Pricing Games: Sony PlayStation and

Microsoft Xbox
Pricing Games: Sony PlayStation and
Microsoft Xbox

This case demonstrates the application of the classic Prisoners’

Dilemma game in pricing strategies.
Here, the players are the firms, while their strategies comprise of
whether they should reduce the price of their console (to $299) or
leave it unchanged (at $399).
Each firm sets its price simultaneously with the objective of
maximising its profits.
Since the firms set their prices simultaneously without knowledge of
the price chosen by the other firm, this is a static/ simultaneous
move game.
The next step involves calculation of the firms’ payoffs for all
possible outcomes.
Pricing Games: Cost Analysis

Profits equal revenue less costs, and the first step in calculating firm
profits will be cost analysis.
Before we do that, we need to identify the costs that should be
included in this computation of profits - we need to focus on short
run variable costs only.
Recall that variable costs are those that vary in the short run in
response to changes in the quantity produced. These include
production labour costs, material and parts and distribution costs.
In particular, fixed costs such as overhead costs that cannot be
adjusted in the short run in response to changes in output need to
be excluded from this computation.
Pricing Games: Cost Analysis for Sony

If PS = $399, and PM = $399, then from Exhibit I, QS = 8.75

Variable cost/ unit = labour costs + material and parts +
distribution = 80 + 161 + 40 = $281
Profit/ unit = 399 − 281 = $118 (from Exhibit 2)
Total profit = 118(8.75) = $1032.5 million
Pricing Games: Cost Analysis for Microsoft

If PS = $399, and PM = $399, then from Exhibit I, QM = 8

Variable cost/ unit = labour costs + material and parts +
distribution = 62 + 167 + 50 = $279
Profit/ unit = 399 − 279 = $120 (from Exhibit 3)
Total profit = 120(8) = $960 million

repeat calculation for all 4 outcomes

Pricing Games: Payoff matrix

cooperative
outcome Microsoft
$399 $299
$399 1032.5, 960 767.3, 1012.5
Sony
$299 1186.8, 637 978.8, 920
underlined strategies are optimal nooncooperative
outcome
Pricing Games: Dominant Strategy
Equilibrium

Recall that a player has a dominant strategy if it yields a higher

playoff than the other strategies for every possible strategy of the
other player.
Here, Sony has a dominant strategy to set price at $299 (compare
payoffs from playing this strategy vs. playing $399 for every possible
strategy played by Microsoft).
Similarly, it is a dominant strategy for Microsoft to set price at $299.
Thus, at the dominant strategy equilibrium, both firms set the lower
price.
When both firms follow their self interest, the result is the
non-cooperative outcome whereby both firms set the lower price.
The better outcome from each firm’s perspective is to set the higher
price but this is never achieved in equilibrium.