University of Cagliari, Faculty of Economics, a.a Business Strategy and Policy A course within the II level degree in Managerial Economics year II, semester I, 6 credits Lecturer: Dr Alberto Asquer Phone:

Business Strategy and Policy Lecture 4 The strategic interaction between firms

Introduction 1. Strategic interaction 2. Dominant strategies 3. Nash equilibrium strategies 4. Coordination strategies 5. Coordination and competition (co-opetition) 6. Mixed strategies 7. Sequential strategic games Summary

1. Strategic interaction Within military field, strategy as winning manoeuvring in the battlefield

1. Strategic interaction Within game theory, strategy as the analysis of strategic interaction What choice option do rational agents select in order to maximise their payoff, taking into account the choice of other agents? (in common-sense argumentation, put yourself “behind your rivals' desk” in order to take into account what they do when you make decisions that affect your interests) Warning: every agents behaves rationally and takes into account the choice of others (in common-sense argumentation, take into account that also your rivals make decisions taking into account what you do)

1. Strategic interaction Game theory: some basic lexicon Game: the structure of interaction between agents (players). Typically, in a game the payoff of agents depends on the choices made by all agents (i.e. not by one agent alone) Simultaneous games: agents make choices at the same time (i.e., one agent cannot wait and see the choice made by others) Sequential games: agents make choices according to a pre- determined sequence (i.e., who chooses later can see what other agents, who chose earlier, did) Repeated games: agents face again the choice situation over time. Non repeated games: agents play the game only once.

1. Strategic interaction Game theory: some basic lexicon Dominant strategy: the only choice that an agent rationally does, no matter what other agents do (or did or will do) Nash equilibrium: a set of strategies where each agent is rationally choosing the best option, given the choice of other agents

2. Dominant strategies Firms may choose their course of action irrespective of what other players do Airbus Scenario: bidding for 10 aircrafts project High price High price Low price Low price B = 500 A = 500 B = 0 A = 1,000 B = 1,000 A = 0 B = 750 A = 750 Boeing

2. Dominant strategies Airbus Scenario: bidding for 10 aircrafts project High price High price Low price Low price B = 500 A = 500 B = 0 A = 1,000 B = 1,000 A = 0 B = 750 A = 750 Boeing Firms may choose their course of action irrespective of what other players do

2. Dominant strategies Airbus Scenario: bidding for 10 aircrafts project High price High price Low price Low price B = 500 A = 500 B = 0 A = 1,000 B = 1,000 A = 0 B = 750 A = 750 Boeing Firms may choose their course of action irrespective of what other players do

3. Nash equilibrium strategies But sometimes, firms behave depending on what other firms do Airbus Scenario: bidding for 10 aircrafts project, but Boeing can earn even if losing the bid High price High price Low price Low price B = 500 A = 500 B = 600 A = 1,000 B = 1,000 A = 0 B = 750 A = 750 Boeing

3. Nash equilibrium strategies But sometimes, firms behave depending on what other firms do Airbus Scenario: bidding for 10 aircrafts project, but Boeing can earn even if losing the bid High price High price Low price Low price B = 500 A = 500 B = 600 A = 1,000 B = 1,000 A = 0 B = 750 A = 750 Boeing

3. Nash equilibrium strategies But sometimes, firms behave depending on what other firms do Airbus Boeing Scenario: bidding for 10 aircrafts project, but Boeing can earn even if losing the bid High price High price Low price Low price B = 500 A = 500 B = 600 A = 1,000 B = 1,000 A = 0 B = 750 A = 750 ?

3. Nash equilibrium strategies Airbus is playing 'low price' anyway (has a dominant strategy)... Airbus Boeing Scenario: bidding for 10 aircrafts project, but Boeing can earn even if losing the bid High price High price Low price Low price B = 500 A = 500 B = 600 A = 1,000 B = 1,000 A = 0 B = 750 A = 750

4. Coordination strategies Sometimes strategy is about cooperation rather than competition Airbus Boeing Scenario: Boeing and Airbus choose which Comm technology invest in Beta Alpha B = 100 A = 100 B = 50 A = 50 B = 50 A = 50 B = 100 A = 100

4. Coordination strategies Sometimes strategy is about cooperation rather than competition Airbus Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in Beta Alpha B = 100 A = 100 B = 50 A = 50 B = 50 A = 50 B = 100 A = 100

4. Coordination strategies Sometimes strategy is about cooperation rather than competition Airbus Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in Beta Alpha B = 100 A = 100 B = 50 A = 50 B = 50 A = 50 B = 100 A = 100

5. Collaboration and competition (co-opetition) Sometimes it is good to cooperate, but every firms has own interests Airbus Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in Beta Alpha B = 100 A = 50 B = 25 A = 25 B = 40 A = 40 B = 50 A = 100

5. Collaboration and competition (co-opetition) Sometimes it is good to cooperate, but every firms has own interests Airbus Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in Beta Alpha B = 100 A = 50 B = 25 A = 25 B = 40 A = 40 B = 50 A = 100

5. Collaboration and competition (co-opetition) Sometimes it is good to cooperate, but every firms has own interests Airbus Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in Beta Alpha B = 100 A = 50 B = 25 A = 25 B = 40 A = 40 B = 50 A = 100

5. Collaboration and competition (co-opetition) Sometimes it is good to cooperate, but every firms has own interests Airbus Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in Beta Alpha B = 100 A = 50 B = 25 A = 25 B = 40 A = 40 B = 50 A = 100

6. Mixed strategies Sometimes, there is really no equilibrium Airbus Boeing Scenario: Boeing and Airbus choose their advertisement campaign Positive tones Positive tones Negative notes Negative tones B = 10 A = -10 B = -10 A = 10 B = -10 A = 10 B = 10 A = -10

6. Mixed strategies Sometimes, there is really no equilibrium Airbus Boeing Scenario: Boeing and Airbus choose their advertisement campaign Positive tones Positive tones Negative notes Negative tones B = 10 A = -10 B = -10 A = 10 B = -10 A = 10 B = 10 A = -10

7. Sequential strategic game Sometimes, one player chooses before the other Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in – but Boeing chooses first! Airbus Alpha Beta Alpha Beta Alpha Beta Boeing: 100 Airbus: 50 Boeing: 40 Airbus: 40 Boeing: 25 Airbus: 25 Boeing: 50 Airbus: 100

7. Sequential strategic game What will Airbus choose? Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in – but Boeing chooses first! Airbus Alpha Beta Alpha Beta Alpha Beta Boeing: 100 Airbus: 50 Boeing: 40 Airbus: 40 Boeing: 25 Airbus: 25 Boeing: 50 Airbus: 100

7. Sequential strategic game What does Boeing choose – provided what Airbus will choose? Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in – but Boeing chooses first! Airbus Alpha Beta Alpha Beta Alpha Beta Boeing: 100 Airbus: 50 Boeing: 40 Airbus: 40 Boeing: 25 Airbus: 25 Boeing: 50 Airbus: 100

7. Sequential strategic game What does Boeing choose – provided what Airbus will choose? Boeing Scenario: Boeing and Airbus choose which Communication technology they invest in – but Boeing chooses first! Airbus Alpha Beta Alpha Beta Alpha Beta Boeing: 100 Airbus: 50 Boeing: 40 Airbus: 40 Boeing: 25 Airbus: 25 Boeing: 50 Airbus: 100 Note: Airbus would really like to make a credible threat to choose Beta!

8. Summary Main points Game theory provides a powerful analytic approach to strategic interaction The approach is especially relevant when the expected performance (payoff) is dependent on the decisions (choices) made by players (firms) Game theory allows to model a wide range of strategic interactions: competition, cooperation, co-opetition, uncertainty and mixed strategies, and sequential games It is enlightening for better understanding the interdependencies between firms' decisions (e.g., issues of credible commitments and sequence of moves)