Strategy Game Theory Grant Chapter

King of Shaves and Gillette

When KoS entered the UK market, Gillette might have threatened it with a price cut, but that wouldn't have been credible, because Gillette's dominant market share meant that a price cut would inflict more damage on itself than on rivals

In compact disks, the reluctance of the dominant firm (Philips) to invest heavily in new capacity to meet growing demand...

encouraged a wave of new entrants

A key deficiency in the five forces framework is...

in viewing inter-firm relations as exclusively competitive in nature

A company may seek to change the structure of the industry within which it is competing in order to...

increase the profit potential of the industry or to appropriate a greater share of the available profit

Why did Intel give up its potential monopoly over its x86 microprocessors?

it was encouraging the adoption of the x86 chip by computer manufacturers (including IBM) who were concerned about over-dependence on Intel

One of the key merits of game theory is...

its ability to encompass both competition and cooperation

Game theory offers two especially valuable contributions to strategic management:

permits the framing of strategic decisions; can predict the outcome of competitive situations and identify optimal strategic choices

The great virtue of game theory is in its..

rigor

Where companies compete on price, game theory shows that..

they tend to match one another's price changes

Can signaling also be used to communicate a desire to cooperate?

yes- price announcements can facilitate collusive pricing among firms

Example of deterrence in war

By establishing the certainty that deserters would be shot, the British army provided a strong incentive to its troops to participate in advances on heavily fortified German trenches during the first world war

Why does the mathematical rigor of game theory have limited applicability to real world situations?

Game theory provides clear prediction in stylized situations involving few external variables and highly restrictive assumptions- result is a mathematically sophisticated body of theory that suffers from unrealistic assumptions, lack of generality, and an analysis of dynamic situations through a sequence of static equilibriums

Changing the payoffs through deterrence

If both Coca-cola and Pepsi were to threaten one another with an aggressive price cuts should the other seek advantage through a big advertising budget, this could shift the equilibrium to the top left cell

What predicament does the prisoners' dilemma analyze?

In many business relationships, competition results in an inferior outcome for the players compared with cooperation

Case with Coke and Pepsi and advertising

So, the best advertising strategy for both firms would be to restrain their advertising to a small budget (both would have payoffs of 10 million dollars), but in reality, in the absence of cooperation, they will both adopt large budgets (payoffs of 4 million dollars) out of fear that the other will shift to a big advertising budget and reduce their payoff to -2 million and the other's to 15 million. This maxi-min point is called the Nash equilibrium- no player can increase his/her payoff by a unilateral change in strategy. It says, even if collusion can be achieved, it will be unstable because there is such a large incentive to cheat

The classic prisoners' dilemma game involves...

a pair of crime suspects who are arrested and interrogated separately; the dilemma is that each will "rat" on the other with the result that both end up in jail despite the fact that, if both had remained silent, both would have been released for lack of evidence

Investing in excess capacity can be...

an effective means of discouraging entry

soft commitments

commitments that moderate competition

Porter's 5 forces

competitive rivalry, supplier power, buyer power, threat of substitution, threat of new entry

For deterrence to be effective it must be...

credible, which means being backed by commitment

The benefits of building a reputation for aggressiveness may be particularly great for...

diversified companies where reputation can be transferred from one market to another

Even though carrying out threats against rivals is costly and depresses short-term profitability,...

exercising such threats can build a reputation for aggressiveness that deters competitors in the future

Apart from any theoretical value of the theory of games, game theory provides a structure, a set of concepts, and a terminology that allows us to describe a competitive situation in terms of:

identity of the players; specification of each player's options; specification of the payoffs from every combination of options; the sequencing of decisions using game trees

The principle behind deterrence is to..

impose costs on the other players for actions deemed to be undesirable

Changing a one-period game (single transaction) to a repeated game

in the case of the supplier-buyer relationship, moving form a spot transaction to a long-term vendor relationship gives the supplier the incentive to offer a better quality product and the buyer to offer a price that offers the seller a satisfactory return

Establishing alliances and agreements with competitors can...

increase the value of the game by increasing the size of the market and building joint strength against possible entrants; may be many opportunities for converting win-lose or even lose-lose games into win-win games

Where companies compete on output, game theory shows that...

increases in output by one firm results in output reductions by the other

Prior to the expiration of its NutraSweet patents, Monsanto...

invested heavily in unneeded plant capacity to deter manufacturers of generic apsartame

As with all our theories and frameworks, game theory is useful not because...

it gives us answers but because it can help us understand business situations

Central to the criticisms of Porter's five forces as a static framework is...

its failure to take full account of competitive interactions among firms

Particularly important for practicing managers, game theory can indicate strategies for improving the structure and outcome of the game through...

manipulating the payoffs to the different players

Game theory has not developed to the point where it permits us to...

model real business situations in a level of detail that can generate precise predictions

Is there a simple dichotomy between competition and cooperation?

no- there is competitive/cooperative duality of business relationships- all business relationships combine elements of both

In its empirical applications, game theory has done a much better job of explaining the past than...

of predicting the future

The essence of strategic competition is the interaction among...

players, such that the decisions made by any one player are dependent on the actual and anticipated decisions of the other players

Game theory provides penetrating insights into central issues of strategy that go well beyond...

pure intuition

If administering the deterrent is costly or unpleasant for the threatening party,...

the deterrent is not credible

Commitment involves...

the elimination of strategic options: "binding an organization to a future course of action"

How can a firm escape from such prisoners' dilemmas? Like the one described above?

to change a one-period game (single transaction) to a repeated game or to change the payoffs through deterrence

signaling

used to describe the selective communication of information to competitors (or customers) designed to influence their perception and hence to provoke or avoid certain types of reaction- could be use of misinformation, but signals need to be credible