G.  Game Theory and Competitive Strategy

1.  Concepts

a.  Game - players make strategic decisions that take into account each other's actions and responses

b.  Payoff - value associated with a possible outcome

c.  Strategy - rule or plan of action for playing a game

d.  Payoff matrix - table showing payoffs to each player for each combination of decisions made

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e.  Cooperative game - participants can negotiate binding contracts that allow them to plan joint strategies

f.  Noncooperative game  - negotiation and enforcement of binding contracts is not possible

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2.  Dominant strategy

• Strategy that is optimal no matter what an opponent does

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• Prisoners' Dilemma - players acting in their own self interest are worse off than if they had cooperated

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3.  Nash equilibrium

• Each firm does the best it can given its competitors' actions

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a.  Maximin strategy

• Maximize the minimum gain that can be earned

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b.  Maximize expected payoff

• Assign probabilities to actions by competitors

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c.  "Battle of the sexes"

• Competitors do the same thing

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4.  Repeated games

• Actions taken and payoffs made over and over again

• Tit-for-tat strategy - player matches opponents last decision

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a.  Infinitely repeated game

• Cooperative behavior is the rational response to tit-for-tat strategy

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b.  Finite number of repetitions

• Game unravels as each competitor looks at last month

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• Competition can break down due to:

- Too many firms - difficult to coordinate

- Rapidly shifting demand or cost conditions - difficult to agree on right course of action

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5.  Sequential games

• One player can move first

• First mover may have an advantage

• Extensive form of a game - use a decision tree

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6.  Competitive strategy

a.  Threats

• Threat must be credible to have impact

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b.  Commitment and credibility

• Commitment can be used to increase credibility

• Reputation important in establishing credibility

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c.  Bargaining strategy

• Might be able to link two or more bargaining problems

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d.  Entry deterrence

• Incumbent firm must convince potential entrants that entry will be unprofitable

• Commitment is again important

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