chapter 13 game theory and competitive strategy

Chapter 13
Game Theory
and Competitive
Strategy
Chapter 13 Slide 2
Topics to be Discussed

Gaming and Strategic Decisions

Dominant Strategies

The Nash Equilibrium Revisited

Repeated Games
Chapter 13 Slide 3
Topics to be Discussed

Sequential Games

Threats, Commitments, and Credibility

Entry Deterrence

Bargaining Strategy
Chapter 13 Slide 4
Gaming and Strategic Decisions

“If I believe that my competitors are
rational and act to maximize their own
profits, how should I take their behavior
into account when making my own

profit-maximizing decisions?”

Definition of a game
Chapter 13 Slide 5
Gaming and Strategic Decisions

Noncooperative versus Cooperative
Games

Cooperative Game

Players negotiate binding contracts that
allow them to plan joint strategies

Example: Buyer and seller negotiating the
price of a good or service or a joint venture
by two firms (i.e. Microsoft and Apple)

Binding contracts are possible
Chapter 13 Slide 6
Gaming and Strategic Decisions

Noncooperative versus Cooperative
Games

Noncooperative Game

Negotiation and enforcement of a
binding contract are not possible


Example: Two competing firms assuming
the others behavior determine,
independently, pricing and advertising
strategy to gain market share

Binding contracts are not possible
Chapter 13 Slide 7
Gaming and Strategic Decisions

Noncooperative versus Cooperative
Games

“The strategy design is based on
understanding your opponent’s point of
view, and (assuming you opponent is
rational) deducing how he or she is likely to
respond to your actions”
Chapter 13 Slide 8
Dominant Strategies

Dominant Strategy

One that is optimal no matter what an
opponent does.

An Example

A & B sell competing products

They are deciding whether to undertake

advertising campaigns
Chapter 13 Slide 9
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10, 5 15, 0
10, 26, 8
Chapter 13 Slide
10
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10, 5 15, 0
10, 26, 8

Observations

A: regardless of

B, advertising is
the best

B: regardless of
A, advertising is
best
Chapter 13 Slide
11
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10, 5 15, 0
10, 26, 8

Observations

Dominant
strategy for A &
B is to advertise

Do not worry
about the other
player


Equilibrium in
dominant
strategy
Chapter 13 Slide
12
Dominant Strategies

Game Without Dominant Strategy

The optimal decision of a player without a
dominant strategy will depend on what the
other player does.
Chapter 13 Slide
13
10, 5 15, 0
20, 26, 8
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
Modified Advertising Game
Chapter 13 Slide
14
10, 5 15, 0
20, 26, 8
Firm A

Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
Modified Advertising Game

Observations

A: No dominant
strategy;
depends on B’s
actions

B: Advertise

Question

What should A
do? (Hint:
consider B’s
decision
Chapter 13 Slide
15
The Nash Equilibrium Revisited

Dominant Strategies


“I’m doing the best I can no matter what
you do.”

“You’re doing the best you can no matter
what I do.”
Chapter 13 Slide
16
The Nash Equilibrium Revisited

Nash Equilibrium

“I’m doing the best I can given what you
are doing”

“You’re doing the best you can given what I
am doing.”
Chapter 13 Slide
17

Examples With A Nash Equilibrium

Two cereal companies

Market for one producer of crispy cereal

Market for one producer of sweet cereal

Each firm only has the resources to
introduce one cereal


Noncooperative
The Nash Equilibrium Revisited
Product Choice Problem
Product Choice Problem
Chapter 13 Slide
18
Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5, -5 10, 10
-5, -510, 10
Chapter 13 Slide
19
Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5, -5 10, 10
-5, -510, 10

Question

Is there a Nash
equilibrium?


If not, why?

If so, how can
it be reached
Chapter 13 Slide
20
The Nash Equilibrium Revisited

Maximin Strategies

Scenario

Two firms compete selling file-encryption
software

They both use the same encryption
standard (files encrypted by one
software can be read by the other -
advantage to consumers)
Chapter 13 Slide
21
The Nash Equilibrium Revisited

Maximin Strategies

Scenario

Firm 1 has a much larger market share
than Firm 2


Both are considering investing in a new
encryption standard
Chapter 13 Slide
22
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0, 0 -10, 10
20, 10-100, 0
Don’t invest
Invest
Chapter 13 Slide
23
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0, 0 -10, 10
20, 10-100, 0
Don’t invest
Invest

Observations

Dominant
strategy Firm 2:
Invest

Nash equilibrium


Firm 1: invest

Firm 2: Invest
Chapter 13 Slide
24
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0, 0 -10, 10
20, 10-100, 0
Don’t invest
Invest

Observations

If Firm 2 does
not invest, Firm
1 incurs
significant
losses

Firm 1 might
play don’t invest

Minimize
losses to 10
maximin
strategy

Chapter 13 Slide
25

If both are rational and informed

Both firms invest

Nash equilibrium
The Nash Equilibrium Revisited
Maximin Strategy
Maximin Strategy