1. Economics of Organization
Power Point
Appendix (Chapter 2)

2. Game Theory and Strategy
Key Concept: Preemption of Strategically Valuable Assets
Access to raw materials (e.g. Alcoa)
Wal-mart’s rural strategy

3. Game Theory and Strategy
Creating Customer Switching Costs
Establishing standards for a computer operating system
Matsushita’s VHS format becoming dominant over Sony’s Beta
Note: Given that a second mover’s product development costs can be much lower than the first mover’s product development costs, first-mover advantages must be substantial to justify first moving as a strategy.

4. Game Theory and Strategy
Technological Leadership
In the 1970s, DuPont built a dominant position in the titanium dioxide market by exploiting:
superior technology
scale economies
accumulated experience for low costs
Gillette competes with a differentiation strategy in disposable razors by exploiting:
reputation
broad distribution

5. Game Theory and Strategy
Exit Barriers are Entry Barriers
Emphasized by Professor Joe Bain, University of California, Berkeley in 1950s
Specialized Assets
Strategic Barriers (e.g., spillover effects)
Government and Social Barriers

6. Game Theory and Strategy
Exit Barriers
High
Low
Entry Barriers
Low Returns
High Returns
High, Uncertain Returns
Worst Case

7. Analyzing Competitive Dynamics - Commitment Vs. Flexibility
Game Theoretic preemption strategy
Flexibility
Real (Strategic) Options Analysis

8. Factors Affecting The Likelihood of Competitor Response:
What are the payoffs relative to other actions the competitor could take?
What prior strategic commitments has the competitor made?
Does the potential market fit with the competitor’s existing strategy?
How “reversible” is your action or the competitor’s potential response?

9. Game Theory - A Simple Example
Tic Tac Toe
What Happens Here?

10. Game Theory and Strategy
Prisoners’ Dilemma Game
Row
Silence
Fink
Column -1
-10 -8

11. Game Theory and Strategy
Prisoners’ Dilemma Game
Row Player: Dominant Strategy: Fink
Column Player: Dominant Strategy: Fink
Dominant Strategy (Nash) Equilibrium: (-8, -8)
Note: It is a dilemma since if they both cooperated by remaining silent: (-1, -1).

12. Game Theory and Strategy
The prisoners’ dilemma game can occur in many contexts:
What is best for an individual may not be best for a division.
What is best for a division may not be best for a firm.
What is best for a firm many not be best for an industry.
What is best for an industry may not be best for a nation.
What is best for a nation may not be best for the world.

13. Game Theory and Strategy
Now that we have learned the concept of dominant strategy equilibrium, there is a second important equilibrium concept called a Nash equilibrium.
Note: All dominant strategy equilibrium are Nash equilibrium, but not all Nash equilibrium are dominant strategy equilibrium.

14. Game Theory and Strategy
Game with no dominant strategy equilibrium, but a Game with a Nash equilibrium.
Row
Cooperate
Fink
Column 5 4 1 9 -1

15. Game Theory and Strategy
A cooperative game with conflict
Game with 2 Nash equilibria.
Man
Prize Fight
Ballet
Woman 2 -1 1 -5

16. Game Theory and Strategy
Suppose this game were played sequentially?
Would it be better to go first or second?
Man
Prize Fight
Ballet
Woman 2 -1 1 -5

17. Game Theory and Strategy
New game: Joe’s sad undergraduate days
Man
Prize Fight
Ballet
Woman 10
100 20 4 90 30 8 6

18. Game Theory and Strategy
Would you want to move first or second?
Man
Prize Fight
Ballet
Woman 10
100 20 4 90 30 8 6

19. Game Theory and Strategy
Initial Game (played simultaneously)
Airbus
No Launch
Launch
Boeing
400
300
200
-100
-200

20. How Can “Commitment” Affect A Competitor’s Response?
Commitment = An Irreversible Action (Sunk Costs)
Competition In The Commercial Aircraft Industry
Airbus
No Launch
Launch
Boeing
400
300
200
-100
-200

21. Game Theory and Strategy
Joint Venture GM
Cooperate
L. Race
Toyota
112
123 58 91

22. How Can “Commitment” Affect A Competitor’s Response?
Commitment = An Irreversible Action (Sunk Costs) GM
Cooperate
L. Race
Toyota
112
123
-28 58 91
-51

23. How Can “Commitment” Affect A Competitor’s Response?
Mutual sunk cost commitments GM
Cooperate
L. Race
Toyota
112
-28 58
-51

24. Game Theory and Strategy
Lessons
1. Commitment (sunk costs) can be used to achieve cooperation.
The importance of mutual economic hostages: The wise manager should think beyond Machiavelli’s myopic approach to contracting and should seek both to give and receive credible (sunk cost) commitments that facilitate ongoing relationships and adaptation.

25. Game Theory and Strategy:
Lessons
2. Commitment (sunk costs) can be used to achieve competitive advantage.
preemption strategy

26. Game Theory and Strategy
Some key points on strategic commitment:
Always give attention to how your competitors’ returns vary under different strategic scenarios;
It is important to communicate the commitment to the other firms (for both competition and cooperation);
“Sunk cost” investments can be used to pre-commit to a certain strategy and, thus, influence competitor response; and
Understand what strategic investments are important in your business and how “sunk” those investments are.

27. Sources of First Mover Advantages
Economies of Scale
Experience or Learning Curve Effects
Brand Equity
“Network Externalities”
- How are you going to use these effects to get a first mover advantage?
- How does this lead to a sustainable advantage?

28. First Mover Disadvantages May Lead To Second Mover Advantages
The Costs of Early Adoption -
The “Bleeding Edge” of Technology
Changing Product and/or Process Technology
Changing Consumer Tastes
Product Technology
Process Technology