Strategic Management Business Policy Game Theory and Strategy

Strategic Management/ Business Policy Game Theory and Strategy

Game Theory and Strategy Key Concept: Preemption of Strategically Valuable Assets Access to raw materials (e. g. , Alcoa) Wal-mart’s rural strategy

Analyzing Competitive Dynamics Commitment Vs. Flexibility Commitment Game-theoretic preemption strategy Flexibility Real (Strategic) Options Analysis

Game Theory and Strategy Prisoners’ Dilemma Game Column Silence Fink Silence -1 0 -10 Fink Row -1 0 -8 -8

Game Theory and Strategy Prisoners’ Dilemma Game Row Player: Column Player: Dominant Strategy: Fink Dominant Strategy (Nash) Equilibrium: (-8, -8) Note: It is a dilemma since if they both cooperated by remaining silent: (-1, -1). -1 -1 0 -10 0 -8 -8

Game Theory and Strategy The Prisoners’ Dilemma Game can occur in many contexts: What is best for an individual may not be best for a division; What is best for a division may not be best for a firm; What is best for a firm many not be best for an industry; What is best for an industry may not be best for a nation; and What is best for a nation may not be best for the world.

Game Theory and Strategy Now that we have learned the concept of dominant strategy equilibrium, there is a second important equilibrium concept called a Nash equilibrium. Note: All dominant strategy equilibrium are Nash equilibrium, but not all Nash equilibrium are dominant strategy equilibrium.

Game Theory and Strategy Game with no dominant strategy equilibrium, but a Game with one Nash equilibrium: Column Cooperate Fink 1 5 4 4 -1 Fink Row Cooperate 9 0 0

Game Theory and Strategy A cooperative game with conflict Game with multiple (two) Nash equilibria Prize Fight Ballet Man Woman Prize Fight Ballet 1 2 -1 -1 -5 -5 2 1

Game Theory and Strategy Suppose this game were played sequentially? Would it be better to go first or second? Prize Fight Ballet Man Woman Prize Fight Ballet 1 2 -1 -1 -5 -5 2 1

Game Theory and Strategy Would you want to move first or second? Prize Fight Ballet Man Woman Prize Fight Ballet 20 10 100 6 90 4 30 8

Game Theory and Strategy Joint Venture Toyota L. Race Cooperate GM Cooperate L. Race 112 123 58 58 123 91 91

How Can “Commitment” Affect A Competitor’s Response? Commitment = An Irreversible Action (Sunk Costs) L. Race Cooperate GM Toyota Cooperate L. Race 112 123 58 58 -28 91 -51

How Can “Commitment” Affect A Competitor’s Response? Mutual sunk cost commitments Toyota L. Race Cooperate GM Cooperate L. Race 112 -28 58 58 -28 -51

Game Theory and Strategy Lessons #1: Commitment (sunk costs) can be used to achieve cooperation. The importance of mutual economic hostages: The wise manager should think beyond Machiavelli’s myopic approach to contracting and should seek both to give and receive credible (sunk cost) commitments that facilitate ongoing relationships and adaptation.

Game Theory and Strategy Initial Game (played simultaneously) No Launch Airbus Boeing No Launch 300 400 200 300 -100 -200

How Can “Commitment” Affect A Competitor’s Response? Commitment = An Irreversible Action (Sunk Costs) Competition In The Commercial Aircraft Industry Launch No Launch Airbus Boeing No Launch 300 400 200 300 -100 -200

Game Theory and Strategy: Lessons #2 2. Commitment (sunk costs) can be used to achieve competitive advantage. • Preemption strategy