Week 4 The Strategic Value of Information This lecture analyze the value of information in strategic contexts. The intuition from decision theory, that more information cannot hurt, does not easily extend to strategic situations, because the anticipation and reactions of the other players must be accounted for.

The strategic value of information In decision theory, new information is never harmful and has positive value if it leads you to change your behavior. The rules we have developed for solving games can be used to value information in strategic contexts. We ask: 1.Is there value form withholding information for the competition, or should we release it? 2.Does providing (the same) new information to everyone increase value? 3.What can we learn from the choices of others when they are more informed than us?

A follower’s advantage Through orders bookings and sales, first entrants typically learn about potential demand earlier than later entrants. If these data cannot be kept confidential, then followers can use the data. Over on the right we see that Eagle decides whether to enter or not, only after seeing what Cheetah has done and the effects on demand.

Folding back and simplifying the game tree If Cheetah begins an air service then Eagle will enter only if demand is high. If Cheetah does not create the service, then Eagle will not get the information on demand. In that case we can exchange the order of the moves of Eagle and nature.

A further reduction Taking expected values we are left with a very simple game tree. Cheetah should stay out, and Eagle should enter.

The value of withholding data on demand Now suppose Cheetah can prevent Eagle from having access to data on the profitability of its new route. In this case Eagle can see whether Cheetah entered or not, but not the state of demand.

Air service -redrawn The game is equivalent to the picture on the right. Both firms must move before the state of demand is revealed.

Air service – further reduction Taking the expectation over the payoffs yields a further simplification. Now Cheetah will enter confident that Eagle will stay out.

Product development race Often companies do not know precisely how much competition they will face before launching a new product:

Strategic form of product development race Both firms have a dominant strategy to advertise the product, which determines the unique solution to this game.

An industry newsletter Now suppose a newsletter is produced to keep firms abreast of the latest developments. The extensive form becomes:

Subgames There are three proper sub-games beginning at nodes 2, 3, and 4. If Thompson is the only firm to develop the product, it should advertise rather than choose a low price, and similarly for Smith. The sub-game starting node 4, when both firms develop the product, illustrates the prisoners’ dilemma. The unique solution is for both firms to charge the low price.

The strategic cost of better information and the value of information silos This example shows that more information about an industry could sometimes hurt it. Additional information helps firms to identify situations where their positions are opposed to each other, and induce competition that might lead to the detriment of all firms. Finally suppose Smith and Thompson were two plants owned by the one firm! This example shows the value of having information silos when different profit centers are competing with each other.

Bottling wine Corks are traditionally used in bottling wine, but recent research shows that screwtops give a better seal, and hence the reduce the risk of oxidation and tainting. They are also less expensive. However consumers associate screwtops with cheaper varieties of wine, so wineries risk losing brand reputation from moving too quickly ahead of the consumer tastes. To illustrate this problem consider two Napa valley wineries who face the choice of immediately introducing screwtops or delaying their introduction.

Extensive form game Mondavi has resources to conduct market research into this issue, but Jarvis does not. However Jarvis can retool more quickly than its larger rival, so it can copy what Mondavi does.

Eliminating the dominated strategies of Mondavi We can simplify the problem that Jarvis has by drawing its decision problem when Mondavi follows its dominant strategy.

Solving for Jarvis Since 4 > 0, Jarvis bottles with cork if Mondavi does. The expected value of using screwtops when Mondavi does is: (0.3* *4 )/( ) = 4.0 while the expected value of retaining corking when Mondavi switches is: ( *6)/( ) = 3.0 Therefore Jarvis always follows the lead of Mondavi.

Rivals as a source of information The solution to this game shows that rivals can be a valuable source of information. Although Jarvis could undertake its own research into bottling, it eliminates these costs by piggybacking off Mondavi’s extensive marketing research. Nevertheless Jarvis receives a noisy signal from Mondavi. Jarvis cannot tell whether consumers prefer screwtops or are indifferent. How much would Jarvis be prepared to pay to conduct its own research, and receive a clear signal?

The value of independent research When consumers are indifferent Jarvis could capture a niche market by corking, increasing its profits by 6 – 4 = 2. Hence access to Mondavi’s superior market research increases Jarvis’s expected net profits by: 0.2*2 = 0.4. This sets the upper bound Jarvis is willing to pay for independent research.

Summary We developed the strategic form of a game, and demonstrated that some games are easier to analyze in their strategic form than in their extensive form. We analyzed a third principle for strategic play, iterative dominance, and showed that it encompasses backwards induction as an application. Then in the latter parts of this lecture we showed that the effects of new information are much more complicated to analyze in strategic situations than in decision theory. For example, we showed that when new information is provided to every player, they can all lose, while another example highlighted the benefits of withholding information.