Suppose you are about to make a deal with someone.
It can be something as low-risk and simple as lending a pencil or as high-risk and complex as merging companies, as down-to-business as designing a compensation plan or as deep-in-the-heart as getting married to raise a family.
The big question in any deal-making is: Will you keep your side of the bargain? Will the person you are dealing with keep their side of the bargain?
Answering this is a question of cooperating or defecting in the future on this deal. Diagnosing which is going to happen is the goal of looking at an upcoming deal through the prism of the Prisoner’s Dilemma.
The Prisoner’s Dilemma concept was first published in 1950 by scientists working for RAND corporation, which was at that time a Cold War think tank. The concept caught on and there are now many variations on the original concept. What I present to you here is another variation—one that emphasizes the concept’s usefulness in predicting the outcomes of the many kinds of day-to-day transactions we all face.
And there is a twist here. By outcome I mean not only answering the question of when will cooperation or defection happen but also the costs and consequences of how the deal is structured. When a deal is looked at from the Prisoner’s Dilemma perspective, two choices are being made: The first choice is how to structure the deal. The second is whether to cooperate or defect on the deal after it has been agreed to.
Let me start by giving you the “Hollywood version” of the Prisoner’s Dilemma concept. It’s time for … Let’s Make a Drug Deal!
You are watching a crime show. Two characters have decided to trade drugs for money. The price and quantity have been set earlier, and they have agreed to come alone to a park. A vigilant policeman is patrolling it, so the two have to exchange their bags without examining the goods on the spot. Each has two bags: Person A, a bag of money and a bag of cut-up newspaper; Person B, a bag of drugs and a bag of cornstarch.
The background music signals dramatic tension … close-ups of hands picking up one bag each … the two people walk towards each other … the handoff is made…
Prisoner’s Dilemma question is: Which bag does each person bring to the transaction?
If Person A brings money and Person B brings drugs then each is a cooperator and the transaction is mutual cooperation.
If A brings newspaper or B brings cornstarch they are a defector, not doing as promised. If only one defects we have a betrayal transaction—and a chase-and-revenge story for the rest of the show.
In mutual defection, something not commonly seen in drama, neither side gains and both point accusing fingers.
In real life this happens all the time, but because both sides will have done a lot to protect themselves from the other party defecting such transactions can still be profitable, although not as profitable as mutual cooperation. In Let’s Make a Drug Deal, an actual mutual defection would more likely involve the conditions than the bags, with both people backed by armed-to-the-teeth gangs and examining the bags on the spot. It’s a lot more expensive, but they have their protection.
Let’s talk first about the predictive value of the Prisoner’s Dilemma—when will cooperation happen, when will a defection happen?
Suppose Person A and Person B are brothers-in-law—they know each other well. Suppose further that they have done this transaction many times before, and are likely to do this transaction many times in the future. Is one of them likely to defect? Not likely. The Prisoner’s Dilemma forecast is for continued cooperation; they both have a lot to gain from cooperation and they both have a lot to lose if they get branded as a betrayer. They will cooperate.
Now suppose a different situation. Suppose that Person A is a Times Square hustler who preys on gullible tourists and Person B is a gullible tourist, so that after this deal is made the two will never see each other again. Is it likely that Person A will cooperate? Not very!
This is the kind of predictive value that the Prisoner’s Dilemma offers when a deal is pending. It says that for a good prediction of cooperation or defection the deal makers should look at their future circumstances as much as they look at the conditions of the deal being made.
Entertainment stories are full of transactions where one party cooperates and one party defects. In real life, most transactions are either mutual cooperation or mutual defection. What I will talk about next are the differences in character between the two environments.
You as a deal designer get to choose which of these environments you want to operate in, so you should be aware of the differences.
When two strangers meet and deal for the first time they are cautious. They will agree to transact only after they have added enough protections that they feel they won’t get burned too badly if the deal falls through.
This is mutual defection dealing when viewed from the Prisoner’s Dilemma perspective. A deal can be made and there can be benefit from doing so but the terms and conditions are inflexible, the ability to change the deal in mid-transaction is limited, and the benefit for making the deal will be low when compared to the benefit if the transaction was made in a mutual cooperation environment.
An arm’s-length deal is another way of saying a deal made in this environment. There is often a written contract, laws will be called upon to enforce the contract, and if a change is made it must be made in writing first and agreed upon by all parties.
Lots of protections built into the agreement are a hallmark of the mutual defection environment.
In my drug deal example, a mutual defection transaction would be when the exchange takes place in an abandoned warehouse rather than at the park, and both men have their heavily-armed gangs backing them up while they carefully examine the goods they have exchanged.
“Trust me” is the hallmark of the mutual cooperation environment. In this the protections are minimal, the deal can be made quickly, and it can be changed quickly if the surrounding circumstances change.
For these reasons, such deals can feel a lot more comfortable than those made in a mutual defection environment. When they work well, they are invoking Neolithic Village us-versus-them thinking, which makes them feel even more comfortable.
Which environment to use?
Mutual cooperation parameters work best in environments where the following are true:
Mutual defection parameters work best where the following are true:
This last point, the question of how long the relation between the deal makers is going to continue, is important. This is why bankruptcies and divorces often get messy. These are end-of-the-line deals so there is a lot more temptation to defect and “you did so first” accusations are easy to make.
One example of a place where choosing between mutual defection and mutual cooperation dynamics regularly comes up is when businesses start up and then later become large and successful.
Startup businesses begin with a dream of doing something in a new and better way. But if the new way were easy to figure out, it would probably have been figured out already! This means that there’s a lot of uncertainty in starting up a new business, so intensive communication among the members of the startup group is essential.
So … which environment does this call for? Mutual defection or mutual cooperation?
Right! Mutual cooperation. The startup group must make a lot of “trust me” deals among themselves. They must move fast, be flexible, and look out for their buddies in the group. And they have a common goal: Making this new idea work, in one way, or another. The biggest challenge of any startup business is doing all of the searching that must be done to find the right formula to make a success.
So a startup business is an intensely mutual cooperation environment and the founders are called visionaries for good reason.
What happens when the startup prospers and grows?
When the company gets bigger more people are involved and the new people who join will have diverse backgrounds. They are in effect strangers. They haven’t shared the pains of birthing this new baby and they’re bringing their own agendas to the company. This growth will stress the mutual cooperation environment and at some point if the company’s success is to continue, the company must transition to a mutual defection environment.
This point in a company’s growth is often clearly marked, when the visionaries leave and the managers take over. The visionaries move on because they really liked the mutual cooperation environment but they see it’s no longer a workable way to run their baby, so they let the managers fill the environment with formal rules and policies. If the company is well managed the transition will be smooth, if not it will be … dramatic.
This evolution of a startup business is one example of how the Prisoner’s Dilemma can be used to see more clearly what’s happening inside an organization. It shows how success can come from matching a deal style—mutual cooperation or mutual defection—to a goal and to the organization that is working for the goal.
This is just one example of where you can spot Prisoner’s Dilemma conditions. There are thousands of others. Keep an eye out for it.