STRATEGIC THINKINGIMBA Managerial EconomicsJack Wu

Strategic Thinking

Nov. 16: Coca-Cola raised price 7% Nov. 22: Pepsi raised price 6.9% “Coke and Pepsi will move now

from price-based competition to marketing-based competition”,

Andrew Conway, Morgan Stanley

COKE VS. PEPSI, 1999

COMPETITIVE DILEMMA

Pepsi Raise price Discount

Raise price

C: 3, P: 3

C: 0, P: 5

Coke Discount C: 5, P: 0

C: 1, P: 1

What should Coke do?

STRATEGIC SITUATIONS parties actively consider the interactions with

one another in making decisions game theory -- set of ideas and principles to

guide strategic thinking simultaneous actions: strategic form sequential actions: extensive form

DOMINATED STRATEGYgenerates worse consequences than another strategy, regardless of the choices of the other parties

never use dominated strategy

NASH EQUILIBRIUMGiven that the other players choose their Nash equilibrium strategies, each party prefers its own Nash equilibrium strategy

• No one is willing to deviate unilaterally from a Nash equilibrium

SOLVING FOR NASH EQUILIBRIUM eliminate dominated strategies, then check

remaining cells “arrow” technique

NASH EQUILIBRIUM: COMPETITIVE DILEMMACOMPETITIVE DILEMMA

PepsiRaise price Discount

Coke

Raise priceC: 3, P: 3

C: 0, P: 5

DiscountC: 5, P: 0

C: 1, P: 1

What should Coke do?

COKE AND PEPSI GAME Nash equilibrium: for both parties, “raise

price” is dominated by “discount”. but discounting is bad for both -- if only they

could agree somehow to raise price. Coke and Pepsi stuck in this situation for four

years until November 1999.

RADIO FORMATSMerkur

Lite AC no change

JupiterHot AC J: 60,

M: 40J: 60, M: 40

no change J: 70, M: 30

J: 50, M: 50

RADIO FORMATS For Merkur, “Lite AC” is dominated by “no

change”; so consider only “no change”, assuming Merkur chooses “no change”,

Jupiter should choose “Hot AC”.

Repeat using “arrow technique”.

NASH EQUILIBRIUM: RADIO FORMATSRADIO FORMATS

MerkurLite AC no change

Jupiter

Hot AC J: 60, M: 40

J: 60, M: 40

no change J: 70, M: 30

J: 50, M: 50

NASH EQUILIBRIUM: PRISONERS’ DILEMMAPRISONERS’ DILEMMA

SamDo not confess

Confess

IanDo not confess

I: 0, S: 0

I: -10, S: 0

ConfessI: 0, S: -10

I: -5, S: -5

What should Sam do?

June 1998: Saudi Oil Minister Naimi, “I don’t think anybody expects 100% compliance… Once the price goes up, there will be cheating”

March 1999: Algerian Oil Minister Youcef Yousfi, “OPEC is still able to act collectively and restore market stability”

OPEC: OIL CARTEL

OUT OF NASH EQUILIBRIUMWhat if another player doesn’t play Nash equilibrium strategy? Nash equilibrium strategy may not be best still don’t use dominated strategy

No Nash equilibrium in pure strategies

Competitor.com NBA NHL

NBA W: 4, C: 3

W: 3, C: 4

We.com NHL W: 3, C: 4

W: 4, C: 3

WHERE TO ADVERTISE?

RANDOMIZED STRATEGIES choose among pure strategies according to

probabilities must be unpredictable Example: where to advertise _ We.com: ½ NBA and ½ NHL _ Competitor.com: ½ NBA and ½ NHL

RANDOMIZED STRATEGIES: RETAIL PRICE COMPETITIONRETAIL PRICE COMPETITION

Two competing retailers – Jaya and Ming Three segments

captive (loyal) to Ming captive (loyal) to Jaya switchers

RANDOMIZED STRATEGIES: RETAIL PRICE COMPETITIONRETAIL PRICE COMPETITION

MingHigh price Low price

JayaHigh price

J: 60, M: 40

J: 40, M: 50

Low price

J: 50, M: 40

J: 50, M: 30

RANDOMIZED STRATEGIES: RETAIL PRICE COMPETITIONRETAIL PRICE COMPETITION

Pricing trade-off: high price to extract buyer surplus of loyal

customers low price to get store switchers

Solution: randomized discounts

COORDINATION/COMPETITION: EVENING EVENING NEWSNEWS

Delta7.30pm 8.00pm

Zeta

7.30pm A: 1, B: 1

A: 3, B: 4

8.00pmA: 4, B: 3

A: 2.5, B: 2.5

COORDINATION AND COMPETITION Prime time for news is 8:0pm; second best is

7:30pm; since audience is limited, get maximum

viewership if two channels schedule at different times.

Question: which station gets 8:0pm? Situation has elements of

coordination -- avoiding same time slot competition -- getting the 8:0pm slot

ZERO/POSITIVE SUM zero-sum games: pure competition -- one

party better off only if other is worse off positive-sum games: coordination -- both can

be better off or both worse off co-opetition: competition and coordination

COORDINATION/COMPETITION: INSTANT MESSAGING INSTANT MESSAGING TECHNOLOGIESTECHNOLOGIES

Venus Inc.

Orange Green

Sol Corp.Orange S: 1.5

V: 1.5

S: 1 V: 1

Green S: 1 V: 1

S: 1.5 V: 1.5

COORDINATION/COMPETITION:FUTURE DVD STANDARD

ConsumersBlu-ray HD-DVD

DVD player manuf-acturers

Blu-ray M: 1, C: 1

M: -1, C: -1

HD-DVDM: -1, C: -1

M: 1, C: 1

COORDINATION/COMPETITION: FOCAL FOCAL POINTPOINT

Single Nash equilibrium - clear focal point Multiple Nash equilibria - look for focal point to

see which one to play

SEQUENCINGGame in extensive form – sequence of moves:

nodesbranchesoutcomes

EXTENSIVE FORM: EQUILIBRIUMbackward induction

final nodes intermediate nodes initial node

SEQUENCING: EXTENSIVE FORMEXTENSIVE FORM - TV NEWS- TV NEWS

STRATEGIC MOVEAction to influence beliefs or actions of other parties in a favorable way

• credibility– first mover advantage– second mover advantage

EXAMPLES Examples: Evening TV news -- both stations want to move first: which one can?

Use strategic move, eg, contracts with advertisers to deliver news at 8pm.

Famous Chinese general: after crossing a river, burnt his ships -- strategic move to force soldiers to fight harder.

Issue: Is the move credible? Will it convince the other players?

Advantage doesn’t always go to first mover; In war, better to see opponent’s move, and then take action, eg is

enemy moving south or north? new product category -- let competitor test the market and

educate the customers

consumer

Litho

LithoMake prints

Do not

Buy

Do not

Make more prints

Do not

(1) serial number (2) destroying the plate(3) other solution?

LITHOGRAPHER

CONDITIONAL STRATEGIC MOVES

Threats – if it succeeds, then it needn’t be carried out

Promises – if it succeeds, then it needn’t be carried out

Ideal strategic move doesn’t impose costs

MORGAN STANLEY:“SHAREHOLDER RIGHTS PLAN”

If any party acquires 15% or more of company’s shares, other shareholders get right to buy additional shares at 50% discount. Impact on hostile bidder?

SHAREHOLDER RIGHTS PLAN This shareholder rights plan is a threat to

potential bidders: most hostile bidders begin with small stake; with shareholder rights plan, if bidder

acquires more than 15%, then rights triggered, and bidder will be diluted.

Nickname: poison pill. Actually works against shareholder rights --

by entrenching existing management.

Sharon

Hilda

acquires 100,000shares

doesn’t bid

does not

activates rights

Hilda loses on initial stake + cost of takeover rises

POISON PILL

Union

Employer

reject union demand

accept

do not

strike Lose current wageand possibly gain infuture wage

Maintain current wage

Why are strikes rare inAmerican professional football?

STRIKE

CONDITIONAL STRATEGIC MOVE: WITHOUT DEPOSIT INSURANCE

depositor

maintains deposit

withdraws deposit

bank insolvent

bank remains solvent

principal + interest

zero

depositor

principal

principal

bank remains solvent

bank insolvent

CONDITIONAL STRATEGIC MOVE: WITH DEPOSIT INSURANCE

depositor

maintains deposit

withdraws deposit

bank insolvent

bank remains solvent

principal + interest

principal

depositor

principal

principal

bank remains solvent

bank insolvent