Strategic Management/ Business Policy

1. Strategic Management/ Business Policy Game Theory and Strategy Power Point Set 6c

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 Shirk Work Hard 170 140 Work Hard 170 130 Row 130 120 Shirk 140 120 Game Theory and Strategy • Invisible-Hand Game

5. Column Cooperate Defect 170 120 Cooperate 170 100 Row 100 110 Defect 120 110 Game Theory and Strategy • Assurance Game

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

7. -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).

8. 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.

9. 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.

10. 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:

11. 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

12. 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?

13. 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?

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

15. 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

16. Game Theory and Strategy: • Lessons #1 • 1. Commitment (sunk costs) can be used to achieve competitive advantage. • Preemption strategy • Note: It is important to communicate the commitment to competitors.

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

18. 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)

19. 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

20. Game Theory and Strategy • Lessons #2: • 2. 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.