Strategic Thinking

If natural selection is “survival of the

fittest,” then under what conditions
should individuals engage aggressively
in conflict for limited resources? Can
aggressive and non-aggressive
strategies coexist?
 Game Theory
• Game Theory is a branch of social sciences
devoted to the study of strategy in which
players seek to maximize their individual
returns
John Nash • Forms the basis of many economic theories,
war strategy, sociological theories (and board
games!)
• John Maynard Smith emphasized the potential
for its use in behavioral ecology

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John Maynard Smith
 What is a Game?

A game is a situation where the

participants’ payoffs depend not only on
their decisions, but also on their rivals’
decisions.
This is called Strategic Interactions:
My optimal decisions will depend on what
others do in the game.
 What is a Game?
• A game is a situation in which
• each member of a group (or, each “player”) makes at least
one decision, and
• Each player’s welfare depends on others’ choices as well as
his own choice
• A game
• Includes any situation in which strategy plays a role
• Advertising, , auctions, negotiation, Product launching,
entrepreneurial ventures, Trade, International relations,
Ecology etc

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 Basic Concepts

• Any situation in which individuals must

make strategic choices and in which the
final outcome will depend on what each
person chooses to do can be viewed as a
game.
• Game theory models seek to portray
complex strategic situations in a
simplified setting.
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 Basic Concepts

• All games have three basic elements:

• Players
• Strategies
• Payoffs
• Players can make binding agreements in
cooperative games, but can not in non-
cooperative games

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 The Heinz Dilemma

• A man’s wife is dying. There is one drug

that could save her life, but it is very
expensive, and the druggist who invented
it will not sell it at a price low enough for
the man to buy it. Finally, the man
becomes desperate and considers
stealing the drug for his wife. What
should he do and why?
Prisoners'’ Dilemma
 The normal-form representation of a game
The Prisoners’ Dilemma
Two prisoners. They are being question by the
police in different rooms. Each can confess or not
Jim
Confess Not
Confess
Confess 5,5 0, 10
Ron
Not 10, 0 1,1
Confess
Be sure that you recognize the elements of the game !!!!
 Iterated Prisoner’s Dilemma
• Game theory shows that a rational player should always
defect when engaged in a prisoner’s dilemma situation
• We know that in real situations, people don’t always do
this
• Why not? Possible explanations:
• People aren’t rational
• Morality
• Social pressure
• Fear of consequences
• Evolution of species-favoring genes
• Which of these make sense? How can we formalize
these?

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 The mind of the strategist
• “Successful business strategies result not
from rigorous analysis, but from a particular
state of mind.”
• Strategy making is in essence a creative and
partly intuitive process, often disruptive of
the status quo.
• Strategists employ analysis only to stimulate
the creative process, to test the ideas that
emerge, to work out their strategic
implications or to ensure successful
execution.
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 Boeing-Airbus game

Boeing and Airbus have to decide whether to invest in the

development of a Super Jumbo for long distance travel;
if they both develop successfully the new plane, their profits
will drop by 50 millions a year;
if only one develop the Super Jumbo, it will make 80
millions a year in additional profits, whereas the profits of
the other firm will drop by 30 millions a year;
if no firm develops the plane, nothing changes.
Matrix Representation of
Boeing-Airbus game

Airbus

Do not
Develop
develop

Develop -50,-50 80,-30

Boeing
Do not
-30,80 0,0
develop
 Battle of Sexes
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• A couple deciding how to spend the evening

• Wife would like to go for a shopping
• Husband would like to go for a boxing
• Both however want to spend the time
together
BOS
Cognitive Biases and why they
exist
• Cognitive biases are influenced by evolution and
natural selection pressure.
• Some are presumably adaptive and beneficial, for
example, because they lead to more effective
actions in given contexts or enable faster decisions,
when faster decisions are of greater value for
reproductive success and survival.
• Others presumably result from a general fault in
human brain structure or the misapplication of a
mechanism that is beneficial under different
circumstances.
 Cognitive Biases
Confirmation bias Ease of recall bias
Seeking information Relying too much on
that confirms early information that is
beliefs and ideas easy to recall from
memory
Cognitive Mental shortcuts involving
Sunk-cost bias Biases simplified ways of thinking
Not treating past
investments (time, Anchoring bias
effort, money) as sunk- Emphasizing too
costs when deciding to much the first piece
continue an investment of information
encountered
 The Strategic Lens
1. You are a manager of a unit with 25 associates. You
have just been informed that you must lay off 20% of
the associates in your unit. What process will you
follow to make the decision and implement it?
2. If you made a decision that your manager told you was
important for the organization and later you learned
that you made an error in that decision, what actions
would you take? Assume that others will not notice
the error for some time.
3. You make decisions on a daily basis. Do you find it
difficult to make decisions, especially those of
importance? What can you do to improve your
decision-making abilities?
 Acting rationally
• Rational behavior: doing the right thing
• The right thing: that which is expected to maximize
goal achievement,
• given the available information
• Doesn't necessarily involve thinking---e.g., blinking
reflex---but
• thinking should be in the service of rational action
• Aristotle (Nicomachean Ethics):
• Every art and every inquiry, and similarly every action
and pursuit, is thought to aim at some good
Real Life Application
 - Product Launch
- Starting your own venture
• What strategy would you apply when you
are not sure, but you are sufficiently
experienced?
 Comparison

Issue Effectuation Causation

Givens Means are given Goals are given

Decision Agenda What effects can I create given these What means ought I accumulate to
means? achieve these goals?
Underlying To the extent that we can control the To the extent that we can predict the
Logic future we do not need to predict it. future, we can control it.

Basis for Can. Do what you are able to do Should. Commit based on rational
Commitment choices from analysis & maximization

Predisposition Affordable Loss. Control downside – Expected Return. Pursue (risk adjusted)
Toward Risk avoid fatal risk, pursue zero resources maximum predicted opportunity
to market

Attitude Toward Partnership. Build YOUR market Competition. Constrain task

Outside Firms together with customers, suppliers and relationships with customers and
even prospective competitors suppliers to just what is necessary
Effectuation as a process

Expanding cycle of resources

New
Goals means

Who I am
What I know What can Call people Stakeholder
Whom I know I do? I know commitments
(Self-efficacy) (Docility) (Creativity)

Means New
goals

Converging cycle of constraints on goals

Both new means and new goals are changes in constraints

What Are Games of Strategy?
• Under what circumstances does it make a difference
whether players can make binding agreements among
themselves before making their choices?
• Under what circumstances might players “gang up” on
each others by forming coalitions?
• Under what circumstance does it make a difference
whether or not the players engage in repeated play of
the same game?

• What general characteristics of games determine the

answers to these questions, by determining their
inherent logic?
 Thinking Strategically:
Dominant Strategies
• Each player in the game knows that her payoff
depends in part on what the other players do
• Needs to make a strategic decision, think about her
own choice taking other players’ view into account
• A players’ best response is a strategy that
yields her the highest payoff, assuming other
players play specified strategies
• A strategy is a player’s dominant strategy if it
is the player’s best response, no matter what
strategies are chosen by other players

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 Thinking Strategically: Iterative
Deletion of Dominated Strategies
• Even if the strategy to choose is not obvious, one can
sometimes identify strategies a player will not choose
• A strategy is dominated if there is some other strategy
that yields a strictly higher payoff regardless of others’
choices
• No sane player will select a dominated strategy
• Dominated strategies are irrelevant and can be
removed from the game to form a simpler game
• Look again for dominated strategies, repeat until there
are no dominated strategies left to remove
• Sometimes this allows us to solve games even when
no player has a dominant strategy
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 Nash Equilibrium in
One-Stage Games
• Concept created by mathematician John Nash,
published in 1950, awarded Nobel Prize
• Has become one of the most central and important
concepts in microeconomics
• In a Nash equilibrium, the strategy played by each
individual is a best response to the strategies played by
everyone else
• Everyone correctly anticipates what everyone else will do and
then chooses the best available alternative
• Combination of strategies in a Nash equilibrium is stable
• A Nash equilibrium is a self-enforcing agreement:
every party to it has an incentive to abide by it,
assuming that others do the same

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 Nash Equilibria in Games with
Finely Divisible Choices
• Concept of Nash equilibrium also applies to
strategic decisions that involve finely divisible
quantities
• To find the Nash Equilibrium:
• Determine each player’s best response function
• A best response function shows the relationship
between one player’s choice and the other’s best
response
• A pair of choices is a Nash equilibrium if it satisfies
both response functions simultaneously

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 Mixed Strategies
• When a player chooses a strategy without randomizing
he is playing a pure strategy
• Some games have no Nash equilibrium in pure
strategies. In these cases, look for equilibria in which
players introduce randomness
• A player employs a mixed strategy when he uses a
rule to randomize over the choice of a strategy
• Virtually all games have mixed strategy equilibria
• In a mixed strategy equilibrium, players choose
mixed strategies and the strategy each chooses is a
best response to the others players’ chosen strategies

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 Games with Multiple Stages

• In most strategic settings events unfold over

time
• Actions can provoke responses
• These are games with multiple stages
• In a game with perfect information, players
make their choices one at a time and nothing is
hidden from any player
• Multi-stage games of perfect information are
described using tree diagrams

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 Thinking Strategically:
Backward Induction
• To solve a game with perfect information
• Player should reason in reverse, start at the end of the tree
diagram and work back to the beginning
• An early mover can figure out how a late mover will react, then
identify his own best choice
• Backward induction is the process of solving a
strategic problem by reasoning in reverse
• A strategy is one player’s plan for playing a game, for
every situation that might come up during the course of
play
• One can always find a Nash equilibrium in a multi-stage
game of perfect information by using backward
induction
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 Cooperation in Repeated Games

• Cooperation can be sustained by the threat of

punishment for bad behavior or the promise of
reward for good behavior
• Threats and promises have to be credible
• A repeated game is formed by playing a
simpler game many times in succession
• May be repeated a fixed number of times or
indefinitely
• Repeated games allow players to reward or
punish each other for past choices
• Repeated games can foster cooperation

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 Repeated Games: Equilibria With
Cooperation
• If the repeated game has no fixed stopping
point, cooperation is possible
• One way to achieve this is through both
players using grim strategies
• With grim strategies, the punishment for
selfish behavior is permanent
• A credible threat of permanent punishment for
non-cooperative behavior can be strong
enough incentive to foster cooperation

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 Asymmetric Information

• Now the true payoffs are not necessarily

known to all players
• Each player knows his own payoffs but not
necessarily the payoffs of the other players
• In these games, each player’s decision can
reveal some of his information to the other
players
• And each player can try to mislead the other
players
 Behavioral Economics;
Uncertainty
• Why do people gamble at casinos when they know
that casinos make large profits because, on
average, gamblers lose money?
• Many people who buy a new appliance (e.g. a
refrigerator or a TV) also buy insurance against its
failure in the early part of its life, even though the
probability of a failure is very low and the expected
value of the insurance is far less than its price.
• The evidence is that people assign larger weights
to very low probability events than is consistent with
the expected utility model of choice.
William James
What Determines
Competitiveness
 EVENTS
What happened?

PATTERNS AND TRENDS

What’s been happening?

UNDERLYING STRUCTURES
What sort of structures or processes might
explain what’s been happening?

MENTAL MODELS
What is the thinking that creates or allows these
structures, patterns and events to occur?

CULTURAL AND INSTITUTIONAL VALUES

What are the values that are instilled in the organization
or community that are shaping this behavior?

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