Date post: | 16-Dec-2015 |
Category: |
Documents |
Upload: | allen-rose |
View: | 220 times |
Download: | 1 times |
Game Theory
“The power to constrain an adversary depends upon
the power to bind oneself.”- Thomas Schelling
Topic 6Strategic Moves
Credibility
Review
Cooperation requires sacrificing immediate profits for a future relationship
The sacrifice is only made if the punishment is both severe enough and credible
But what is credibility?
Mike Shor2
Review
Credible commitments require Severe enough punishment to change behavior Irreversible and clear actions
Strategic Moves: Changing the game for strategic advantage Being credible Overcoming the prisoner’s dilemma
Mike Shor3
What is Credibility?
“The difference between genius and stupidity is that genius has its limits.”
– Albert Einstein
Telling you I’m going to act in my best interest is not committing
To commit to a suboptimal action, I need to: Change the game Change perceptions
Mike Shor5
How to be Credible?
Reduce payoffs from those strategies that may tempt you
Make it costly to renege
Remove strategiesfrom among those that may tempt you in the future
Destroy avenues of retreat
Replace playersby eliminating strategic control
Remove “human meddling”
Mike Shor6
Commitment
Must commit to be credible!
“The difference between ‘involvement’ and ‘commitment’ is like an eggs-and-ham breakfast:
the chicken was ‘involved’ – the pig was ‘committed.’ ”
Mike Shor7
Commitment vs. Involvement
Two firms considering market entry: Market potential is $10 million NPV profits Entry costs $7 million
It is in our best interest to stay out if we think that the other firm will enter
Mike Shor8
In Out
UsIn -2 , -2 3 , 0
Out 0 , 3 0 , 0
Them
Involvement
We make an initial investment: Invest first $1 million to deter entry
It is still in our best interest to stay out if we think that the other firm will enter
Mike Shor9
In Out
UsIn -2 , -2 3 , 0
Out -1 , 3 -1 , 0
Them
Commitment
We make an initial investment: Invest first $3 million to deter entry
Now, it is our dominant strategy to enter regardless of what the other firm will do
Mike Shor10
In Out
UsIn -2 , -2 3 , 0
Out -3 , 3 -3 , 0
Them
Credible Commitment
By reducing our own payoffs from staying out, we have committed to entry
It is credible because it is now in our own best interest!
Mike Shor11
Commitment & Competition
Consumers want companies to compete Companies prefer to cooperate Credible commitment by companies:
Change payoffs toMaximize joint gainsPromise higher pricesThreaten competitors that lower prices
Three practices consumers like but economists hate
Mike Shor12
Promises and Threats
Getting the promise or threat right Making it credible
Firms want to promise each other high prices threaten rivals who lower prices
Mike Shor13
Getting the Threat Right
The Operation1. Select a victim2. Threaten to beat him up if he pays the “protection”
money The Other Operation
1. Select a victim2. Threaten not to beat him up if he pays the
“protection” money The Other Other Operation
1. Select a victim2. Threaten to beat him up if he doesn’t pay the
“protection” moneyMike Shor
14
Monty Python’s Piranha Brothers
Making it Credible
Promises can sometimes be credible through a contract with the party to whom you are making the promise
Threats can never be credible through a contract with the party to whom you are making the threat
Must contract with third party
Mike Shor15
The Bocchicchio Family
“ Once a particularly ferocious branch of the Mafia in Sicily, it had become an instrument of peace in America. ”
How can Michael invite Don Tessio for a meeting and guarantee that Don Tessio will not be harmed?
Mike Shor16
Customers as Hostages
Firms can contract with customers as a third party to make credible threats and promises
Mike Shor17
Customers as Hostages:Promises
“I promise to keep prices high”
Most Favored Customer clause If I ever offer a lower price to any other customer,
I will offer it to you as well
Mike Shor18
High
Firm 1Low 65 , 35 65 customers @ $1
High 60 , 60 30 customers @ $2
Firm 2
Most Favored Customer Clause
Say, in period 1, both firms charge high In period 2, pricing low requires a $1 refund
to 30 customers from last period
Mike Shor19
High
Low 65 , 35
High
Low 35 , 35Firm 1:
65 – 30 = 35
Most Favored Customer Clause
Mike Shor20
Low High
Firm 1Low 10 , 10 35 , 35
High 35 , 35 60 , 60
Firm 2
Low High
Firm 1Low 40 , 40 65 , 35
High 35 , 65 60 , 60
Firm 2
Customers as Hostages:Threats
“I will punish you if you lower prices”
Price Matching Guarantee If any competitor offers a lower price,
I will match it
Mike Shor21
High
Low 65 , 35
Low
Low 40 , 40
Price Matching Guarantee
Mike Shor22
Low High
Firm 1Low 40 , 40 40 , 40
High 40 , 40 60 , 60
Firm 2
Low High
Firm 1Low 40 , 40 65 , 35
High 35 , 65 60 , 60
Firm 2
Customers as Hostages
Price matching guarantees and most favored customer clauses exploit: customer price sensitivity customer price awareness low customer switching costs
Exactly the factors that make price competition brutal!
Mike Shor23
Other Price Guarantees
What is the impact of:
“Drug companies should not be allowed to charge Americans more than Canadians”
China requests a “Most Favored Nation” clause with the United States
WalMart requires a price from suppliers that is no worse than its competitors
Mike Shor24
Increasing Search Costs:Theory
It costs a consumer a transportation cost, t, to “visit” another firm
If consumers expect prices of pe, how much should you charge?
Can charge up to pe + t But, if you iterate this
If you charge pe+t, competitor can charge pe+t+t, but then you can charge pe+t+t+t
Mike Shor25
Increasing Search Costs:Implementation
Prevent price advertising Government regulation (liquor stores) Industry agreement (likely illegal) Professional trade groups (doctors)
Limit store hours Closing laws (florists)
Obfuscate price information (Dilbert “confusopolies”) Make comparison difficult (mattresses,
insurance) Use multiple prices (banking, auto
dealers)
Mike Shor26
Strategic Moves
A strategic move is an action taken prior to the play of the game
Transforms the original game into a two-stage game Setting the Rules Playing the Game
"Victorious warriors win first and then go to war.
Defeated warriors go to war first and then try to win.“ -- Sun Tzu
Mike Shor27
Strategic Moves
A credible strategic move must be Observable Irreversible Incentive-changing
Incentive-changing Change strategies, payoffs, or players Be creative
Mike Shor28
The Prisoner’s Dilemma
Mike Shor29
Firm 2
Low High
Firm 1Low 40 , 40 65 , 35
High 35 , 65 60 , 60
Equilibrium: $40 K
Cooperation: $60 K
Joint Ventures & Cross-Shareholding
If each firm acquires 20% of the other:
Mike Shor30
Low
High 35 , 65
Low
High 41 , 59
Firm 1:
(4/5) 35 + (1/5) 65
= 41
Firm 2:
(4/5) 65 + (1/5) 35
= 59
Joint Ventures & Cross-Shareholding
Mike Shor31
Low High
Firm 1Low 40 , 40 59 , 41
High 41 , 59 60 , 60
Firm 2
Low High
Firm 1Low 40 , 40 65 , 35
High 35 , 65 60 , 60
Firm 2
Reducing Payoffs: Contracting
Takeover offer: $200 million You can “afford” $20 million / year Finance takeover for 20 years at 7%
Add penalty: if amount greater than $200 million, +1.5 points on interest rate
Annual Payments:$200 million: $18.6 million / year$210 million: $19.6 million / yearwith penalty: $21.9 million / year
Mike Shor32
Credible Threats
Targeted threats are generally more credible than blanket threats
But what if a blanket threat is exactly what we need? Assign responsibility to alter incentives
Mike Shor33
From Incredible to Credible
Ten suppliers each have two options: Deliver on time at a cost of $70,000 Deliver a week late at a cost of $20,000
Delivery results in $100,000 payment
I need at least nine suppliers and the suppliers know this
Mike Shor34
A Non-Credible Threat
I threaten not to deal with any supplier who delivers late But, suppliers know that I can punish at most one
Two equilibria: All deliver on time All deliver late (the likely equilibrium) Even if I think that only one other supplier will
deliver late, it is in my best interest to do so: ½ (80) > 30
Mike Shor35
A Credible Threat
I number the suppliers arbitrarily: 1…10 I refuse delivery from the lowest numbered
supplier among those who are late
Result: Supplier 1 delivers on time
(better than getting nothing) Thus, supplier 2 delivers on time …
Mike Shor36
Removing Strategies I
You are not always better off with more options.
Delegation Delegate decision to a disinterested third party In contract negotiation, can “squabble” over many
details Instead, send an agent with power of attorney to
“sign as is” or “walk away”
Learn from government bureaucracy: “The rules won’t allow me to do what you ask!”
Mike Shor37
Delegation Examples
Human resource departments Shield from requests for higher salaries HR execs not compensated based on employer
value
Collection agencies Shield from pleas or threats of the debtor Reinforce repayment to protect reputation
Accounting firms overseeing contests Accountant’s payment not tied to outcome Concerned with reputation for fairness
Mike Shor38
Removing Strategies II
Sometimes, you should burn bridges.
Burning Bridges Power comes from not being able to retreat Allow opponent to retreat (Sun Tzu)
The nicotine patch Hunt for Red October Cortes upon arriving in Mexico
Mike Shor39
Burning Bridges
Reputation “I burn all cities about to be conquered” “We do not negotiate with terrorists” Takeover defenses
Irreversibility Pressing the “send” button Turning off the phone Extreme form: Last Will and Testament
Mike Shor40
Burning Bridges Example
Semiconductor patent sharing
“Mosaid Technologies, a designer and licensor of semiconductor chips and technologies, just announced a patent sharing deal with Mitsubishi Electric”
Share patent with another competing firmCommit to chip supply to production plantsCommit to no opportunistic behavior
Mike Shor41
Building Bridges
Build bridges for your opponents.
“When you surround an enemy, you must leave an outlet for him to go free.” – Sun-Tzu
Jimmy Hoffa’s negotiation lesson: What is the single most important
thing for a negotiator to know?
Mike Shor42
Commitment Is Counterintuitive
Mike Shor43
Reduce your strategy space and decrease your own payoffs to commit.
(Hurt yourself to help yourself)
Increase your opponent’s strategy space
to preclude the rival from committing.(Help your rival to help yourself)
Irrationality
U.S. / U.S.S.R. nuclear deterrence Mutually Assured Destruction (MAD)
like Grim Trigger Strategy
Proportional Response like Tit-for-Tat
Want a lot of deterrence Want irrationality to be credible Dr. Strangelove & the Doomsday device
Mike Shor44
Dr. Strangelove The Credibility Checklist
Severity “Create fear in the mind of the enemy”
Irreversibility “It is essential”
Irrationality “Not something a sane man would do”
Practicality “It wasn’t a practical deterrent”
Clarity “Tell the world”
Mike Shor45
Commitment Under Uncertainty
An offer you can’t refuse After a seemingly successful interview,
the interviewer asks where the firm ranks on your list of potential employees
Before answering, you are told:The firm only hires applicants who rank it firstIf the firm is in fact your first choice,
then you must accept a job offer in advance, should one be made
Mike Shor46
Commitment Under Uncertainty
Why make such proposals?Take advantage of your uncertaintyTake advantage of your risk-aversionMake you commit before they do!
Binding early-decision college applications
Mike Shor47
Flexibility vs. Commitment
Must balance:
Value of commitment Change in others’ behavior from your
committing to some course of action generates value
Value of flexibility Keeping your options open and remaining
flexible allows you to react to changing situations (option value)
Mike Shor48
Philips, N.V.
Commitment in CD introduction Philips: innovator’s advantage
Initiate construction of plant ahead of competitors
Decision problem of Philips in 1982:Build a disk-pressing plant in the U.S. and
invest in a substantial amount of capacity to deter potentially entry (Sony, etc.)
Delay decision until commercial appeal of CDs can be determined. Import CDs to the U.S. To “test the waters.”
Mike Shor49
Calculating Option Value
The science Option Value:
Added profit from flexibility (can’t lose)
The art Countervailing forces:
By waiting, the firm risks: Failing to capitalize fully on an opportunity. Having the opportunity preempted by competitors.
What to do?
Mike Shor50
Philips, N.V. (continued)
q probability of mass acceptance of CDs
Pure option value In the absence of any competition
Philips should wait if q < 0.380
Commitment value If Sony is as well informed about the market as Philips
Philips should wait if q < 0.006
Informational advantage Because of proprietary market information obtained
through its CD operations in Europe:Philips should wait if q < 0.130
Mike Shor51
Resolution
Philips did not build a U.S. Plant in 1983Its assessment of the likelihood of general
acceptance did not meet the threshold
Market realization (surprise!) Sony constructed a U.S. Plant in 1984
Terry Haute, Indiana
Philips attempted to compete Increased capacity in Hanover, Germany plant
Philips decided to invest in a U.S. Plant Only after the Sony plant was fully operational
Mike Shor52