Strategic Management/ Business Policy

1. Strategic Management/ Business Policy Game Theory and Strategy

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

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

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

5. -1 0 -1 -10 -10 -8 0 -8 Game Theory and Strategy • Prisoners’ Dilemma Game • Row Player: Dominant Strategy: Fink • 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).

6. 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.

7. 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.

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

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

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

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

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

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

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

15. 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.

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

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

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