How the prisoner's dilemma explains costly ad wars

HostIt feels like every time I turn on a game or watch a show, I see the same three or four brands over and over. They spend millions of dollars on these tiny clips, and half the time, they're just fighting for the same group of people. It seems like a huge waste of money when everyone already knows who they are. Why do these big companies keep throwing cash into a pit like that?

GuestIt's easy to look at those big budgets and think the people in charge have lost their minds. But they're actually stuck in a very old trap. To understand it, you have to look at a famous puzzle about two people in jail. Imagine two partners in crime get caught by the police. The cops put them in separate rooms so they can't talk to each other. Each one is given a choice. You can stay quiet and look out for your friend, or you can rat them out to get a better deal for yourself.

HostAnd I guess the catch is that they don't know what the other person is going to do.

GuestThat's the whole point. If both stay quiet, the cops don't have much evidence, so they both get a light sentence, maybe one year. If one rats and the other stays quiet, the snitch goes free while the friend gets ten years. But if they both rat each other out, they both get five years. If you're sitting in that cell, you might think, well, if I stay quiet and my partner talks, I'm in big trouble. But if I talk, I either go free or I get a medium sentence. No matter what the other guy does, talking seems like the safer bet for me as a single person. So they both talk, and they both end up with five years instead of the one year they would've had if they just stayed quiet and trusted each other.

HostSo they both end up worse off because they couldn't trust each other to play nice. But how does that move from a jail cell to a TV commercial?

GuestThink of two big soda companies. Let's call them Blue Soda and Red Soda. They're the only two players in town. If neither of them spends money on ads, they split the market fifty-fifty and keep all their profits. That's like the two prisoners staying quiet. They both win big. But then the boss at Blue Soda starts thinking. If I spend some money on a big ad campaign and Red Soda stays quiet, I can steal their customers and make way more money.

HostBut Red Soda is thinking the exact same thing. They're not just going to sit there and let their customers walk away.

GuestExactly. They see Blue Soda buying ads, so they have to buy ads too, just to keep the customers they already have. Now, both companies are spending millions of dollars on commercials. Because they're both doing it, their share of the market stays exactly the same. They still split the customers fifty-fifty, but now they both have millions of dollars less in the bank because they had to pay for the ads. They're in that five-year jail sentence spot. They're both worse off than if they had just agreed to stay quiet, but neither one can stop.

HostWhy don't they just pick up the phone? It seems like they could just grab lunch and agree that neither of them will buy ads this year. Everyone saves money and everyone stays happy.

GuestWell, there are two big problems with that. First, in most places, that's actually against the law. It's called price fixing or market sharing, and the government will step in and fine you for it because it hurts the people buying the products. But the second reason is even deeper. Even if it were legal, could you really trust the other guy? If you agree to stop ads, you're giving your rival a massive opening. If they break the deal and put an ad on during the big game while you're silent, they could ruin your business in a weekend. The fear of being the only one not talking is what keeps everyone spending.

HostIt's like an arms race where nobody wants the bombs, but nobody wants to be the only one without them either. Is there any way for them to actually break the cycle, or are they just stuck forever?

GuestSometimes they get lucky and the choice is taken away from them. There's a famous case with cigarette companies back in the early seventies. For years, they were spending huge amounts of money on TV ads, mostly just fighting each other for the same smokers. They were all losing money to the ad networks. Then, the government stepped in and banned cigarette ads on TV and radio.

HostYou would think the companies would've fought that to the death.

GuestThey did at first. But once the ban happened, something strange happened. Their profits went up. Since nobody was allowed to advertise on TV, the arms race was forced to end. They didn't have to worry about a rival stealing their spot because the spot didn't exist anymore. They saved all that ad money and their sales stayed pretty much the same. The government basically acted like a guard who forced both prisoners to stay quiet.

HostSo they were saved from themselves. But most businesses don't get a ban like that. If I'm a smaller company, do I just have to accept that I'll be drained by these wars?

GuestNot always. The trap only works if you're selling the exact same thing to the exact same people. If you find a way to be different, the logic changes. But for the big players selling phones or cars or insurance, they're often stuck. They're not buying those ads because they think the ads are amazing or because they love spending the money. They're buying them because they're terrified of what happens if they're the only ones who stop.

HostIt turns out those loud commercials are less about selling us on a new drink and more about two giants who are too scared to blink.

GuestThe most successful companies are often the ones that figure out how to stop fighting over the same patch of ground and go find a new one where they can be quiet for a while.

HostThose soda companies are still stuck in that cell, even if the cell is made of gold and expensive airtime.

GuestFinn, thanks for having me.

HostThe big game next year will probably have the same commercials, but it's wild to think that the people paying for them might be just as frustrated as we are.