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Strategic Thinking

Strategic Thinking. Managerial Economics Jack Wu. Strategic Thinking. 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”,

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Strategic Thinking

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  1. Strategic Thinking Managerial Economics Jack Wu

  2. Strategic Thinking

  3. 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

  4. Competitive Dilemma What should Coke do?

  5. 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

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

  7. 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

  8. Solving for Nash Equilibrium • eliminate dominated strategies, then check remaining cells • “arrow” technique

  9. Nash equilibrium:Competitive dilemma • What should Coke do?

  10. 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.

  11. Radio Formats

  12. 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”.

  13. Nash equilibrium:Radio formats

  14. Nash equilibrium:Prisoners’ dilemma • What should Sam do?

  15. OPEC: Oil Cartel June 1998: Saudi Oil Minister Naimi, “I don’t 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”

  16. Out of Nash Equilibrium What if another player doesn’t play Nash equilibrium strategy? • Nash equilibrium strategy may not be best • still don’t use dominated strategy

  17. WHERE TO ADVERTISE? No Nash equilibrium in pure strategies

  18. 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

  19. Randomized strategies: Retail price competition • Two competing retailers – Jaya and Ming • Three segments • captive (loyal) to Ming • captive (loyal) to Jaya • switchers

  20. Randomized strategies: Retail price competition

  21. Randomized strategies: Retail price competition • Pricing trade-off: • high price to extract buyer surplus of loyal customers • low price to get store switchers • Solution: randomizeddiscounts

  22. Coordination/competition:Evening news

  23. Coordination and Competition • Prime time for news is 8:0pm; second best is 7:30pm; • since audience is limited, get maximum viewership if two channels schedule at different times. • Question: which station gets 8:0pm? Situation has elements of • coordination -- avoiding same time slot • competition -- getting the 8:0pm slot

  24. 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

  25. Coordination/Competition: Instant Messaging Technologies

  26. Coordination/competition:Future DVD standard

  27. Coordination/Competition: Focal Point • Single Nash equilibrium - clear focal point • Multiple Nash equilibria - look for focal point to see which one to play

  28. Sequencing Game in extensive form – sequence of moves: • nodes • branches • outcomes

  29. Extensive Form: Equilibrium backward induction • final nodes  intermediate nodes  initial node

  30. Sequencing:Extensive Form- TV News

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

  32. 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 doesn’t always go to first mover; • In war, better to see opponent’s move, and then take action, eg is enemy moving south or north? • new product category -- let competitor test the market and educate the customers

  33. 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

  34. Conditional Strategic Moves • Threats – if it succeeds, then it needn’t be carried out • Promises – if it succeeds, then it needn’t be carried out • Ideal strategic move doesn’t impose costs

  35. MORGAN STANLEY:“SHAREHOLDER RIGHTS PLAN” If any party acquires 15% or more of company’s shares, other shareholders get right to buy additional shares at 50% discount. • Impact on hostile bidder?

  36. 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.

  37. Poison Pill Hilda loses on initial stake + cost of takeover rises activates rights acquires 100,000 shares Sharon Hilda does not doesn’t bid

  38. 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?

  39. depositor bank remains solvent principal + interest maintains deposit bank insolvent zero depositor bank remains solvent principal withdraws deposit bank insolvent principal Conditional strategic move: Without deposit insurance

  40. depositor bank remains solvent principal + interest maintains deposit bank insolvent principal depositor bank remains solvent principal withdraws deposit bank insolvent principal Conditional strategic move: With deposit insurance

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