Universitas Indonesia

Fakultas Ilmu Sosial dan Politik

Program Pasca Sarjana MM Komunikasi

EKONOMI MANAJERIAL INDUSTRI KOMUNIKASI

Topik :Game Theory and Competitive Strategy

Instruktur: Henry Faizal Noor

Email : [email protected]
12/07/2021 Henry F Noor.docApril 2010 1
 Gaming and Strategic Decisions
“If I believe that my competitors are rational and act to maximize their own profits, how should I take their behavior

into account when making my own profit-maximizing decisions?”

Gaming
Cooperative Game Non Cooperative Game
Players negotiate binding contracts that Negotiation and enforcement of a binding
allow them to plan joint strategies contract are not possible
a. Buyer and seller negotiating the price of a Two competing firms assuming the others
good or service or a joint venture by two behavior determine, independently, pricing
firms (i.e. Microsoft and Apple). and advertising strategy to gain market share
b. Binding contracts are not possible
b. Binding contracts are possible

Noncooperative versus Cooperative Games

“The strategy design is based on understanding your opponent’s point of view, and (assuming you

opponent is rational) deducing how he or she is likely to respond to your actions”

 Gaming and Strategic Decisions
Example 1.: How to buy a dollar bill
1)Auction a dollar bill
2)Highest bidder receives the dollar in return for the amount bid
3)Second highest bidder must pay the amount he or she bid
4)How much would you bid for a dollar?

Acquiring a Company
Scenario : Company A: The Acquirer, and Company T: The Target
A will offer cash for all of T’s shares, and What price to offer?
1 st Scenario : The value of T depends on the outcome of a current oil exploration project.
Failure: T’s value = $0, Success: T’s value = $100/share, All outcomes are equally likely

2 nd Scenario : T’s value will be 50% greater with A’s management.

A, must submit the proposal before the exploration outcome is known.
T will not choose to accept or reject until after the outcome is known only to T.

How much should A offer?

 Acquiring a Company

3 rdScenario T’s value will be 50% greater with A’s management.

A, must submit the proposal before the exploration outcome is known.
T will not choose to accept or reject until after the outcome is known only to T.
How much should A offer?
Dominant Strategies
Dominant Strategy : One that is optimal no matter what an opponent does. An Example : A & B sell
competing products: They are deciding whether to undertake advertising campaigns

Payoff Matrix for Advertising Game

Don’t
Advertise Firm B Advertise

Advertise 10, 5 15, 0

Firm A
Don’t 6, 8 10, 2
Advertise
 Payoff Matrix for Advertising Game Firm B Don’t
• Observations 1. Advertise
Advertise
– A: regardless of B,
advertising is the best
– B: regardless of A, Advertise 10, 5 15, 0
advertising is best
Firm A
Don’t
Advertise 6, 8 10, 2

Firm B Don’t
Advertise Advertise
• Observations 2.
– Dominant strategy for A &
Advertise 10, 5 15, 0
B is to advertise
– Do not worry about the
Firm A
other player
– Equilibrium in dominant Don’t
Advertise 6, 8 10, 2
strategy
 Dominant Strategies
Game Without Dominant Strategy : The optimal decision of a player without a dominant strategy
will depend on what the other player does.
Don’t
Modified Advertising Game Advertise Firm B Advertise

Advertise
10, 5 15, 0
Firm A

Don’t Advertise 6, 8 20, 2

Firm B Don’t
Advertise Advertise
• Observations 3
– A: No dominant strategy; depends
on B’s actions Advertise
– B: Advertise
10, 5 15, 0
• Discussion : What should A do? (Hint:
consider B’s decision Firm A
Don’t
Advertise 6, 8 20, 2
 The Nash Equilibrium Revisited
• Dominant Strategies
– “I’m doing the best I can no matter what you do.”
– “You’re doing the best you can no matter what I do.”

• Nash Equilibrium
– “I’m doing the best I can given what you are doing”
– “You’re doing the best you can given what I am doing.”

Product Choice Problem

Examples With A Nash Equilibrium

– Two cereal companies
– Market for one producer of crispy cereal
– Market for one producer of sweet cereal
– Each firm only has the resources to introduce one cereal
– Noncooperative
 Product Choice Problem
Crispy Firm 2 Sweet
Crispy
-5, -5 10, 10
Firm 1

Sweet 10, 10 -5, -5

Firm 2
Crispy Sweet

• Discussion
– Is there a Nash Crispy -5, -5 10, 10
equilibrium?
– If not, why? Firm 1
– If so, how can it be
reached
Sweet 10, 10 -5, -5
 Beach Location Game
• Scenario
– Two competitors, Y and C, selling soft drinks
– Beach 200 yards long
– Sunbathers are spread evenly along the beach
– Price Y = Price C
– Customer will buy from the closest vendor

Ocean
C

0 B Beach A 200 yards

Where will the competitors locate i.e. where is the Nash equilibrium)?

2) Examples of this decision problem include:

– Locating a gas station , - Presidential elections
 The Nash Equilibrium Revisited
• Maximin Strategies
• Scenario : Two firms compete selling file-encryption software
They both use the same encryption standard (files encrypted by one software can
be read by the other - advantage to consumers)
• Maximin Strategies
Scenario : Firm 1 has a much larger market share than Firm 2
Both are considering investing in a new encryption standard

Maximin Strategy
Firm 2
Don’t invest Invest

Don’t invest
0, 0 -10, 10
Firm 1

Invest -100, 0 20, 10

 Maximin Strategy Firm 2
Don’t invest Invest
• Observations 4:
– Dominant strategy Firm
2: Invest Don’t invest
– Nash equilibrium
0, 0 -10, 10
• Firm 1: invest Firm 1
• Firm 2: Invest
Invest -100, 0 20, 10

• Observations
Firm 2
– If Firm 2 does not invest, Don’t invest Invest
Firm 1 incurs significant
losses
– Firm 1 might play don’t Don’t invest
invest
0, 0 -10, 10
• Minimize losses to 10
Firm 1
--maximin strategy
Invest -100, 0 20, 10
 The Nash Equilibrium Revisited

Maximin Strategy • If both are rational and informed

– Both firms invest
– Nash equilibrium
Consider : If Player 2 is not rational or completely informed
• Firm 1’s maximin strategy is to not invest
• Firm 2’s maximin strategy is to invest.
• If 1 knows 2 is using a maximin strategy, 1 would invest
 Prisoners’ Dilemma
Prisoner B

Confess Don’t Confess

Confess -5, -5 -1, -10

Prisoner A

Don’t
Confess -10, -1 -2, -2

Chapter 13 Slide 13
 Prisoners’ Dilemma
• What is the:
– Dominant Prisoner B
strategy Confess Don’t Confess
– Nash equilibrium
– Maximin solution Confess -5, -5 -1, -10

Prisoner A
Don’t
Confess
-10, -1 -2, -2

Chapter 13 Slide 14
 The Nash Equilibrium Revisited
Mixed
MixedStrategy
Strategy

• Pure Strategy
– Player makes a specific choice

• Mixed Strategy
– Player makes a random choice among two or
more possible actions based on a set of chosen
probabilities

Chapter 13 Slide 15
 Matching Pennies
Player B
Heads Tails

Heads 1, -1 -1, 1
Player A

Tails -1, 1 1, -1

Chapter 13 Slide 16
 Matching Pennies
• Observations
– Pure strategy: No
Nash equilibrium Player B
– Mixed strategy: Heads Tails
Random choice is
a Nash Heads 1, -1 -1, 1
equilibrium
– Would a firm set Player A
price based on
random choice Tails -1, 1 1, -1
assumption?

Chapter 13 Slide 17
 The Battle of the Sexes
Joan

Wrestling Opera

Wrestling 2,1 0,0

Jim

Opera 0,0 1,2

Chapter 13 Slide 18
 The Battle of the Sexes
• Pure Strategy
– Both watch Joan
wrestling Wrestling Opera
– Both watch opera
• Mixed Strategy Wrestling 2,1 0,0

– Jim chooses Jim

wrestling
Opera 0,0 1,2
– Joan chooses
wrestling

Chapter 13 Slide 19
 Repeated Games
• Oligopolistic firms play a repeated game.
• With each repetition of the Prisoners’
Dilemma, firms can develop reputations about
their behavior and study the behavior of their
competitors.

Chapter 13 Slide 20
 Pricing Problem
Firm 2

Low Price High Price

Low Price 10, 10 100, -50

Firm 1

High Price -50, 100 50, 50

Chapter 13 Slide 21
 Pricing Problem
• Non-repeated
game
Firm 2
– Strategy is Low1, Low Price High Price

Low2
Low Price 10, 10 100, -50
• Repeated game
Firm 1
– Tit-for-tat strategy
High Price -50, 100 50, 50
is the most
profitable

Chapter 13 Slide 22
 Repeated Games
• Conclusion:
– With repeated game
• The Prisoners’ Dilemma can have a cooperative
outcome with tit-for-tat strategy

Chapter 13 Slide 23
 Repeated Games
• Conclusion:
– This is most likely to occur in a market with:
• Few firms
• Stable demand
• Stable cost

Chapter 13 Slide 24
 Repeated Games
• Conclusion
– Cooperation is difficult at best since these factors
may change in the long-run.

Chapter 13 Slide 25
 Oligopolistic Cooperation
in the Water Meter Industry

• Characteristics of the Market

– Four Producers
• Rockwell International (35%), Badger Meter, Neptune
Water Meter Company, and Hersey Products (Badger,
Neptune, and Hersey combined have about a 50 to 55%
share)

Chapter 13 Slide 26
 Oligopolistic Cooperation
in the Water Meter Industry

• Characteristics of the Market

– Very inelastic demand
• Not a significant part of the budget

Chapter 13 Slide 27
 Oligopolistic Cooperation
in the Water Meter Industry

• Characteristics of the Market

– Stable demand
– Long standing relationship between consumer and
producer
• Barrier
– Economies of scale
• Barrier

Chapter 13 Slide 28
 Oligopolistic Cooperation
in the Water Meter Industry

• Characteristics of the Market

– This is a Prisoners’ Dilemma
• Lower price to a competitive level
• Cooperate
– Repeated Game

• Question
– Why has cooperation prevailed?

Chapter 13 Slide 29
 Competition and Collusion
in the Airline Industry

• What Do You Think?

– Is there cooperation & collusion in the airline
industry?

Chapter 13 Slide 30
 Sequential Games
• Players move in turn
• Players must think through the possible
actions and rational reactions of each player

Chapter 13 Slide 31
 Sequential Games
• Examples
– Responding to a competitor’s ad campaign
– Entry decisions
– Responding to regulatory policy

Chapter 13 Slide 32
 Sequential Games
The
TheExtensive
ExtensiveForm
Formof
ofaaGame
Game

• Scenario
– Two new (sweet, crispy) cereals
– Successful only if each firm produces one
cereal
– Sweet will sell better
– Both still profitable with only one producer

Chapter 13 Slide 33
Modified Product Choice Problem
Firm 2

Crispy Sweet

Crispy
-5, -5 10, 20
Firm 1

Sweet
20, 10 -5, -5

Chapter 13 Slide 34
 Modified Product Choice Problem

• Question Firm 2
– What is the likely Crispy Sweet
outcome if both
make their Crispy -5, -5 10, 20
decisions
independently, Firm 1
simultaneously,
Sweet 20, 10 -5, -5
and without
knowledge of the
other’s
intentions?

Chapter 13 Slide 35
 Modified Product Choice Problem
The
TheExtensive
ExtensiveForm
Formof
ofaaGame
Game

• Assume that Firm 1 will introduce its new

cereal first (a sequential game).
• Question
– What will be the outcome of this game?

Chapter 13 Slide 36
 Sequential Games
The
TheExtensive
ExtensiveForm
Formof
ofaaGame
Game

• The Extensive Form of a Game

– Using a decision tree
• Work backward from the best outcome for Firm 1

Chapter 13 Slide 37
 Product Choice Game in Extensive Form

Crispy -5, -5

Crispy Firm 2
Sweet 10, 20
Firm 1
Crispy 20, 10

Sweet Firm 2
Sweet -5, -5

Chapter 13 Slide 38
 Sequential Games
• The Advantage of Moving First
– In this product-choice game, there is a clear
advantage to moving first.

Chapter 13 Slide 39
 Sequential Games
The
TheAdvantage
Advantageof
ofMoving
MovingFirst
First

• Assume: Duopoly
P  30  Q
Q  Total Production  Q1  Q2
MC  0
Q1  Q2  10 and P  10   100 / Firm

Chapter 13 Slide 40
 Sequential Games
The
TheAdvantage
Advantageof
ofMoving
MovingFirst
First

• Duopoly
With Collusion
Q1  Q2  7.5 and P  15   112.50 / Firm
Firm Moves First (Stackelberg)
Q1  15 Q2  7.5 and P  7.50
 1  112.50  2  56.25

Chapter 13 Slide 41
 Choosing Output
Firm 2

7.5 10 15

7.5 112.50, 112.50 93.75, 125 56.25, 112.50

Firm 1 10 125, 93.75 100, 100 50, 75

15 112.50, 56.25 75, 50 0, 0

Chapter 13 Slide 42
 Choosing Output
• This payoff matrix
illustrates various Firm 2
7.5 10 15
outcomes
– Move together, 7.5 112.50, 112.50 93.75, 125 56.25, 112.50

both produce 10
Firm 1 10 125, 93.75 100, 100 50, 75
– Question
• What if Firm 1
15 112.50, 56.25 75, 50 0, 0
moves first?

Chapter 13 Slide 43
 Threats, Commitments, and Credibility

• Strategic Moves
– What actions can a firm take to gain advantage in
the marketplace?
• Deter entry
• Induce competitors to reduce output, leave, raise price
• Implicit agreements that benefit one firm

Chapter 13 Slide 44
 Threats, Commitments, and Credibility

• How To Make the First Move

– Demonstrate Commitment
– Firm 1 must constrain his behavior to the extent
Firm 2 is convinced that he is committed

Chapter 13 Slide 45
 Threats, Commitments, and Credibility

• Empty Threats
– If a firm will be worse off if it charges a low price,
the threat of a low price is not credible in the eyes
of the competitors.

Chapter 13 Slide 46
 Pricing of Computers
and Word Processors
Firm 2

High Price Low Price

High Price 100, 80 80, 100

Firm 1

Low Price 20, 0 10, 20

Chapter 13 Slide 47
 Pricing of Computers
and Word Processors

• Question
– Can Firm 1 force Firm 2
Firm 2 to charge a High Price Low Price
high price by
threatening to High Price 100, 80 80, 100
lower its price?
Firm 1
Low Price 20, 0 10, 20

Chapter 13 Slide 48
 Threats, Commitments, and Credibility

• Scenario
– Race Car Motors, Inc. (RCM) produces cars
– Far Out Engines (FOE) produces specialty car
engines and sells most of them to RCM
– Sequential game with RCM as the leader
– FOE has no power to threaten to build big since
RCM controls output.

Chapter 13 Slide 49
 Production Choice Problem
Race Car Motors

Small cars Big cars

Small engines 3, 6 3, 0
Far Out Engines

Big engines
1, 1 8, 3

Chapter 13 Slide 50
 Threats, Commitments, and Credibility

• Question
– How could FOE force RCM to shift to big cars?

Chapter 13 Slide 51
 Modified Production Choice Problem
Race Car Motors

Small cars Big cars

Small engines 0, 6 0, 0
Far Out Engines

Big engines
1, 1 8, 3

Chapter 13 Slide 52
 Modified Production Choice Problem

• Questions
1) What is the risk of this strategy?
2) How could irrational behavior give FOE
some power to control output?

Chapter 13 Slide 53
 Wal-Mart Stores’
Preemptive Investment Strategy

• Question
– How did Wal-Mart become the largest retailer in
the U.S. when many established retail chains were
closing their doors?
• Hint
– How did Wal-Mart gain monopoly power?
– Preemptive game with Nash equilibrium

Chapter 13 Slide 54
 The Discount Store Preemption Game
Company X

Enter Don’t enter

Enter
-10, -10 20, 0
Wal-Mart

Don’t enter
0, 20 0, 0

Chapter 13 Slide 55
 The Discount Store Preemption Game

• Two Nash
equilibrium
Company X
– Low left Enter Don’t enter

– Upper right Enter -10, -10 20, 0

• Must be Wal-Mart

preemptive to win Don’t enter 0, 20 0, 0

Chapter 13 Slide 56
 Entry Deterrence
• To deter entry, the incumbent firm must
convince any potential competitor that entry
will be unprofitable.

Chapter 13 Slide 57
 Entry Possibilities
Potential Entrant

Enter Stay out

High price
(accommodation) 100, 20 200, 0
Incumbent

Low Price
(warfare) 70, -10 130, 0

Chapter 13 Slide 58
 Entry Deterrence
• Scenario
– Incumbent monopolist (I) and prospective entrant
(X)
– X single cost = $80 million to build plant

Chapter 13 Slide 59
 Entry Deterrence
• Scenario
– If X does not enter I makes a profit of $200 million.
– If X enters and charges a high price I earns a profit
of $100 million and X earns $20 million.
– If X enters and charges a low price I earns a profit
of $70 million and X earns $-10 million.

Chapter 13 Slide 60
 Entry Deterrence
• Question
– How could I keep X out?
• Is the threat credible?

Chapter 13 Slide 61
 Entry Deterrence
• How could I keep X out?
1) Make an investment before entry
(irrevocable commitment)
2) Irrational behavior

Chapter 13 Slide 62
 Entry Deterrence
After
After$50
$50million
millionEarly
EarlyInvestment
Investment
Potential Entrant

Enter Stay out

High price
(accommodation) 50, 20 150, 0
Incumbent

Low Price
(warfare) 70, -10 130, 0

Chapter 13 Slide 63
 Entry Deterrence
After
After$50
$50million
millionEarly
EarlyInvestment
Investment

• Warfare likely
Potential Entrant
• X will stay out Enter Stay out

High price
(accommodation)
50, 20 150, 0

Incumbent

Low Price
(warfare)
70, -10 130, 0

Chapter 13 Slide 64
 Entry Deterrence
• Airbus vs. Boeing
– Without Airbus being subsidized, the payoff matrix
for the two firms would differ significantly from
one showing subsidization.

Chapter 13 Slide 65
 Development of a New Aircraft
Airbus

Produce Don’t produce

Produce -10, -10 100, 0

Boeing

Don’t produce 0, 120 0, 0

Chapter 13 Slide 66
 Development of a New Aircraft
• Boeing will
produce Airbus
Produce Don’t produce
• Airbus will not
produce Produce -10, -10 100, 0

Boeing

Don’t produce 0, 120 0, 0

Chapter 13 Slide 67
 Development of a Aircraft
After European Subsidy

Airbus

Produce Don’t produce

Produce -10, 10 100, 0

Boeing

Don’t produce 0, 120 0, 0

Chapter 13 Slide 68
 Development of a Aircraft
After European Subsidy

• Airbus will
produce Airbus
Produce Don’t produce
• Boeing will not
produce Produce -10, 10 100, 0

Boeing

Don’t produce 0, 120 0, 0

Chapter 13 Slide 69
 Diaper Wars
• Even though there are only two major firms,
competition is intense.
• The competition occurs mostly in the form of
cost-reducing innovation.

Chapter 13 Slide 70
 Competing Through R & D
Kimberly-Clark

R&D No R&D

R&D 40, 20 80, -20

P&G

No R&D -20, 60 60, 40

Chapter 13 Slide 71
 Competing Through R & D
• Both spend on
R&D
Kimberly-Clark
• Question R&D No R&D

– Why not
R&D 40, 20 80, -20
cooperate
P&G

No R&D -20, 60 60, 40

Chapter 13 Slide 72
 Bargaining Strategy
• Alternative outcomes are possible if firms or
individuals can make promises that can be
enforced.

Chapter 13 Slide 73
 Bargaining Strategy
• Consider:
– Two firms introducing one of two complementary
goods.

Chapter 13 Slide 74
 Bargaining Strategy
Firm 2

Produce A Produce B

Produce A 40, 5 50, 50

Firm 1

Produce B 60, 40 5, 45

Chapter 13 Slide 75
 Bargaining Strategy
• With collusion:
– Produce A1B2
Firm 2
Produce A Produce B
• Without collusion:
Produce A 40, 5 50, 50
– Produce A1B2
Firm 1
– Nash equilibrium
Produce B 60, 40 5, 45

Chapter 13 Slide 76
 Bargaining Strategy
• Suppose
– Each firm is also bargaining on the decision to join
in a research consortium with a third firm.

Chapter 13 Slide 77
 Bargaining Strategy
Firm 2

Work alone Enter consortium

Work alone 10, 10 10, 20

Firm 1

Enter
consortium 20, 10 40, 40

Chapter 13 Slide 78
 Bargaining Strategy
• Dominant strategy
– Both enter
Firm 2
Work alone Enter consortium

Work alone 10, 10 10, 20

Firm 1
Enter
consortium 20, 10 40, 40

Chapter 13 Slide 79
 Bargaining Strategy
• Linking the Bargain Problem
– Firm 1 announces it will join the consortium only if
Firm 2 agrees to produce A and Firm 1 will
produce B.
• Firm 1’s profit increases from 50 to 60

Chapter 13 Slide 80
 Bargaining Strategy
• Strengthening Bargaining Power
– Credibility
– Reducing flexibility

Chapter 13 Slide 81
 Auctions
• Auction Formats
– Traditional English (oral)
– Dutch auction
– Sealed-bid
• First price
• Second price

Chapter 13 Slide 82
 Auctions
Valuation
Valuationand
andInformation
Information

• How to choose an auction format

– Private-value auction: bidders uncertain about
the other bidders reservation price
– Common-value auction: bidders uncertain
what the value is

Chapter 13 Slide 83
 Auctions
Private
PrivateValue
ValueAuction
Auction

• Second-price sealed auction: bid your

reservation price
• English auction: Bid in small increments
until you reach your reservation price

Chapter 13 Slide 84
 Auctions
Private
PrivateValue
ValueAuction
Auction

• The winning bids in both auctions is the

reservation price of the second highest
bidder

Chapter 13 Slide 85
 Auctions
Private
PrivateValue
ValueAuction
Auction

• Sealed-bid auction
– First-price auction: lowers the bid
– Second-price auction: bid just above the
second highest reservation price

• Both yield the same revenue

Chapter 13 Slide 86
 Auctions
Common
CommonValue
ValueAuction
Auction

• Winner’s Curse
– The winner is worse off than those who did not
win

Chapter 13 Slide 87
 Auctions
Common
CommonValue
ValueAuction
Auction

• Examples
– Bidding on a construction job
– Bidding on offshore oil reserves

Chapter 13 Slide 88
 Auctions
Common
CommonValue
ValueAuction
Auction

• Question
– How can you avoid the winner’s curse?

Chapter 13 Slide 89
 Auctions
Maximizing
MaximizingAuction
AuctionRevenue
Revenue

• Private-value Auction
– Have as many bidders as possible

• Common-value Auction
– Use open-bid format
– Release information about value

Chapter 13 Slide 90
 Internet Auctions

• A Few Caveats
– Now quality control function
– Poor seller feedback
– Bid manipulation may occur

Chapter 13 Slide 91
 Summary
• A game is cooperative if the players can
communicate and arrange binding contracts;
otherwise it is noncooperative.
• A Nash equilibrium is a set of strategies such
that all players are doing their best, given the
strategies of the other players.

Chapter 13 Slide 92
 Summary
• Some games have no Nash equilibrium in pure
strategies, but have one or more equilibria in
mixed strategies.
• Strategies that are not optimal for a one-shot
game may be optimal for a repeated game.
• In a sequential game, the players move in
turn.

Chapter 13 Slide 93
 Summary
• An empty threat is a threat that one would
have no incentive to carry out.
• To deter entry, an incumbent firm must
convince any potential competitor that entry
will be unprofitable.
• Bargaining situations are examples of
cooperative games.

Chapter 13 Slide 94
 Summary
• Auctions can be conducted in a number of
formats which influence the revenue raised
and the price paid by the buyer.

Chapter 13 Slide 95