Strategic Management/ Business Policy

Game Theory and Strategy

Game Theory and Strategy

Key Concept: Preemption of Strategically Valuable Assets

Access to raw materials (e.g., Alcoa)

Wal-mart’s rural strategy

Analyzing Competitive Dynamics Commitment Vs. Flexibility

CommitmentGame-theoretic preemption strategy

FlexibilityReal (Strategic) Options Analysis

Game Theory and Strategy

Prisoners’ Dilemma Game

Row

Silen

ce

Fin

k

Silence Fink Column

-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).

-1

0-1

0

-10 -8-8

-10

Game Theory and StrategyThe 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; and

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 Strategy

Game with no dominant strategy equilibrium, but a Game with one Nash equilibrium:

Row

Coop

era

teFin

k Cooperate Fink

Column

5

4 1

9

-1 0

0

4

Game Theory and Strategy

A cooperative game with conflict

Game with multiple (two) Nash equilibria

Man

Pri

ze F

igh

tB

allet

Prize Fight Ballet Woman

2

-1 1

-5

-5 2

1

-1

Game Theory and Strategy

Suppose this game were played sequentially?

Would it be better to go first or second?

Man

Pri

ze F

igh

tB

allet

Prize Fight Ballet Woman

2

-1 1

-5

-5 2

1

-1

Game Theory and Strategy

Would you want to move first or second?

Man

Pri

ze F

igh

tB

allet

Prize Fight Ballet Woman

10

100 20

4

90 30

8

6

Game Theory and Strategy

Joint Venture

GM Coop

era

teL.

Race

Cooperate L. Race Toyota

112

123112

123

58 91

91

58

How Can “Commitment” Affect A Competitor’s Response?

Commitment = An Irreversible Action (Sunk Costs)

GM Coop

era

teL.

Race

Cooperate L. Race Toyota

112

123112

-28

58 91

-51

58

How Can “Commitment” Affect A Competitor’s Response?

Mutual sunk cost commitments

GM Coopera

teL.

Race

Cooperate L. Race Toyota

112

-28112

-28

58 -51

-51

58

Game Theory and Strategy

Lessons #1:

Commitment (sunk costs) can be used to achieve cooperation.

The importance of mutual 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

Initial Game (played simultaneously)

Air

bu

s

No L

au

nch

Lau

nch

No Launch Launch Boeing

400

400300

300

200 -100

-200

200

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 Launch Boeing

400

400300

300

200 -100

-200

200

Game Theory and Strategy:

Lessons #2

2. Commitment (sunk costs) can be used to achieve competitive advantage.

• Preemption strategy