L ECTURE T EN : S TRATEGIC T HINKING IPEM Tohoku University Managerial Economics Lecturer: Jack Wu Period 3/ February 18

Nov. 16: Coca-Cola raised price 7% Nov. 22: Pepsi raised price 6.9% “Coke and Pepsi will move now from price-based competition to marketing- based competition”, Andrew Conway, Morgan Stanley C OKE VS. P EPSI, 1999

C OMPETITIVE D ILEMMA What should Coke do?

S TRATEGIC S ITUATIONS parties actively consider the interactions with one another in making decisions game theory -- set of ideas and principles to guide strategic thinking simultaneous actions: strategic form sequential actions: extensive form

D OMINATED S TRATEGY generates worse consequences than another strategy, regardless of the choices of the other parties never use dominated strategy

N ASH E QUILIBRIUM Given that the other players choose their Nash equilibrium strategies, each party prefers its own Nash equilibrium strategy No one is willing to deviate unilaterally from a Nash equilibrium

S OLVING FOR N ASH E QUILIBRIUM eliminate dominated strategies, then check remaining cells “ arrow ” technique

C OMPETITIVE DILEMMA N ASH EQUILIBRIUM : C OMPETITIVE DILEMMA Pepsi Raise priceDiscount Coke Raise price C: 3, P: 3 C: 0, P: 5 Discount C: 5, P: 0 C: 1, P: 1  What should Coke do?

C OKE AND P EPSI G AME Nash equilibrium: for both parties, “raise price” is dominated by “discount”. but discounting is bad for both -- if only they could agree somehow to raise price. Coke and Pepsi stuck in this situation for four years until November 1999.

P RISONERS ’ DILEMMA N ASH EQUILIBRIUM : P RISONERS ’ DILEMMA Sam Do not confessConfess Ian Do not confess I: 0, S: 0 I: -10, S: 0 Confess I: 0, S: -10 I: -5, S: -5  What should Sam do?

O UT OF N ASH E QUILIBRIUM What if another player doesn ’ t play Nash equilibrium strategy? Nash equilibrium strategy may not be best still don ’ t use dominated strategy

No Nash equilibrium in pure strategies WHERE TO ADVERTISE?

R ANDOMIZED S TRATEGIES choose among pure strategies according to probabilities must be unpredictable Example: where to advertise _ We.com: ½ NBA and ½ NHL _ Competitor.com: ½ NBA and ½ NHL

R ETAIL PRICE COMPETITION R ANDOMIZED STRATEGIES : R ETAIL PRICE COMPETITION Solution: randomized discounts

E VENING NEWS C OORDINATION / COMPETITION : E VENING NEWS Delta 7.30pm8.00pm Zeta 7.30pm A: 1, B: 1 A: 3, B: pm A: 4, B: 3 A: 2.5, B: 2.5

C OORDINATION AND C OMPETITION Prime time for news is 8:0pm; second best is 7:30pm; since audience is limited, get maximum viewership if two channels schedule at different times. Question: which station gets 8:0pm? Situation has elements of coordination -- avoiding same time slot competition -- getting the 8:0pm slot

Z ERO /P OSITIVE S UM zero-sum games: pure competition -- one party better off only if other is worse off positive-sum games: coordination -- both can be better off or both worse off co-opetition: competition and coordination

F OCAL P OINT C OORDINATION /C OMPETITION : F OCAL P OINT Single Nash equilibrium - clear focal point Multiple Nash equilibria - look for focal point to see which one to play

S EQUENCING Game in extensive form – sequence of moves: nodes branches outcomes

E XTENSIVE F ORM : E QUILIBRIUM backward induction  final nodes  intermediate nodes  initial node

E XTENSIVE F ORM - TV N EWS S EQUENCING : E XTENSIVE F ORM - TV N EWS

S TRATEGIC M OVE Action to influence beliefs or actions of other parties in a favorable way credibility – first mover advantage – second mover advantage

E XAMPLES Examples: Evening TV news -- both stations want to move first: which one can? Use strategic move, eg, contracts with advertisers to deliver news at 8pm. Famous Chinese general: after crossing a river, burnt his ships -- strategic move to force soldiers to fight harder. Issue: Is the move credible? Will it convince the other players? Advantage doesn’t always go to first mover; In war, better to see opponent’s move, and then take action, eg is enemy moving south or north? new product category -- let competitor test the market and educate the customers

consumer Litho Make prints Do not Buy Do not Make more prints Do not (1) serial number (2) destroying the plate (3) other solution? L ITHOGRAPHER

C ONDITIONAL S TRATEGIC M OVES Threats – if it succeeds, then it needn’t be carried out Promises – if it succeeds, then it needn’t be carried out Ideal strategic move doesn’t impose costs

MORGAN STANLEY: “ SHAREHOLDER RIGHTS PLAN ” If any party acquires 10% or more of company ’ s shares, other shareholders get right to buy additional shares at 50% discount. Impact on hostile bidder?

S HAREHOLDER R IGHTS P LAN This shareholder rights plan is a threat to potential bidders: most hostile bidders begin with small stake; with shareholder rights plan, if bidder acquires more than 10%, then rights triggered, and bidder will be diluted. Nickname: poison pill. Actually works against shareholder rights -- by entrenching existing management.

Sharon Hilda acquires 100,000 shares doesn’t bid does not activates rights Hilda loses on initial stake + cost of takeover rises P OISON P ILL

Union Employer reject union demand accept do not strike Lose current wage and possibly gain in future wage Maintain current wage Why are strikes rare in American professional football? S TRIKE

C ONDITIONAL STRATEGIC MOVE : W ITHOUT DEPOSIT INSURANCE depositor maintains deposit withdraws deposit bank insolvent bank remains solvent principal + interest zero depositor principal bank remains solvent bank insolvent

C ONDITIONAL STRATEGIC MOVE : W ITH DEPOSIT INSURANCE depositor maintains deposit withdraws deposit bank insolvent bank remains solvent principal + interest principal depositor principal bank remains solvent bank insolvent