Behavioral Economics 06-08-2018 0

The Multi-Armed Bandit

Imagine this, you’re at a casino, of course, trying your luck. There are 10 slot machines in front of you, each one has a potential reward. Your Goal- maximize your winnings. How do you go about it? Do you sit at one machine the entire night and try exploit your winnings? Or do you chance it and move from machine to machine exploring the various options available?

Believe it or not this simple example, often referred to as the “Multi-Armed-Bandit” or the “exploit vs explore” theorem has been consciously used my millions to assist the decision making of everyday life. Whether it be dating, finding a great parking spot or purchasing that “perfect” first home, the multi-armed bandit is fundamental to everyday decision making, whether you are aware of it or not.

Let’s take a step back for a minute, what exactly is the “exploit vs explore” theorem all about, and how is it applicable to our everyday lives? Think about it like this, every decision you make is based on two options; option one, you continue doing or using the same thing you know and love, and option two, you try something new. Let’s take a real-life example, it’s Friday night and you feel like heading out to get something to eat, do you go back to that Greek place you know and love for some crispy fried fish, or do you try out that new Italian restaurant down the street? In essence, do you continue to enjoy the place you know, or do you try something new? The crucial tradeoff of course being, the new may not necessarily be better than the old.

So, now that we know what it is. How do we go about using this decision-making theory in our everyday lives? How do you know whether to ignore that first house you saw with the amazing en-suite bathroom and move onto the next one? At what point do you stop looking and choose? Statistically, the answer is after 37% of your search period time has elapsed.

Let’s unpack this a bit more, you’re at your favorite mall, its 13:50 and you have 40 minutes until Timmy finishes soccer practice at school. You know that you need 30 minutes to complete your grocery shopping for the week, this leaves you with 10 minutes to find parking, your goal of course, to get as close to the mall as possible. As you are driving, you pass some open parking spots, but you try to sneak a little bit closer to minimize your walking distance. At what point do you stop searching and park? In this case you should stop looking after 3.7 minutes have passed and pick the immediate next open parking space available, if you follow this theory you will have the statistically highest possible probability of finding the best spot available.

Imagine if you had followed that theory this morning on your way to work? I would have saved you 6.3 minutes of your day, probably the same amount of time you spent reading this blog!

So, why is this all relevant? Well, in a world which is changing at an exponential pace, our ability to explore the unexplored, and to sacrifice the existing in search of new and better things is becoming more and more relevant. In financial services, an industry ripe for disruption, it is imperative that you (whether an incumbent insurance house or financial advisor) can look past the present.

For financial advisors and the likes, the old way of doing business is dead. In order to thrive in the new age world, you will need to arm your practice with the right technologies and partners who will enable you to scale whilst providing increased value to your customer base. The fear of sacrificing the existing for the new is something that has kept many from beginning this journey, and although every action has an opportunity cost, if you are able to tackle the challenges of the future with the mind of a bandit, you may just come out alive!

For insurance houses, this concept could provide a possible solution to gauging the ratio of expenditure between R&D and existing product. In an industry characterized by slow moving giants and minimal innovation, taking the Multi-Armed-Bandit rule on board by spending a greater proportion of time, money and resources on exploration, research and development could reap great rewards in the medium to long term, whilst minimizing the impact on existing revenue lines and profit.

The fourth industrial revolution is bringing changes at a speed unlike anything we have ever seen before, and your ability to actively seek new technologies and partners whom are able to digitally transform your business is no longer a nice to have, but an absolute essential! It is now, more than ever, crucial to devote a significant part of your time towards the exploration of the unknown. Discovering new business models, technologies, revenue streams and collaborative partnerships is a modern-day requirement not just for success, but survival.

The Multi-Armed Bandit is by no means a guarantee but provides a solid foundation off which to build your journey of exploration. Our future success in life and business will be based on our ability to adequately balance the exploitation vs exploration equation, allowing us to maximize utility without reducing our preparation for the future.

So the next time you find yourself sitting in a position which requires some tough decision making, calm down to a panic, remember this blog and just “Multi-Armed-Bandit” that thing!

By Sean Kelly

Leave a Reply

Your email address will not be published. Required fields are marked *