face ten years in prison. If one stays quiet while the other confesses, the confessor goes free and the other fellow faces a lifetime in prison. But if both stay dumb, they get away with just one year behind bars. It may surprise you that there is only one stable outcome to this game – both confess! If you keep quiet, hoping to get away with a minor conviction, you can never be sure that the other culprit will confess. And this would end you in prison for a lifetime. The dilemma is that if only they could find a way of cooperation, coordination and mutual trust then they could both make themselves better off. It also shows that crowds can be foolish as well as wise. What is good for the individual can be disastrous for the group. The prisoner dilemma can be found in many ways in daily life.

To return to our specific questions:
• What happens if I raise my prices to fund my additional expenses and to cover my cost, but my competitors will not?
• To cut prices could be good for me to attract more business, but maybe I just started ruining price levels at a given airport.
• If I raise my offer first, others will simply have to keep their prices, and I will still lose my customers.
• But, if I start to lower prices in order to keep my customers and maybe gain additional business, will they do they same starting a vicious cycle or will they refrain from it, hoping to retain their customers?
• Is moving early smart or short-witted?
• Are claims of concerted steps to be trusted?
• Is my strategy only good if others play along?
• Do I trust that pre-crisis promises will be kept?

It would be naïve to think that there are true answers to these questions. If business would only be so simple! The accuracy of any answer depends on the reaction of the other players. If there is consensus that price levels are too low, there is a chance to raise them. But if the consensus is that only market share can bring economic viability then price pressure will remain. Decision makers should be aware that we all decide not only on rational facts. Emotions play a large part in our decision making process. Very often it is not only mathematics that decide price levels. But pie-in-the-sky strategies that are geared towards perpetual growth will have to be reviewed as well. What is paramount though is the fact that the outcome, the results of our decisions, will be heavily influenced by the decisions other market participants make. The current situation can be well compared with the prisoner’s dilemma, whereby a lifetime in prison can be equated with exit from the market. A translation of the model into real life suggests
that after the resumption of business activities in aviation, it is highly likely that GSPs will fight hard to keep and enlarge their customer base. So, it must be assumed that the temptation to be price aggressive is huge. Or to use the example of the prisoner dilemma, if a GSP stays quiet then it could end him for a lifetime in prison!”

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