You're arrested for a crime you may or may not have committed. Your best friend is locked up in a separate cell. A corrupt Vic Mackey - type cop, who has no evidence, tells you with a sneer that if neither of you confesses, you'll both get two years in jail. If only you confess, you'll walk free while your friend will get 12 years -- and vice versa. If you both confess, however, you'll each get four years.
What do you do?
Chances are, both of you will sing like canaries, even though you'd both be better off keeping your mouths shut. It's the classic "prisoner's dilemma" that sits at the heart of game theory -- a branch of economics that analyzes how people interact to achieve their goals. The solution to the paradox? According to the theory, only by changing the rules of the game -- allowing cooperation -- can both prisoners get out of jail early.
Here's the next question: What does any of this have to do with food, trucks, and logistics? The answer: Food giant Mars Inc. is using the game theory of John Nash -- subject of last year's Oscar-winning A Beautiful Mind -- to change the rules of logistics and tease out win-win deals with manufacturers and truckers delivering goods in Europe.
For the average company, hiring a trucking outfit to move finished goods or raw materials demands a phone, a pen, a Rolodex, and a trailer load of patience. But Mars, which runs up a European freight tab of more than $250 million per year, instead uses the Internet and game theory. In fact, the online tenders and auctions that Mars runs to select its carriers have been so successful that the company has launched a UK-based subsidiary, Freight Traders. From its headquarters in the English town of King's Lynn, Freight Traders has helped Kellogg, Lever Fabergé, and Reckitt Benckiser move about $1 billion worth of goods in the past three years. Tenders that used to take months now run in weeks, and at least one shipper is banking savings of up to 50% on its freight costs. In classic game-theory terms, Mars has changed the game to come up with win-win logistical solutions.
Disruptive influence Transportation costs account for between 3% and 6% of the budget of most companies that are in the fast-moving consumer-goods sector. Planning truck movements for these giant enterprises is usually a stunningly complex task. And yet, despite the scale and complexity of the operation, according to Freight Traders' managing director Garry Mansell, negotiations between shippers and carriers almost inevitably devolve into the age-old practice of haggling over price. Driving a single load between the UK and Italy may cost $1,100 -- or it may cost $2,300, depending on whether the shipper or the carrier has the upper hand.
In the language of game theory, a "zero-sum" game is one in which somebody wins and somebody loses, period. But there is an alternative approach to competitive interactions, one that John Nash envisioned at Princeton in the early 1950s: Rivals can compete and cooperate at the same time.
To disrupt the zero-sum framework in logistics, Freight Traders uses some of the best game theorists in the world to help shippers and carriers strike deals that are mutually beneficial. The first step is for Freight Traders to create a broad "community" of shippers with cargo to move who are then introduced to a wide selection of carriers with trailers to fill at Freight Traders' Web site. After that initial step, game theory takes over.
Here's how it works: Game theory helps Freight Traders decide when to end a tender or auction. Say you're bidding for a rare Eminem action doll on eBay. The deadline is midday Friday, but you're going to watch the action and wait until 11:55 before making your bid. It's no different with freight. A shipper might post a big tender on Freight Traders' Web site for seven days, but 95% of the bids from carriers will probably occur in the last two hours.
"Sniping" -- withholding bids until the last moment -- suppresses competition, says Gail Hohner, a game theorist from New Jersey and Freight Traders' research director. Freight Traders has found the way to fix that problem: By introducing a "soft ending" mechanism, the company changes the rules of the bidding process so that any offer made in the last hour automatically triggers an extension of the deadline, removing the incentive for sniping.
Critics might dismiss game theory and logistics as, well, just theory. But hard economics are at work: Mansell estimates average savings to shippers in the region of 5% to 8%. Geoff Norris, distribution manager of babyfood manufacturer Nutricia Wells, calculates that Freight Traders saved him $1 million in a single tender. And the online tenders and auctions enable carriers to allocate their trucks more efficiently: "Empty running" -- the number of unloaded trailers on fruitless journeys -- is down 20%.
Opportunity knocked In 1990, Mars appointed Mansell, an applied chemist, to Consolidated European Logistics Services, an internal organization tasked with bringing pace, power, and focus to Mars's logistics buying. Having worked with Hohner before on a crop-forecasting project, Mansell asked if game theory could be applied to logistics. Hohner's reply: "Let's find out."
Over the course of the 1990s, Mars gained a reputation as a logistics pioneer. "When other companies started asking to buy our software, I smelled a business opportunity," says Mansell, who convinced Mars that it could, by creating Freight Traders, offer the service to other companies via the Internet. IBM beat four rivals in a game-theory tender (of course) to build the high-powered site that can handle 3,000 to 5,000 offers in a typical 20-minute blitz.
Freight Traders employs just 10 staffers, but with more than 1,000 carriers and almost 200 shippers active in its tenders and auctions, the company is already making money by charging shippers a fee. Now Freight Traders is plunging into deep-sea freight. And by 2004, Mansell expects to introduce collaborative buying, which will allow shippers to pool their needs, giving carriers fuller loads on certain routes. John Nash -- who received a Nobel Prize in 1994 -- waited 40 years for his achievements in game theory to be recognized. Mansell and Freight Traders won't need to be so patient.
Sidebar: Playing Games
Game theory -- the painstaking analysis of bargaining, bidding, and negotiation -- has finally escaped Economics 101 and the classroom and is beginning to make its mark in political science, military science, evolutionary biology, sports, and, now, the competitive world of business.
Governments used game theory in auctions for third-generation mobile licenses to wring out the highest possible price from the telecom companies. The result? The companies ended up paying roughly $100 billion. Game theory is also a favorite weapon of antitrust lawyers to support the case for the breakup of dominant competitors or the imposition of penalties.
In sports, game theory informs Major League Baseball salary negotiations. Soccer authorities have also used game theory to make the game more exciting by introducing sudden death, or golden goals.
In insurance, such companies as Risk Management Solutions are using game theory to analyze the risk of future terrorist attacks by modeling the likely response of terrorist groups to stepped-up security and counter-intelligence efforts.
"Game theory is more than A Beautiful Mind. Now it's really a business application," says game theorist Gail Hohner, who divides her workweek between Freight Traders and Mars's Catalyst business-research group. "Yet I'm often disappointed when I go to game-theory conferences and I'm the only businessperson there." In other words, for most of business, it's still zero-sum.