Week 1

Introduction
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich
Week 1

Simultaneous Games I
Game Setting
 Toothpaste Wars
 Sensodyne and Colgate both sell toothpaste
 They share the market equally (total sales £10mn)
 Each company considers launching an
advertising campaign (costs £2.5mn)
• No effect on total market size and sales
• Increase of company‘s market share to 80%
• But only if the other does not advertise
 Game Setting (I/II)
 Players
• Sensodyne
• Colgate
 Actions
• Advertise
• Do not advertise
 Rules
• Both have to decide simultaneously
 Game Setting (II/II)
 Payoffs
• Both do not advertise: Each £5mn
• Both advetise: Each £5mn - £2.5mn =
• Only one advertises
o Advertiser:
£8mn - £2.5mn =
o Non-Advertiser: £2mn
 Matrix Form

Colgate
Advertise Do not advertise
Sensodyne

Advertise £2.5mn / £2.5mn £5.5mn / £2.0mn

Do not
£2.0mn / £5.5mn £5.0mn / £5.0mn
advertise
 Strategy
 Working definition for this course:
A player‘s plan of actions in a game (here: Ad/no Ad)
 This sounds trivial for now,
but very useful later on in more complex situations
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 1

Simultaneous Games II
Eliminating Dominated
Strategies
 Pizza War
 Piccola Osteria and Rosso Pizza sell pizza
 They can charge
• High price: €12
• Medium price: €10
• Low price: €5
 Around school there are 1,000 students
• 300 only buy at Piccola Osteria
• 300 only buy at Rosso Pizza
• 400 buy the cheaper pizza or
choose randomly if same prices
 Game Setting (I/II)
 Players
• Piccola Osteria
• Rosso Pizza
 Actions
• High prices
• Medium prices
• Low prices
 Rules
• Both decide on prices simultaneously
 Game Setting (II/II)
 Example
• Piccola Osteria: medium price
• Rosso Pizza: high price
 Payoffs
• Piccola Osteria sells to its 300 loyal students
plus the 400 price-sensitive students
at €10 per pizza

• Rosso Pizza sells to its 300 loyal students

at €12 per pizza
 Matrix Form
Piccola Osteria
High Medium Low
Pizza Rosso

H 6.0 / 6.0 3.6 / 7.0 3.6 / 3.5

M / 5.0 / 5.0 3.0 / 3.5 in 1000 Euros

L 3.5 / 3.6 3.5 / 3.0 2.5 / 2.5

 Dominant Strategy
 A strategy that always does better than
any other strategy
 Hence, should always be chosen by
a rational player

 You can rely on a rational rival

always playing a dominant strategy
 Dominated Strategy
 A strategy that never does better
than another one
 Hence, a rational player would never
opt for this strategy

 You can rely on a rational rival

never playing a dominated strategy
 Solving the Pizza War
Piccola Osteria
High Medium Low
Pizza Rosso

H 6.0 / 6.0 3.6 / 7.0 3.6 / 3.5

M 7.0 / 3.6 5.0 / 5.0 3.0 / 3.5 in 1000 Euros

L 3.5 / 3.6 3.5 / 3.0 2.5 / 2.5

 Elimination Process
 Eliminate dominated strategies one by one
 Continue until a solution to the game
can be found / you cannot eliminate more
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 1

Simultaneous Games III

Nash Equilibrium
 Pizza War simplified

Piccola Osteria
High Medium
Pizza Rosso

High 6.0 / 6.0 3.6 / 7.0

in 1000 Euros

Medium 7.0 / 3.6 5.0 / 5.0

 Nash Equilibrium
 A combination of strategies
 No player can deviate unilaterally
from his / her current strategy
 To improve his / her payoffs

 Natural resting point of the game

 Pizza War simplified

Piccola Osteria
High Medium
Pizza Rosso

High 6.0 / 6.0 3.6 / 7.0

in 1000 Euros

Medium 7.0 / 3.6 5.0 / 5.0

 Relationship to Other Concepts
1) Is a Nash Equilibrium the same as a dominant strategy?

2) Can a Nash Equilibrium contain dominated strategies?

3) Will every Nash Equilibrium contain dominant strategies?

 Pizza War extended
Picola Osteria
High Medium Low
Pizza Rosso

H 6.0 / 6.0 3.6 / 7.0 3.6 / 3.5

M 7.0 / 3.6 5.0 / 5.0 3.0 / 3.5 in 1000 Euros

L 3.5 / 3.6 3.5 / 3.0 2.5 / 2.5

 Nature of a Nash Equilibrium
1) Will every game have a Nash Equilibrium (in pure strategies)?

2) Can a game have more than one Nash Equilibrium?

 Game without a Nash Equilibrium
Example: Penalty taking in football / soccer

Penalty Taker
Left Right

Left 1/0 0/1

Goalie
Right 0/1 1/0
 Game with multiple Nash Equilib.
Example: Battle for competing technical standards

Firm B
Standard A Standard B

Standard A 5/4 1/0

Firm A
Standard B 0/1 4/5
 Game with multiple Nash Equilib.
Example: Battle for competing technical standards

Philips
Standard S Standard P

Standard S 5/4 1/0

Sony
Standard P 0/1 4/5
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 1

Sequential Games I
Game Setting
 Chocolate Wars
 Universal Studio charges $1.0mn
for a product placement
 Product placement by Mars
• Mars’ gross profits increase by $0.8mn
• Hershey’s decrease by $0.1mn
 Product placement by Hershey
• Hershey’s gross profits increase by $1.2mn
• Mars’ decrease by $0.5mn
 No product placement: “business as usual”
 Game Tree (I/II)
 First decision starts the game

 Every decision point represents a node

 From there, the decisions of subsequent

players branch out accordingly
 Game Tree (II/II)
no
Mars product product
placement placement

product no
Hershey status product
quo placement
placement

Mars $ -0.5mn $0
Hershey $ 0.2 mn $0
 Strategy (I/II)
 (Extended) Working definition for this course:
A player’s plan of actions in a game,
given any possible circumstance
 Strategy (II/II)
Example: Price Setting Potential strategies for B

Firm A
high low

Firm B
high low high low
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 1

Sequential Games II
Backward Induction
 Chocolate Wars
no
Mars product product
placement placement

product no
Hershey status product
quo placement
placement

Mars $ -0.2mn $ -0.5mn $0

Hershey $ -0.1mn $ 0.2 mn $0
 Backward Induction
 Simplification of a sequential game
 Eliminate actions at the final node and work one’s way forward
 Choose those actions that would not maximize an
individual’s profit at that point
 A rational player always tries
to maximize their own profits
 You can rely on a rational rival
never choosing these actions
 Chocolate Wars
no
Mars product product
placement placement

product no
Hershey status product
quo placement
placement

Mars $ -0.2mn $ -0.5mn $0

Hershey $ -0.1mn $ 0.2 mn $0
 Price Setting

Firm A high low

Firm B
high low high low

Firm A $ 8mn $ 0mn $ 10mn $ 5mn

Firm B $ 8mn $ 10mn $ 0mn $ 5mn
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 1

Sequential Games III

Credible Threats
 Airlines in Germany
 Lufthansa is monopolist on domestic flights

 British Airways considers entering the market (German BA)

 Lufthansa threatens British Airways to start a price war after entry

 Is this a credible threat?

 Airlines in Germany

Deutsche BA no market market

entry entry

Lufthansa status price no price

quo war war

Deutsche BA 0 -500 400

Lufthansa 1000 0 400
 Nash Equilibria (NE)

Deutsche BA no market market

entry entry
Nash Equilibrium I

Lufthansa status price no price

quo war war

Deutsche BA 0 -500 400

Lufthansa 1000 0 400
 Subgame Perfect NE

Deutsche BA no market market

entry entry Nash Equilibrium I
Nash Equilibrium II

Lufthansa status price no price

quo war war

Deutsche BA 0 -500 400

Lufthansa 1000 0 400
 Airlines in Germany
 Lufthansa is monopolist on domestic flights

 British Airways considers entering the market (German BA)

 Lufthansa threatens British Airways to start a price war after entry

 Is this a credible threat?

 Airlines in Germany
 Now: Lufthansa commits to a price war
 Contract with Star Alliance specifying a penalty of 500
if Lufthansa does not start a price war after Deutsche BA’s entry
 Is this a credible threat?
 Airlines in Germany

Deutsche BA no market market

entry entry

Lufthansa status price no price

quo war war

Deutsche BA 0 -500 400

Lufthansa 1000 0 400 - 500 = -100
 Subgame Perfect NE

Deutsche BA no market market

entry entry Nash Equilibrium I
Nash Equilibrium II

Lufthansa status price no price

quo war war

Deutsche BA 0 -500 400

Lufthansa 1000 0 400 - 500 = -100
 Airlines in Germany
 Now: Lufthansa commits to a price war
 Contract with Star Alliance specifying 500 penalty
if Lufthansa does not start a price war after Deutsche BA’s entry
 Is this a credible threat?
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich

© 2013 LMU Munich

Week 1

Wrap Up
Competitive Strategy
Tobias Kretschmer
Professor of Management, LMU Munich