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Name : Gopal Krishan Section : D Semester : III Course Code: SLGM611 Course Title: Business Strategy I Submitted on: 6th September, 2010 Submitted to: Surjyabrat Buragohain Assignment title: Business strategies explained through game theory, real business scenario examples.
Game theory: Explaining business strategies
Game theory is applicable to all the conditions where decision making is applicable. In business scenarios there are a number of occasions where game theory can be applied and decisions can be made. If one fails to do so one may face difficulties later due to the decision made. Game theory assumes that the player is a rational thinker, which is actually the nature of human being. Here are some caselets which explains the real life examples of business implications of game theory.
1. Why did cigarette companies agree to abandon advertising?
History of cigarette advertising: Prior to 1970, there was huge amount of money spent on cigarette advertisements by the companies especially the four giants in cigarette manufacturing of that time i.e. Philip Morris, American Blend, Tareyton and Liggett & Myers. People could frequently see cigarette commercial being broadcasted on the television and radio. But in 1970, Congress passed the Public Health Cigarette Smoking Act according to which advertising was banned for tobacco companies. But the question is why did cigarette companies agree to abandon advertising? The answer lies in game theory. The condition before the act was passed was like a prisoner’s dilemma for cigarette companies. Cigarette smokers were not being attracted much because of advertisements. Commercials were helping the cigarette companies to just retain their market share. And for that they had to spend million of dollars every year on advertising. At the same time, if a company will stop advertising, other company will take away its market share because possibility of customers switching from one brand to other was very high. In such a situation, if company stops to advertise it’ll lose its market share. The above bewilderment can be depicted by the diagram below: Phillip Morris Advertise No Advertise Advertise Liggett & Myers No Advertise
If Phillip Morris and Liggett & Myers both advertise, they will have to spend a huge amount and at the same time the addition to their market share would be very less. Thus they would actually be losing being in the top left quadrant. However, if only their company advertises and the other company doesn’t they will get a major portion of the market share and the other company’s share will drop. But this condition will not occur in such a competitive market.
Thus top right quadrant and bottom left quadrant are also not the solution part. Being in the bottom right quadrant would be beneficial for both the companies but they would be reluctant to enter the bottom right quadrant first, the reason being what if the other company doesn’t play the same strategy. Thus advertising becomes the dominant strategy for both the companies. The hierarchy of strategy in terms of benefit to the company would thus become: 1. 2. 3. 4. No advertisement Only your company advertise Both advertise Only other company advertise
Observing this, all the government did was to remove the first three quadrants from the matrix by putting a ban on advertising. This is actually the situation where the companies wanted to be all the time but could not do it. Thus, when the act was passed, the companies agreed to the same and stopped advertisement without showing any unwillingness. Now all the companies could stop pondering over the massive advertising budgets and increase their profits. This game is a win-win situation for both the government as well as the cigarette companies.
2. Why was revenue generated from 3G spectrum sales for Indian government was three times to that of expected?
In the recently happened 3G spectrum sales in India almost all the telecommunication giants participated and bet for spectrums. But the most interesting part was that the government was expecting a total revenue generation of Rs. 67,710 crores which is in multiples of what actually the government expected would be the revenue generations from the auction. A telecom company while placing a bid for a spectrum would be in confusion as to what should be the price it should bid. If he bids very high he would land up having the winner’s curse of paying more than what the next winner to him is paying for the similar spectrum. At the same time if he bids low he would lose the auction. This is how we get the matrix below: Vodafone Low Bid Low Bid High Bid
Let us assume that there are only two participants in the auction, one being Bharati Airtel and other one being Vodafone. The both have to bid for the spectrum without knowing what other
player is going to bid and they have option of bidding a low amount or a high amount. The number 1 and 0 denotes win and lose situations for each player. This is typical example of simultaneous game where one player does not know about the other player’s move. In reality, if both of them bid a lower amount or rather same amount the payoff for both will be the same. However, there would be temptation with one of the two to bid higher and win the game alone. Players know that if they bid slightly higher than the other player they will win the battle and gain market. Thus none of the player wants to be in the top right or bottom left quadrant because this situation is worse for them. But this situation will be there in the minds of both the players and thus they will increase the bid that they are going to offer. Therefore, bidding higher in every round becomes the dominant strategy for the players and this made the prices of spectrum rally upwards. This situation will make them land up in the bottom right quadrant where both will be losers as one person will not be able to get the spectrum and the one who wins would have to pay a price much higher than what he was supposed to pay under fair circumstances. Even then being rational thinkers, they will have to follow the dominant strategy to have advantage over their competitors. Any auctioneer takes the advantage of this simultaneous game wherein one player has to make a move which he thinks is better for him without knowing what other player is going to do. If his strategy outperforms to what his rival has chosen he will win.
3. Why cinema companies give licenses to Moser Baer and Super DVD to sell movies at extremely low prices?
Till there were no low priced movies CDs and DVDs sold in the market by companies like Moser Baer and Super DVD, there was a major part of the market captured by the pirated DVDs and CDs sellers. They were eating up the revenues of the movie producers. But at the same time original movie DVDs and CDs cannot be brought to market soon after it is released because it will hamper the revenue generated from theaters and nor could the prices of original movie CDs and DVDs could be reduced because that would again decrease their revenues in the overall market share that they have. Thus, the movie producers thought to take back some of the market share from the pirated DVDs and CDs sellers and not to touch the market share that they already have. For this we will call the market share occupied by the pirates the pirated market. Previous condition was that players in the pirated market were playing the hard game that is making duplicates of movies and selling at extremely low prices. In that market the movie producers cannot enter directly and thus their share is 0 and others are making profits of say 4 as shown in the matrix below, in the bottom right quadrant. The upper two quadrants are definitely not the conditions that will occur because the pirate sellers are not going to sell the CDs and DVDs at higher prices thus these two conditions are ruled out. At this point Moser Baer and Super DVD goes to the movie producers and offer them some amount in return of license to sell movies at a very low price in the market. Since this sector
will directly compete with that of the pirated market and will fetch some money out of it, companies will definitely be better-off than being in the fourth quadrant which was giving them nothing. Cinema Comp Low Rates
0 0 0 4
The above is the payoff matrix for the cinema companies which explain the payoffs that they will get if they license their movies to companies like Moser Baer and Super DVD and if they do not do so. Thus, though the amount that the companies are getting out of this deal is very low but they are better than previous condition. This is an example of a sequential game where player knows each other’s strategy and moves. Here the movie companies know that their revenues are being harmed by the pirated market and at the same time Moser Baer also knows that movie companies are getting nothing out of the present condition. Thus whatever Moser Baer offers to the movie companies will be acceptable by them because they would surely like to have something out of market where they are not getting anything. Hence accepting the proposal will become the dominant strategy for cinema companies and they will end up in the bottom left quadrant making some amount.