Complicated Games

Published: Oct 20 , 2014
Author: Stephen White

This week the 2014 Nobel Prize for Economics was awarded to Professor Jean Tirole for his writings on the regulation of large corporations. Professor Tirole made his reputation largely on his work about Game Theory; his book (with Drew Fudenberg) called Game Theory is not an easy read. Densely packed with mathematical equations the book tries to explain the behaviour of individuals in a market who make decisions based on their expectations of how their customers, suppliers and competitors are likely to react in the future. Even the first example in the book, which describes how a pie manufacturer would use Game Theory to choose how to set his prices in the market for one single day, would make most people’s head spin.

There is an irony in Professor Tirole’s selection as the Nobel Prize winner, because it comes at the time when one very large corporation, UK-based supermarket group Tesco, finds itself in hot water with its investors and the market regulators because of the discovery that it may have overstated current year profits by up to a quarter of a billion sterling. The problem is the way in which the Tesco accounts treat the money balances they operate with their major suppliers. These balances include payments by the supermarket for goods received, and payments made to them for trade promotions, which have become ever more complex over the years. I wonder if it is just coincidence that this discovery was announced only weeks after David Lewis, the new CEO at Tesco, was appointed. Mr Lewis had previously been a senior manager at Unilever, a major supplier of many branded products to Tesco, including Walls ice cream which is so often the accompaniment to pies.  Maybe he knew where to look.

Tesco is unlikely to be alone in their predicament – the other UK supermarket giants, and probably retailers in other parts of the world, will have similar set-ups with their suppliers and may have similar accounting issues. The underlying cause of these issues is the failure of the market to regulate the relationship between Buyers and Sellers, woefully true in the case of power imbalances such as the relationships between the supermarkets and agricultural producers, but even true between two powerful parties such as the big supermarkets and the big brand owners. Where market forces are unable to provide effective regulation then policy makers need to step in and do it, although that too has not been effective so far.

I think they need to read Professor Tirole’s book. It must be good – his Nobel prize is worth $1 million.

Stephen White


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