Strategic Thinking

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Strategic Thinking

• IMBA Managerial Economics
• Jack Wu

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Strategic Thinking
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Coke vs. Pepsi, 1999
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
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Competitive Dilemma
What should Coke do?
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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

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Dominated Strategy

• generates worse consequences than another
  strategy, regardless of the choices of the other
  parties
• never use dominated strategy

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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

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Solving for Nash Equilibrium

• eliminate dominated strategies, then check
  remaining cells
• arrow technique

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Nash equilibrium
Competitive dilemma
Pepsi Pepsi
Raise price Discount
Coke Raise price C 3, P 3 C 0, P 5
Coke Discount C 5, P 0 C 1, P 1

• What should Coke do?

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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.

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Radio Formats
Merkur Merkur
Lite AC no change
Jupiter Hot AC J 60, M 40 J 60, M 40
Jupiter no change J 70, M 30 J 50, M 50
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Radio Formats

• For Merkur, Lite AC is dominated by no
  change so consider only no change,
• assuming Merkur chooses no change, Jupiter
  should choose Hot AC.
• Repeat using arrow technique.

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Nash equilibrium
Radio formats
Merkur Merkur
Lite AC no change
Jupiter Hot AC J 60, M 40 J 60, M 40
Jupiter no change J 70, M 30 J 50, M 50
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Nash equilibrium
Prisoners dilemma
Sam Sam
Do not confess Confess
Ian Do not confess I 0, S 0 I -10, S 0
Ian Confess I 0, S -10 I -5, S -5

• What should Sam do?

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OPEC Oil Cartel
June 1998 Saudi Oil Minister Naimi, I dont
think anybody expects 100 compliance Once the
price goes up, there will be cheating March
1999 Algerian Oil Minister Youcef Yousfi, OPEC
is still able to act collectively and restore
market stability
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Out of Nash Equilibrium

• What if another player doesnt play Nash
  equilibrium strategy?
• Nash equilibrium strategy may not be best
• still dont use dominated strategy

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WHERE TO ADVERTISE?
No Nash equilibrium in pure strategies
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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

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Randomized strategies
Retail price competition

• Two competing retailers Jaya and Ming
• Three segments
• captive (loyal) to Ming
• captive (loyal) to Jaya
• switchers

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Randomized strategies
Retail price competition
Ming Ming
High price Low price
Jaya High price J 60, M 40 J 40, M 50
Jaya Low price J 50, M 40 J 50, M 30
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Randomized strategies
Retail price competition

• Pricing trade-off
• high price to extract buyer surplus of loyal
  customers
• low price to get store switchers
• Solution randomized discounts

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Coordination/competition
Evening news
Delta Delta
7.30pm 8.00pm
Zeta 7.30pm A 1, B 1 A 3, B 4
Zeta 8.00pm A 4, B 3 A 2.5, B 2.5
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Coordination and Competition

• Prime time for news is 80pm second best is
  730pm
• since audience is limited, get maximum
  viewership if two channels schedule at different
  times.
• Question which station gets 80pm? Situation
  has elements of
• coordination -- avoiding same time slot
• competition -- getting the 80pm slot

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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

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Coordination/Competition
Instant Messaging Technologies
Venus Inc. Venus Inc.
Orange Green
Sol Corp. Orange S 1.5 V 1.5 S 1 V 1
Sol Corp. Green S 1 V 1 S 1.5 V 1.5
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Coordination/competitionFuture DVD standard
Consumers Consumers
Blu-ray HD-DVD
DVD player manuf-acturers Blu-ray M 1, C 1 M -1, C -1
DVD player manuf-acturers HD-DVD M -1, C -1 M 1, C 1
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Coordination/Competition
Focal Point

• Single Nash equilibrium - clear focal point
• Multiple Nash equilibria - look for focal point
  to see which one to play

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Sequencing

• Game in extensive form sequence of moves
• nodes
• branches
• outcomes

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Extensive Form Equilibrium

• backward induction
• final nodes ? intermediate nodes ? initial node

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Sequencing Extensive Form - TV
News

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Strategic Move

• Action to influence beliefs or actions of other
  parties in a favorable way
• credibility
• first mover advantage
• second mover advantage

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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 doesnt always go to first mover
• In war, better to see opponents move, and then
  take action, eg is enemy moving south or north?
• new product category -- let competitor test the
  market and educate the customers

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Lithographer

Make more prints
Buy
Litho
Make prints
consumer
Do not
Do not
Litho
(1) serial number (2) destroying the plate (3)
other solution?
Do not
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Conditional Strategic Moves

• Threats if it succeeds, then it neednt be
  carried out
• Promises if it succeeds, then it neednt be
  carried out
• Ideal strategic move doesnt impose costs

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MORGAN STANLEYSHAREHOLDER RIGHTS PLAN

• If any party acquires 15 or more of companys
  shares, other shareholders get right to buy
  additional shares at 50 discount.
• Impact on hostile bidder?

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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 15, then rights triggered, and bidder
  will be diluted.
• Nickname poison pill.
• Actually works against shareholder rights -- by
  entrenching existing management.

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Poison Pill
Hilda loses on initial stake cost of takeover
rises

activates rights
acquires 100,000 shares
Sharon
Hilda

does not
doesnt bid
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Strike

Lose current wage and possibly gain in future wage
strike
reject union demand
Union
do not
Maintain current wage
Employer

accept
Why are strikes rare in American professional
football?
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Conditional strategic move Without deposit
insurance
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Conditional strategic move With deposit
insurance