Game Theory: Entry Games
MANEC 387
Economics of Strategy
David J. Bryce
David J. Bryce © 2002
Michael R. Baye © 2002
The Structure of Industries
Threat of new
Entrants
Bargaining
Power of
Suppliers
Competitive
Rivalry
Threat of
Substitutes
From M. Porter, 1979, “How Competitive Forces Shape Strategy”
David J. Bryce © 2002
Michael R. Baye © 2002
Bargaining
Power of
Customers
Entry as a Game
• Earlier in the course we discussed barriers to
entry, how barriers are created, and how
they’re overcome.
• Now that we have (some of) the tools of
game theory, we will revisit entry as a game
• We will examine entrant and incumbent
actions and discuss entry deterrence
• We will look particularly at credible
deterrence by the incumbent under the
heading “strategic commitment.”
David J. Bryce © 2002
Michael R. Baye © 2002
Competitive Response in an
Entry Game
Monopoly
Accommodate
David J. Bryce © 2002
Michael R. Baye © 2002
Enter
Not Enter
Potential Entrant
Fight
-5
-10
0
5
*
12
*
5
12
0
Commitment Influences Competitive
Response in an Entry Game
Monopoly
Accommodate
David J. Bryce © 2002
Michael R. Baye © 2002
Enter
Not Enter
Potential Entrant
Fight
-5
-10
0
-7
5
*
12
12
0
Simultaneous Moves in the Game Tree
Consider the last game in extensive form:
Payoffs
-10
-5
5
5
*
0
12
*
M
E
M
David J. Bryce © 2002
Michael R. Baye © 2002
Monopoly
Fight/Cooperate
Sequential Strategies in the
Game Tree: Review
• Final player chooses the option that maximizes
her payoff
• The previous player chooses the option that
maximizes his payoff conditional on the
expected choice of the final player, and so on
• This is backward induction – work backward
from the end “sub-game,” each player makes
optimal choices assuming that each subsequent
rival chooses rationally
• The equilibrium is called sub-game perfection
David J. Bryce © 2002
Michael R. Baye © 2002
Sequential Moves in the Game Tree
Payoffs
-10
-5
5
5
*
0
12
*
M
E
M
David J. Bryce © 2002
Michael R. Baye © 2002
Monopoly
Fight/Cooperate
Preemptive Strategic Commitment
Let the Monopolist Move First
Payoffs
-10 -5
M
5 -7
E
M
Monopoly
M
0 12
-10 -5
M
5
E
M
David J. Bryce © 2002
Michael R. Baye © 2002
Monopoly
5
0 12
*
Kinds of Strategic Commitments that
may deter entry
• Expanding plant capacity (in an environment
of economies of scale)
• Expanding output (or building a new plant)
• Offering “permanent” price reductions
• Review: Other strategies
– Aggressively spend to move down learning curve
– Build “network” to create externalities
– Build brand through aggressive advertising
David J. Bryce © 2002
Michael R. Baye © 2002
Summary and Takeaways
• Entry threats can be modeled as a
(sequential) game.
• Threats of retaliation by incumbent for entry
must be credible
• Incumbents may deter entrants by making
major strategic commitments (credible
threats)
• .. But these commitments may be so costly
that they limit pricing flexibility … allowing
entry anyway (and even “ruining” incumbent)
David J. Bryce © 2002
Michael R. Baye © 2002