A zero-sum game is a conceptual framework to describe a competition where one party’s gains come at the expense of another party. It’s a metaphor that is often used in business to describe a battle over market share between two companies or when one decision counteracts another due to trade-offs. It can also describe a personal or relationship dilemma where the benefit of one decision is erased by its costs.
Where does the term come from?
A zero-sum game is a mathematical concept meaning that the sum of gains and losses for both parties zero out or negate each other.
The phrase is based on classical game theory, where one person’s win means that another has lost, producing a net gain of zero.
The concept of a zero-sum game can be applied to a wide range of activities, including business, competitions like sports, relationships, and more general financial activities.
What you should know about zero-sum games
Some common examples of zero-sum games are chess and poker. In those games, one can’t win without another losing, and the gains of one party come from the losses of another.
In chess, a move can improve your position or take your opponent’s piece, and those gains come at the expense of your opponent.
In the financial world, options represent one form of a zero-sum game since an option will gain or lose value for one party and do the opposite for the other. The buyer and seller are at odds, meaning that a gain for one is a loss for the other. The same holds true for other derivatives.
Stocks, on the other hand, are arguably a non-zero-sum game. Selling a stock may be right for one investor since it gives them cash they need for something like retirement or buying a home, while another investor may benefit from purchasing a stock that goes up over the long term.
Why zero-sum games matter
Whether you’re an investor or seeking to understand the zero-sum game concept for personal reasons, it helps to know when you’re dealing with a zero-sum game. In business, for example, two companies may be fighting over a fixed amount of market share. That would be a zero-sum game since one company’s market share gains would come at the expense of the other.
Alternatively, in a growth market, both parties might be going after a growing pie rather than pieces of a fixed pie, which is going to make their strategies different. Instead of focusing on profitability and market share, companies in a growing market are likely to spend more on growth drivers like marketing or research and development, potentially accepting a short-term loss because they believe it will lead to a long-term gain.
Elsewhere, a non-zero-sum game leaves room for collaboration since both parties have room to win. For that reason, playing a non-zero-sum game is preferable to a zero-sum game. Trade is one example of a non-zero-sum game since, according to the theory of comparative advantage, trade creates economic benefits for all parties that participate.
An example of a zero-sum game
Any one-on-one type of game offers a good example of a zero-sum game. This includes chess, gambling when two parties take the opposite sides of a bet, and sports such as tennis when each side is playing against the other.
In finance, there isn’t a perfect example of a zero-sum game, but derivatives trades such as options or futures are close since they tend to be short-term in nature and because there is a direct relationship between one party making a gain and the other party experiencing a loss.
Understanding zero-sum games can help you be a better kind of investor in any kind of market environment, including bull markets, and can help you make better decisions in your personal life as well.
If you can find a way to turn zero-sum games into non-zero-sum games, you can use that to your advantage, and it can help you look at decisions differently.
About the Author
