Transcript Economic Foundations of Strategy Power Point Set #4 Game Theory and Strategy Key Concept: Preemption of Strategically Valuable Assets Access to raw materials (e.g.

Economic Foundations
of Strategy
Power Point Set #4
Game Theory and Strategy
Key Concept: Preemption of
Strategically Valuable Assets
Access to raw materials
(e.g. Alcoa)
Wal-mart’s rural strategy
Game Theory and Strategy
Creating Customer Switching Costs
Establishing standards for a computer
operating system
Matsushita’s VHS format becoming
dominant over Sony’s Beta
Note: Given that a second mover’s product
development costs can be much lower than
the first mover’s product development costs,
first-mover advantages must be substantial
to justify first moving as a strategy.
Game Theory and Strategy
Technological Leadership
In the 1970s, DuPont built a dominant
position in the titanium dioxide market by
exploiting:
• superior technology
• scale economies
• accumulated experience for low costs
Gillette competes with a differentiation
strategy in disposable razors by exploiting:
• superior technology
• reputation
• broad distribution
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
Row
-1
-1
0
-10
-10
0
-8
-8
Game Theory and Strategy
Prisoners’ Dilemma Game
Row Player:
Column Player:
Dominant Strategy: Fink
Dominant Strategy: Fink
Dominant Strategy (Nash) Equilibrium:
(-8, -8)
Note: It is a dilemma since if they both
cooperated by remaining silent: (-1, -1).
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.
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 a Nash
equilibrium.
Cooperate
Row
Column
Cooperate
Fink
1
5
4
4
-1
9
0
0
Game Theory and Strategy
A cooperative game with conflict
Game with 2 Nash equilibria.
Prize Fight
Man
Woman
Prize Fight
Ballet
-1
1
2
-1
-5
-5
2
1
Game Theory and Strategy
Suppose this game were played
sequentially?
Would it be better to go first or
Woman
second?
Prize Fight
Man
Prize Fight
Ballet
-1
1
2
-1
-5
-5
2
1
Game Theory and Strategy
New game: Joe’s sad undergraduate
days
Prize Fight
Man
Woman
Prize Fight
Ballet
100
20
10
6
90
4
30
8
Game Theory and Strategy
Would you want to move first or
second?
Prize Fight
Man
Woman
Prize Fight
Ballet
100
20
10
6
90
4
30
8
Sources of First Mover Advantages
Economies of Scale
Experience or Learning
Curve Effects
Brand Equity
“Network Externalities”
- How are you going to use these effects to get a
first mover advantage?
- How does this lead to a sustainable advantage?
First Mover Disadvantages May Lead
To Second Mover Advantages
The Costs of Early Adoption The “Bleeding Edge” of Technology
Changing Product and/or Process
Technology
Changing Consumer Tastes
Product Technology
Process Technology
Game Theory and Strategy
Initial Game (played simultaneously)
No Launch
Airbus
Boeing
No Launch
Launch
300
400
200
200
300
400
-100
-200
How Can “Commitment” Affect A Competitor’s Response?
Commitment = An Irreversible Action (Sunk Costs)
Competition In The Commercial Aircraft Industry
No Launch
Airbus
Boeing
No Launch
Launch
300
400
200
200
300
400
-100
-200
Game Theory and Strategy
Joint Venture
Cooperate
Cooperate
L. Race
112
112
123
58
58
123
91
91
How Can “Commitment” Affect A Competitor’s Response?
Commitment = An Irreversible Action
(Sunk Costs)
Cooperate
GM
Toyota
Cooperate
L. Race
112
112
123
58
58
-28
91
-51
How Can “Commitment” Affect A Competitor’s Response?
Mutual sunk cost commitments
Cooperate
GM
Toyota
Cooperate
L. Race
-28
112
112
58
58
-28
-51
-51
Game Theory and Strategy
Lessons
1. Commitment (sunk costs) can be used to achieve
cooperation (e.g., Toyota and GM)
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:
Lessons
2. Commitment (sunk costs)
can be used to achieve
competitive advantage.
• preemption strategy (e.g.,
Airbus vs. Boeing)
Game Theory and Strategy
Some key points on strategic commitment:
Always give attention to how your competitors’ returns vary
under different strategic scenarios;
It is important to communicate the commitment to the other
firms (for both competition and cooperation);
“Sunk cost” investments can be used to pre-commit to
a certain strategy and, thus, influence competitor
response; and
Understand what strategic investments are important
in your business and how “sunk” those investments
are.