David vs Goliath in Entry Decisions

• Suppose Goliath has $700 and David has $300

• They are gambling types, and prefer roulette

• Whoever ends up with more money after the next round will win ultimately

• Suppose David moves first and makes the safest bet

• He can never win

David vs Goliath in Entry Decisions

• He should take one of the more risky gambles

• Bets $300 that the ball would land on a multiple of 3 – wins $900 w.p. 12/37

• What is Goliath’s best response

• To exactly imitate David’s bet

• Again, David can never win • Is there any hope for David?

David vs Goliath in Entry Decisions

• David should have gone second and differentiated himself

• This situation is parallel to new product launch decisions when a firm with shallow pockets competes against a firm with deep pockets

• If going second is not feasible, then entrant should take riskier bets – like launching a product with some chance of failing!!

The idea behind a product line

• Consider a linear city

• It has several evenly spaced firehouses

• City closes every second firehouse and doubles the speed of response

• Clearly the average response time remains unchanged

• This increases efficiency: lower cost for same average response

The old locations and response times

• Suppose the firehouses are one mile apart

• The maximum distance from a firehouse is 0.5 miles, and the average distance 0.25 miles

• Response time is 60 minutes per mile

• Average response time is 15 minutes and maximum response time is 30 minutes

0 1 2 3 4

Maximum distance =0.5 miles

The new locations and response times

• Maximum distance is 1 miles and average distance is 0.5 miles

• Maximum response time is 30 minutes and average response time is 15 minutes

• Consider a fire at a place 2/3rd of a mile from a new firehouse

0 2 4

Variety, equity and efficiency

• The new response time is 20 minutes• In the old system this place would be 1/3rd of a mile

away from the nearest firehouse• It would have a response time of 20 minutes • What about a place that is more than 2/3rd of a mile

from nearest firehouse• New response time is 20-30 minutes, and old

response time would be less than 20 minutes

• Any change that increases efficiency by reducing variety can reduce equity!!!

The limits of product differentiation: customization

• Customized products are co-created by consumer and producer

• Product comes into existence after first interaction between consumer and firm

• A monopolist usually charges a higher price for customized products than for standard products

• What happens under competition?

Customization

• When two competing firms offer highly customized products, they are not differentiated

• This intensifies competition• Heightened competition can drastically reduce

prices• Thus prices can be below what would obtain

with standard products• Just because consumers are willing to pay more

doesn’t mean firms can charge more!!!

Differentiating strategies through randomness

• Consider competition in the market for razors• Suppose Gillette runs a coupon promotion on

the first week of every month • Bic can preempt Gillette by running a similar

promotion a week earlier• But then Gillette can preempt Bic the week

before

• The only sensible way to play this game is to run promotions randomly

Baseball anyone?

• 1986 baseball National League championship series

• The New York Mets won a crucial game against he Houston Astros

• Len Dykstra hit Dave Smith’s second pitch for a two-run home run

• Later the two players talked about this critical play

Analysis of a home run

• Dykstra said, “He threw me a fastball on the first pitch and I fouled it off. I had a gut feeling then that he’d throw me a forkball next, and he did. I got a pitch I saw real well, and I hit it real well”.

• Smith said, “What it boils down to is that, it was a bad pitch selection…if I had to do it over again, it would be [another] fastball”.

• Would Dykstra not have been prepared for a fastball?

• Again, randomization is the only way to go

But how do you randomize?

• In a game of tennis, suppose receiver’s forehand is stronger than backhand

• Consider following probabilities of successfully returning serve

Forehand Backhand

Forehand 90% 20%

Backhand 30% 60%

Server’s Aim

Receiver’s Move

Reducing receiver’s effectiveness by randomizing

• Suppose server tosses a coin before each serve• Aims to forehand or backhand according to coin turning

heads/tails• When receiver moves to forehand, his successful return

rate is 55%• When receiver moves to backhand, his successful return

rate is 45%• Given server’s randomization, receiver should move to

forehand

• The server has already an improved outcome compared to serving the same way all the time!!

What is server’s best mix?

• Consider following graph

20

60

90

30

0 40 100

48

Percentage of times server aims serve to forehand

Per

cen

tag

e su

cces

sfu

l re

turn

s

The mixing probabilities

• The 40:60 mixture of forehands to backhands is the equilibrium

• This mixture is the only one that cannot be exploited by the receiver to his own advantage

• With this mixture the receiver does equally well with either of his choices

• Both ensure the receiver a success rate of 48%

Co-promotions as differentiation

• Consider two firms selling undifferentiated products

• Price competition will be very fierce

• However one of the firms can bundle their product with another product for which consumers differ in their willingness to pay

• Thus both firms can benefit from the resulting differentiation!!

Game theory detour

• Focal market (F):-Two firms A and B selling

undifferentiated products at cost c and quality q

-Consumers willingness to pay for quality is a constant r

• Competition is intense and firms have to sell at marginal cost c

• They make zero profits

Game theory detour

• Outside market (O):

- Has potential partnering brand with quality and cost

-Consumers have heterogeneous willingness to pay for quality given by

- is distributed uniformly on [0, ] • Suppose A partners with C and B stands alone• Let the prices be and • Consumers will prefer AC to AC if >

O

CqCc

O

O

Bp ACp

Bpr ACCo pqr

Game theory detour

• The demands are and =1-

• The profit functions are and

• The optimal prices are ,

• And the optimal profits are ,

OC

BACB q

ppd

ACd Bd

( )AC ACACp c d

BBBdcp )(

3

2 OCAC

qcp

3OC

B

qcp

9

4 OCAC

q

9OC

B

q

Sources of differentiation

• Differentiation grows out of the firm’s value chain

• A firm can also differentiate itself through the breadth of its activities

• Differentiation is useful only if buyers value it

• Buyer value operates through - by lowering buyer cost- by raising buyer performance

Buyer purchase criteria

• Buyer value applied to a particular industry can identify Buyer Purchase Criteria

• Buyer purchase criteria- Use criteria- Signaling criteria

• Use criteria: supplier affects actual buyer value through lowering buyer cost or raising buyer performance

• Signaling criteria: stems from signals that enable buyer to judge what supplier’s value is, e.g. advertising, attractiveness of facilities, branding and reputation