Look Forward Reason Back The Cornerstone of Strategic

Look Forward, Reason Back The Cornerstone of Strategic Reasoning

Overview n Advertising and entry n Retail location strategies n General Principles

Advertising and Entry n An established retailer is facing possible competition from a rival n The established retailer can try to stave off entry by engaging in a costly advertising and price cutting campaign

Speed and flexibility n The rival is fast and flexible, so its policy is to wait and decide at the last possible instant its entry choice n Thus, the rival observes the initiation of this campaign before making its entry decision

Strategies and Payoffs n Incumbent: Advertise or not n Rival: Enter or not

Payoffs: n Incumbent (Best to worst) n No entry and no ads n No entry and ads n Entry and no ads n Entry and ads n Rival n Entry and no ads n No entry and no ads n Entry and ads

Game Tree In Ads 1, 1 R 3, 3 Out I In No ads 2, 4 R Out 4, 2

Backward Induction n Look to the end of the game tree and prune back n Rationality assumption implies that players choose the best strategy at each node.

Rival’s Choice In Ads 1, 1 R 3, 3 Out I In No ads 2, 4 R Out 4, 2

Incumbent’s Choice In Ads 1, 1 R 3, 3 Out I In No ads 2, 4 R Out 4, 2

Equilibrium Prediction n The prediction from this model is that the incumbent will run its ad campaign and this will effectively forestall entry n Notice that even in absence of actual entry, the potential competition from the rival eats into the incumbent’s profits.

Is Flexibility an Advantage? n Suppose that the rival is less flexible in its management practices. n It must commit to enter or not before the advertising decision of the incumbent. n How does this affect the outcome of the game?

Game Tree – Stodgy Rival Ads In 1, 1 I 2, 4 No ads R Ads Out 3, 3 I No ads 4, 2

Backward Induction - Incumbent Ads In 1, 1 I 2, 4 No ads R Ads Out 3, 3 I No ads 4, 2

Backward Induction – Rival Ads In 1, 1 I 2, 4 No ads R Ads Out 3, 3 I No ads 4, 2

Equilibrium Prediction n Notice that now the prediction is that the rival will enter and the incumbent will not advertise n The absence of flexibility on the part of the rival improves its outcome relative to the case where it retained flexibility. n This game has a first-mover advantage

Do all games exhibit first-mover advantage? n No n Procurement contracts: n Two firms are bidding for a procurement contract, which will be awarded to the low bidder. n There is a cost to preparing a bid n Firm 1 chooses its bid followed by firm 2. n Clearly it pays to go second and undercut the bid of the first firm

More Players n Same methods apply to more players n Only the tree grows more complex

Location Decisions n Three retailers (A, B, and C) are deciding their location decisions for an emerging metropolitan area n Their decision is whether to locate in an urban mall or a suburban mall n The urban mall has spots for 2 stores n The suburban mall has spots for all 3.

Motivation n The urban mall has more traffic than the suburban mall n There are synergies in mall location n The presence of 2 or more large stores drives disproportionate traffic to that mall

Strategies and Payoffs n Each retailer chooses where to locate: urban or suburban n Payoffs (Best to worst) Urban mall with other store n Suburban mall with other stores n Urban mall alone n Suburban mall alone n No mall n

Mall Allocation n The malls are not strategic players. n Urban: B and C have priority over A n Suburban: Accept anyone

Timing n Firm A is moves first, followed by B and then C

Game Tree U C U S U B U C S 1, 5, 5, 2, 5 3, 4, 4 S U A 2, 5, 5 C U S 4, 3, 4 S B U 4, 4, 3 S 4, 4, 4 C S

Backward Induction - C U S U B U C S 1, 5, 5, 2, 5 3, 4, 4 S U A 2, 5, 5 C U S 4, 3, 4 S B U 4, 4, 3 S 4, 4, 4 C S

Backward Induction - B U C U S U B U C S 1, 5, 5, 2, 5 3, 4, 4 S U A 2, 5, 5 C U S 4, 3, 4 S B U 4, 4, 3 S 4, 4, 4 C S

Backward Induction – A U C U S U B U C S 1, 5, 5, 2, 5 3, 4, 4 S U A 2, 5, 5 C U S 4, 3, 4 S B U 4, 4, 3 S 4, 4, 4 C S

Equilibrium Prediction n Firm C chooses suburban only if other 2 choose S n Firm B knows that by choosing an urban location, C will follow suit, therefore it goes urban n Firm A knows that B will go urban regardless and that C will follow B’s lead, therefore if it goes urban, it will be shut out n Therefore A goes suburban and ends up alone

General Principles n Sketch a game tree outlining who moves when n Construct a ranking of outcomes for both you and your rivals. n Look forward and reason back n If the outcome is not a desirable one, think about how you might change the game

Ways to Change the Game n Contracting: Look ahead in thinking about the strategic implications of contract terms n Change the order of moves (i. e. commitment) to gain a first-mover advantage.