Prisoner’s Dilemma in the Software Industry

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2001 Peter Louis & Nikolas Kelaiditis. All Rights Reserved Page 1 of 9

Game Theory

Prisoners Dilemma in the

Software Industry

by Peter Louis and Nikolas Kelaiditis

November 2001


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Abstract:

This paper shows that the Prisoners Dilemmas problem exists in real business

situations. As an example, the software industry is depicted, namely the case

of National Cash Register (NCR) developing software for BCP Telecomuni-

caes, a Bell South company, in Sao Paulo. It will be demonstrated that both

NCR and BCP have an incentive to defect in order to maximize their benefit in a

single-phase game. It will become apparent, however, that this behavior, like in

the classical Prisoners Dilemma, will lead to a Nash Equilibrium that is

suboptimal for both parties and that it is in the best interest of NCR and BCP to

cooperate, allowing them to achieve a mutually beneficial outcome. It will then

be further demonstrated that a multi-phased project is a possible way of solving

this problem (meaning to reduce the incentive to behave uncooperatively to a

minimum). Here, each project phase corresponds to a round in a Prisoners

Dilemma with the optimization of each phase, as a whole, providing the

incentive to continue the iterative game with the Tit For Tat strategy being

used by both parties to achieve the an optimal solution.

Game Theory:We live in a society where people do not always act the right, moral way but

sometimes tend to look after themselves and their own interests first. In some

situations, persons seek to maximize their benefit at the expense of others.

Therefore, there is little incentive to cooperate, to improve the outcome of both

parties. However, cooperation does occur and is a feature of our society.

Hence, how does cooperation develop when each individual has the incentive

to be selfish and not cooperate?

In game theory, cooperation is usually analyzed by way of a non-zero-sum

game called the Prisoners Dilemma1 A "zero sum" game is a win-lose game

such as tic-tac-toe. For every winner, there is a loser. In contrast, non-zero

sum games allow for cooperation.

1Axelrod 1984


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In a Prisoners Dilemma, the two players have the choice between two moves,

either "cooperate" or "defect". The idea is the following: each player gains

when both cooperate, but if only one of them cooperates, the other one (who

defects) will gain more. If both defect, both lose (or gain very little) but not as

much as the "cheated" cooperator whose cooperation is not returned.

The classical Prisoners Dilemma describes a hypothetical situation whereby

two criminals are arrested under the suspicion of having committed a crime

together. However, the police do not have sufficient proof in order to convict

them. The two prisoners are isolated from each other, and the police visit each

of them offering the following: the one who offers evidence against the other

one will be freed. If none of them accepts the offer, i.e. they are cooperating

against the police, then both of them will get only a small sentence because

they have insufficient proof. They both would gain. However, if one of them

betrays the other by confessing to the police, the defector will gain more, since

he will be set free; the one who remains silent, on the other hand, will receive

the full sentence, as he did not assist the police, and there is adequate proof. If

both betray, both will be sentenced, but less severely than if they had refused to

talk. The dilemma occurs because each prisoner has a choice between only twooptions, but cannot make a good decision without being aware of what the other

intends to do.

Such a distribution of gains and losses appears to be natural in many situations,

since the cooperator whose action is not reciprocated will lose resources to the

defector, without either one being able to collect the additional gain coming from

the synergy of their cooperation.

In a non-zero-sum game, the player's interests are not completely opposed.

Rather, the possibility of achieving a mutually beneficial outcome exists. The

problem with the prisoner's dilemma is that if both decision-makers were entirely

rational, they would not cooperate. Indeed, rational decision-making means

that you make the optimal decision for you regardless of what the other actor

decides. Assume the other one would defect, then it would be rational to defect

as well: you will not gain anything, but if you do not defect, you will end up witha loss. Suppose the other one would cooperate, then you will gain, but not as


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much as you would if you decided not to cooperate - so here too the rational

choice is to defect. The problem is that if both actors are rational, both will

defect, and none of them will gain anything, ending up in a so-called Nash

Equilibrium2. Nevertheless, if both would "irrationally" decide to cooperate, both

would gain. This paradox can be formulated more explicitly through the

principle of suboptimization: optimizing the outcome for a subsystem will

generally not optimize the outcome for the system as a whole. In the classical

prisoners dilemma, the suboptimization for each of the prisoners separately is

to betray the other one, but this leads to both of them being sentenced rather

severely, while they might have gone away with a mild sentence if they had

stayed silent.

By playing a Prisoners Dilemma situation a repeated number of times, each

party is given the possibility to adapt its decision to the counterparts one and

thus reach a more optimal solution as the incentive for defecting is reduced.

For instance, if we could play the classical Prisoners Dilemma a few times, we

would try to figure out our counterparts strategy and use it to minimize our own

total jail time. We could pursue several different strategies:

The Golden Rule - "Do unto others as you would have them do unto

you." Always cooperate (don't confess). This rule would theoretically lead

to the optimal outcome, but if our counterpart acts rationally, he will

always defect, maximizing our jail time.

Tit For Tat - "Do unto others as they do unto you."

Begin with a defection (confess) for the reasons described in the above

section, but after that do whatever our counterpart did last. However, in

many real-life situations (e.g. business), then to start by not confessing

would be preferable.

Tit For Tat 3 - Almost the same as the Tit For Tat rule. The exception is

that we are a little more forgiving. If the counterpart defects (confesses),

we will forgive him about once every three times and cooperate the next

2If there is a set of strategies with the property that no player can benefit by changing her strategy whilethe other players keep their strategies unchanged, then that set of strategies and the correspondingpayoffs constitute a Nash Equilibrium.


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time anyway. As with the golden rule, the counterpart to our

disadvantage may exploit this strategy.

The Iron Rule - "Do unto others as you wish, before they do it unto you."

Always defect. Both parties tend to accumulate a large prison sentence.

The Random Rule - Randomly choose "confess" or "don't confess."

This strategy is not likely to lead to an optimal outcome as it does not

follow a pattern and thus does not allow a joint strategy.

The Prisoner's Dilemma in Business

Software development is an area where a Prisoners Dilemma relationship can

exist, particularly when one party might be more dominant in the relationship

than the other party. For example, consider a data warehouse project where

NCR is looking to create the first major data warehouse in Brazil with the major

mobile operator in Sao Paulo, BCP. The success of this project is critical to

NCRs fortunes in Brazil and NCR can use it as an example to campaign for

other projects in the industry or other sectors.

NCR intends to develop the data warehouse software for BCP in exchange forthe payment as agreed by the contract. If by the end of the contract, NCR

delivers substandard work or something that does not work according to

specifications or its deliverables are late and BCP pays, then NCR has received

its payment whilst BCP has not received the deliverables as agreed. BCP has

been short-changed.

On the other hand, if NCR meets its contract requirements and produces itsdeliverables on time and BCP refuses to pay, then BCP has received the

agreed deliverables as per contract whilst NCR has received either nothing for

its efforts or less than agreed. Defection by BCP might also include requests

for additional functionality at the same price or ambiguous interpretations of

deliverables different from that of the NCR insisting on rework, etc. In essence,

the outcomes have been reversed.


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However, if both NCR and BCP perform cooperatively, NCR delivers what it has

agreed on time and BCP pays upon receipt of the deliverables, then both

parties will benefit from the relationship. The extent of the benefit, however, is

less if either party decided to take advantage of the other. For example, it will

require more effort and money by NCR to produce the agreed deliverables than

simply to produce poor or non-functional work for the same amount of money

from BCP. If both NCR and BCP both break their agreement then they both

lose with NCR not getting that foothold in Brazil while BCP gets to keep their

money.

If honour was a guarantee of contract conformity, then one could expect

developers to produce all that was agreed, and on time. Similarly, companies,

such as BCP, would pay the full contract price upon receipt of the deliverables.

Unfortunately, this is not the case and the solution that NCR and BCP have

employed to ensure the conformity of the other party and to minimize their risk,

is the multi-phase software contract. Here, deliverables are specified for each

critical stage during the project and payments are made based upon the

completion of phases. This in turn, turns a one-turn prisoners dilemma into a

multi-turn game whilst reducing the risks to each party at each phase. At each

phase, each party can determine if the other party has fulfilled their part of the

contract has their been cooperation. For example, BCP can inspect load

scripts and/or the contents of the data warehouse to ensure compliance before

deciding whether to pay or not. Similarly, NCR can ensure the receipt of

payment before deciding whether to commence the next phase.

Yet, a well-drafted contract also includes provisions to protect the developer to

restrict deliverables to what has been agreed and clearly specified. This

reduces the clients ability to defect by withholding acceptance. These

provisions are usually required to enforce customer acceptance of the contract

on the last round. Without a provision, a client could holdout for the inclusion of

a modification or extras not previously thought of at the cost of the developer.

Even with such a provision, where the number of rounds are known, a client

might choose to defect on the last round if the client believes that he will not


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have to deal with you again hoping to keep the balance of the money.

However, a well-drafted contract will limit this occurrence.

As with NCR, it is usually not in the interest of developers to defect and

defection is usually due to negligence not malicious intent. NCRs prospects in

Brazil, in part, are determined by the success of the project and for this reason

they have ensured that experienced team members were included. Whereas

BCP has less need to play by the rules and can easily find another developer

willing to provide a data warehouse for such an important client.

The most effective strategy for NCR to employ in an iterated prisoners dilemma

is a simple Tit For Tat one offering cooperation on the first move and then

echoing (cooperation or defection) what BCP does on their last move. Here

cooperation is rewarded with cooperation whilst defection is immediately

punished with defection. However, NCR, like most developers who are looking

to establish a position in a market or who are in an unbalanced relationship, do

not apply this strategy. This can be due to the need to keep the account happy

or the desire to have additional sales after the contract has been completed.

This approach only encourages BCP to defect.

Given this situation, NCR should be prepared to suspend work on a subsequent

phase given defection by BCP on the current phase. This, however, should

only be done once a review is performed to ensure that NCR was not at fault or

that a misunderstanding did not occur that can be resolved without NCRs

defection. However, if NCR complied with the agreement on the current phase,

then moving to the next phase in the presence of the defection of BCP is a

suckers move.

The IT project is for a known number of phases (therefore the associated

prisoners dilemma is for a known number of iterations) and preventing BCPs

defection on the last round is a difficult problem. The uncertainties at the start

of the project are almost gone as the phases have been completed and the

minor issues resolved. BCP has an almost complete working data warehousebut can use the issue of minor bugs to withhold payment. The benefit of


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Exhibit 1: Classical Prisoners Dilemma

Prisoner 2

Confess Dont Confess

Confess

Prisoner 1

Dont Confess

Confess / Confess constitutes a Nash Equilibrium.

(the higher the numbers in this matrix, the stricter the sentence, i.e. the players will prefer alower number to a higher one)

Exhibit 2: NCR vs. BCP

BCP

Pay Dont Pay

Good Code

NCR

Bad Code

Deliver a bad code / Dont pay constitutes a Nash Equilibrium.

(the higher the numbers in this matrix, the higher the utility, i.e. here the players will prefer ahigher number to a lower one. Furthermore, it is assumed that a bad code will have some utilityfor BCP, and that delivering a bad code is dominant over delivering a good one due to lowerdevelopment cost)

5 , 5 0 , 10

10 , 0 2 , 2

3 , 3 0 , 5

5 , 1 1 , 2

Prisoner’s Dilemma in the Software Industry

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