Strategic Management/
Business Policy
Joe Mahoney
Game Theory and Strategy
Key Concept: Preemption of
Strategically Valuable Assets
Access to raw materials (e.g.,
Alcoa; Royal Dutch Shell)
Wal-mart’s rural strategy
Game Theory and Strategy
Creating Customer Switching Costs
Establishing standards for a computer
operating system
Matsushita’s VHS format becoming
dominant over Sony’s Beta
Note: Given that a second mover’s product
development costs can be much lower than the
first mover’s product development costs, firstmover advantages must be substantial to justify
first moving as a strategy.
Game Theory and Strategy
Technological Leadership
In the 1970s, DuPont built a dominant position in
the titanium dioxide market by exploiting:
• superior technology
• scale economies
• accumulated experience for low costs
Gillette competes with a differentiation strategy in
disposable razors by exploiting:
• superior technology
• reputation
• broad distribution
Game Theory and Strategy
“Exit Barriers are Entry Barriers”
Specialized Assets
Strategic Barriers (e.g., spillover
effects)
Government and Social Barriers
Game Theory and Strategy
Exit Barriers
Entry Barriers
Low
Low
Low
Returns
High
High
Returns
High
Worst
Case
High,
Uncertain
Returns
Analyzing Competitive Dynamics Commitment Vs. Flexibility
Commitment
Game Theoretic preemption strategy
Flexibility
Real (Strategic) Options Analysis
Factors Affecting The Likelihood of Competitor Response:
What are the payoffs relative to other
actions the competitor could take?
What prior strategic commitments has the
competitor made?
Does the potential market fit with the
competitor’s existing strategy?
How “reversible” is your action or the
competitor’s potential response?
Game Theory - A Simple Example
Tic Tac Toe
What Happens Here?
Game Theory and Strategy
Prisoners’ Dilemma Game
Column
Silence
Fink
Silence
Row
-1
-1
0
-10
-10
0
-8
-8
Game Theory and Strategy
Prisoners’ Dilemma Game
Row Player:
Column Player:
Dominant Strategy: Fink
Dominant Strategy: Fink
Dominant Strategy (Nash) Equilibrium:
(-8, -8)
Note: It is a dilemma since if they both
cooperated by remaining silent: (-1, -1).
Game Theory and Strategy
The prisoners’ dilemma game can occur in
many contexts:
What is best
a division.
What is best
firm.
What is best
industry.
What is best
a nation.
What is best
world.
for an individual may not be best for
for a division may not be best for a
for a firm many not be best for an
for an industry may not be best for
for a nation may not be best for the
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.
Game Theory and Strategy
Game with no dominant strategy
equilibrium, but a Game with a Nash
equilibrium.
Cooperate
Row
Column
Cooperate
Fink
1
5
4
4
-1
9
0
0
Game Theory and Strategy
A cooperative game with conflict
Game with 2 Nash equilibria.
Prize Fight
Man
Woman
Prize Fight
Ballet
-1
1
2
-1
-5
-5
2
1
Game Theory and Strategy
Suppose this game were played
sequentially?
Would it be better to go first or
Woman
second?
Prize Fight
Man
Prize Fight
Ballet
-1
1
2
-1
-5
-5
2
1
Game Theory and Strategy
New game: Joe’s sad undergraduate
days
Prize Fight
Man
Woman
Prize Fight
Ballet
100
20
10
6
90
4
30
8
Game Theory and Strategy
Would you want to move first or
second?
Prize Fight
Man
Woman
Prize Fight
Ballet
100
20
10
6
90
4
30
8
Game Theory and Strategy
Initial Game (played simultaneously)
No Launch
Airbus
Boeing
No Launch
Launch
300
400
200
200
300
400
-100
-200
How Can “Commitment” Affect A Competitor’s Response?
No Launch
Airbus
Commitment = An Irreversible Action (Sunk
Costs)
Competition In The Commercial Aircraft
Boeing
Industry
No Launch
Launch
300
400
400
200
200
300
-100
-200
Game Theory and Strategy
Joint Venture
Cooperate
GM
Toyota
Cooperate
L. Race
112
112
123
58
58
123
91
91
How Can “Commitment” Affect A Competitor’s Response?
Commitment = An Irreversible Action
(Sunk Costs)
Cooperate
GM
Toyota
Cooperate
L. Race
112
112
123
58
58
-28
91
-51
How Can “Commitment” Affect A Competitor’s Response?
Mutual sunk cost commitments
Cooperate
GM
Toyota
Cooperate
L. Race
-28
112
112
58
58
-28
-51
-51
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.
Game Theory and Strategy:
Lessons
2. Commitment (sunk costs) can be
used to achieve competitive
advantage.
• preemption strategy
Game Theory and Strategy
Some key points on strategic commitment:
Always give attention to how your competitors’
returns vary under different strategic scenarios;
It is important to communicate the commitment
to the other firms (for both competition and
cooperation);
“Sunk cost” investments can be used to precommit to a certain strategy and, thus, influence
competitor response; and
Understand what strategic investments are
important in your business and how “sunk” those
investments are.
Sources of First Mover Advantages
Economies of Scale
Experience or Learning Curve
Effects
Brand Equity
“Network Externalities”
- How are you going to use these effects to get a
first mover advantage?
- How does this lead to a sustainable advantage?
First Mover Disadvantages May
Lead To Second Mover Advantages
The Costs of Early Adoption The “Bleeding Edge” of Technology
Changing Technology
Product Technology
Process Technology
Changing Consumer Tastes Saturn & Chrysler