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Economic Foundations Economic Foundations of Strategyof Strategy
Power Point Set #4
Game Theory and Strategy
Key Concept: Preemption of Strategically Valuable Assets
Access to raw materials (e.g. Alcoa)
Wal-mart’s rural strategy
Game Theory and Strategy
Creating Customer Switching Costs
Establishing standards for a computer operating systemMatsushita’s VHS format becoming dominant over Sony’s BetaNote: Given that a second mover’s product development costs can be much lower than the first mover’s product development costs, first-mover advantages must be substantial to justify first moving as a strategy.
Game Theory and StrategyTechnological Leadership
In the 1970s, DuPont built a dominant position in the titanium dioxide market by exploiting:• superior technology• scale economies• accumulated experience for low costs
Gillette competes with a differentiation strategy in disposable razors by exploiting:• superior technology• reputation• broad distribution
Analyzing Competitive Dynamics -Commitment Vs. Flexibility
CommitmentGame Theoretic preemption strategy
FlexibilityReal (Strategic) Options Analysis
Game Theory and Strategy
Prisoners’ Dilemma GameR
ow
Silen
ce
Fin
k
Silence FinkColumn
-1
0-1
0
-10 -8
-8
-10
Game Theory and Strategy
Prisoners’ Dilemma Game
Row Player: Dominant Strategy: FinkColumn Player: Dominant Strategy: Fink
Dominant Strategy (Nash) Equilibrium: (-8, -8)
Note: It is a dilemma since if they both cooperated by remaining silent: (-1, -1).
Game Theory and Strategy
The prisoners’ dilemma game can occur in many contexts:
What is best for an individual may not be best for a division.What is best for a division may not be best for a firm.What is best for a firm many not be best for an industry.What is best for an industry may not be best for a nation.What is best for a nation may not be best for the world.
Game Theory and Strategy
Now that we have learned the concept of dominant strategy equilibrium, there is a second important equilibrium concept called a Nash equilibrium.
Note: All dominant strategy equilibrium are Nash equilibrium, but not all Nash equilibrium are dominant strategy equilibrium.
Game Theory and StrategyGame with no dominant strategy equilibrium, but a Game with a Nash equilibrium.
Row
Coop
era
teFin
kCooperate Fink
Column
5
4 1
9
-1 0
0
4
Game Theory and Strategy
A cooperative game with conflictGame with 2 Nash equilibria.
Man
Pri
ze F
igh
tB
allet
Prize Fight BalletWoman
2
-1 1
-5
-5 2
1
-1
Game Theory and StrategySuppose this game were played sequentially?Would it be better to go first or second?
Man
Pri
ze F
igh
tB
allet
Prize Fight BalletWoman
2
-1 1
-5
-5 2
1
-1
Game Theory and StrategyGame Theory and Strategy
New game: Joe’s sad undergraduate days
Man
Pri
ze F
igh
tB
allet
Prize Fight BalletWoman
10
100 20
4
90 30
8
6
Game Theory and StrategyGame Theory and Strategy
Would you want to move first or second?
Man
Pri
ze F
igh
tB
allet
Prize Fight BalletWoman
10
100 20
4
90 30
8
6
Sources of First Mover Advantages
Economies of ScaleExperience or Learning Curve EffectsBrand Equity“Network Externalities”
- How are you going to use these effects to get a first mover advantage? - How does this lead to a sustainable advantage?
First Mover Disadvantages May Lead To Second Mover Advantages
The Costs of Early Adoption - The “Bleeding Edge” of Technology
Changing Product and/or Process Technology
Changing Consumer Tastes Product TechnologyProcess Technology
Game Theory and Strategy
Initial Game (played simultaneously)
Air
bu
s
No L
au
nch
Lau
nch
No Launch LaunchBoeing
400
400300
300
200 -100
-200
200
How Can “Commitment” Affect A Competitor’s Response?How Can “Commitment” Affect A Competitor’s Response?
Commitment = An Irreversible Action (Sunk Costs)Competition In The Commercial Aircraft Industry
Air
bu
s
No L
au
nch
Lau
nch
No Launch LaunchBoeing
400
400300
300
200 -100
-200
200
Game Theory and StrategyGame Theory and Strategy
Joint Venture
Coop
era
teL.
Race
Cooperate L. Race
112
123112
123
58 91
91
58
How Can “Commitment” Affect A Competitor’s Response?How Can “Commitment” Affect A Competitor’s Response?
Commitment = An Irreversible Action (Sunk Costs)
GM Coop
era
teL.
Race
Cooperate L. RaceToyota
112
123112
-28
58 91
-51
58
How Can “Commitment” Affect A Competitor’s Response?How Can “Commitment” Affect A Competitor’s Response?
Mutual sunk cost commitments
GM Coopera
teL.
Race
Cooperate L. RaceToyota
112
-28112
-28
58 -51
-51
58
Game Theory and StrategyLessons
1. Commitment (sunk costs) can be used to achieve cooperation (e.g., Toyota and GM)
The importance of mutualmutual economic hostages: The wise manager should think beyond Machiavelli’s myopic approach to contracting and should seek both to give and receive credible (sunk cost) commitments that facilitate ongoing relationships and adaptation.
Game Theory and Strategy:Lessons
2. Commitment (sunk costs) can be used to achieve competitive advantage.
•preemption strategy (e.g., Airbus vs. Boeing)
Game Theory and StrategySome key points on strategic commitment:
Always give attention to how your competitors’ returns vary under different strategic scenarios;
It is important to communicate the commitment to the other firms (for both competition and cooperation);
“Sunk cost” investments can be used to pre-commit to a certain strategy and, thus, influence competitor response; and
Understand what strategic investments are important in your business and how “sunk” those investments are.