LECTURE TEN: STRATEGIC THINKING

IPEM Tohoku University

Managerial Economics

Lecturer: Jack Wu

Period 3/ February 18

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 STRATEGY

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

never use dominated strategy

NASH EQUILIBRIUM

Given 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

Pepsi

Raise 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.

NASH EQUILIBRIUM: PRISONERS’ DILEMMAPRISONERS’ DILEMMA

Sam

Do not confess

Confess

Ian

Do not confess

I: 0,

S: 0

I: -10,

S: 0

ConfessI: 0,

S: -10

I: -5,

S: -5

What should Sam do?

OUT OF NASH EQUILIBRIUM

What 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

Solution: randomized discounts

COORDINATION/COMPETITION: EVENING EVENING NEWSNEWS

Delta

7.30pm 8.00pm

Zeta

7.30pmA: 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: FOCAL FOCAL POINTPOINT

Single Nash equilibrium - clear focal point

Multiple Nash equilibria - look for focal point to see which one to play

SEQUENCING

Game in extensive form – sequence of moves:

nodesbranchesoutcomes

EXTENSIVE FORM: EQUILIBRIUM

backward induction final nodes intermediate nodes initial node

SEQUENCING: EXTENSIVE FORMEXTENSIVE FORM - TV NEWS- TV NEWS

STRATEGIC MOVE

Action 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 10% 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 10%, 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