STRATEGIC THINKING

IMBA Managerial Economics

Jack Wu
 COKE VS. PEPSI, 1999

Nov. 16: Coca-Cola raised price 7%

Nov. 22: Pepsi raised price 6.9%
“Coke and Pepsi will move now from
price-based competition to marketing-
based competition”,
Andrew Conway, Morgan Stanley
COMPETITIVE DILEMMA

Pepsi
Raise price Discount
Raise C: 3, C: 0,
price P: 3 P: 5
Coke
Discount C: 5, C: 1,
P: 0 P: 1

What should Coke do?

STRATEGIC SITUATIONS
 parties actively consider the interactions with one
another in making decisions
 game theory -- set of ideas and principles to guide
strategic thinking
 simultaneous actions: strategic form
 sequential actions: extensive form
DOMINATED STRATEGY
generates worse consequences than another strategy,
regardless of the choices of the other parties
 never use dominated strategy
NASH EQUILIBRIUM
Given that the other players choose their Nash equilibrium
strategies, each party prefers its own Nash equilibrium
strategy
• No one is willing to deviate unilaterally from a Nash
equilibrium
SOLVING FOR NASH EQUILIBRIUM
 eliminate dominated strategies, then check remaining
cells
 “arrow” technique
NASH EQUILIBRIUM:
COMPETITIVE DILEMMA

Pepsi
Raise price Discount

C: 3, C: 0,
Raise price P: 3 P: 5

Coke C: 5, C: 1,
Discount
P: 0 P: 1

What should Coke do?

COKE AND PEPSI GAME
Nash equilibrium: for both parties, “raise price” is
dominated by “discount”.
 but discounting is bad for both -- if only they could
agree somehow to raise price.
 Coke and Pepsi stuck in this situation for four
years until November 1999.
RADIO FORMATS
Merkur

Lite AC no change

Hot AC J: 60, J: 60,

Jupiter M: 40 M: 40

no change J: 70, J: 50,

M: 30 M: 50
RADIO FORMATS
For Merkur, “Lite AC” is dominated by “no change”;
so consider only “no change”,
 assuming Merkur chooses “no change”, Jupiter
should choose “Hot AC”.

 Repeat using “arrow technique”.

NASH EQUILIBRIUM:
RADIO FORMATS

Merkur

Lite AC no change

J: 60, J: 60,
Hot AC
M: 40 M: 40
Jupiter J: 70, J: 50,
no change
M: 30 M: 50
NASH EQUILIBRIUM:
PRISONERS’ DILEMMA

Sam
Do not confess Confess

Do not I: 0, I: -10,
confess S: 0 S: 0
Ian
I: 0, I: -5,
Confess
S: -10 S: -5

What should Sam do?

OPEC: OIL CARTEL

June 1998: Saudi Oil Minister Naimi, “I

don’t think anybody expects 100%
compliance… Once the price goes up,
there will be cheating”
March 1999: Algerian Oil Minister
Youcef Yousfi, “OPEC is still able to act
collectively and restore market stability”
OUT OF NASH EQUILIBRIUM
What if another player doesn’t play Nash equilibrium
strategy?
 Nash equilibrium strategy may not be best

 still don’t use dominated strategy

 WHERE TO ADVERTISE?

Competitor.com
NBA NHL
NBA W: 4, W: 3,
C: 3 C: 4
We.com
NHL W: 3, W: 4,
C: 4 C: 3
No Nash equilibrium in pure strategies
RANDOMIZED STRATEGIES
 choose among pure strategies according to probabilities
 must be unpredictable

 Example: where to advertise

 _ We.com: ½ NBA and ½ NHL

 _ Competitor.com: ½ NBA and ½ NHL

RANDOMIZED STRATEGIES:
RETAIL PRICE COMPETITION

 Two competing retailers – Jaya and Ming

 Three segments
 captive (loyal) to Ming
 captive (loyal) to Jaya
 switchers
RANDOMIZED STRATEGIES:
RETAIL PRICE COMPETITION

Ming
High price Low price

High price J: 60, J: 40,

Jaya M: 40 M: 50

Low price J: 50, J: 50,

M: 40 M: 30
RANDOMIZED STRATEGIES:
RETAIL PRICE COMPETITION

 Pricing trade-off:
 high price to extract buyer surplus of loyal customers
 low price to get store switchers

 Solution: randomized discounts

COORDINATION/COMPETITION:
EVENING NEWS

Delta
7.30pm 8.00pm

A: 1, A: 3,
7.30pm
B: 1 B: 4
Zeta A: 4, A: 2.5,
8.00pm
B: 3 B: 2.5
COORDINATION AND COMPETITION
Prime time for news is 8:0pm; second best is
7:30pm;
 since audience is limited, get maximum viewership
if two channels schedule at different times.
 Question: which station gets 8:0pm? Situation has
elements of
 coordination -- avoiding same time slot
 competition -- getting the 8:0pm slot
ZERO/POSITIVE SUM
 zero-sum games: pure competition -- one party better off
only if other is worse off
 positive-sum games: coordination -- both can be better
off or both worse off
 co-opetition: competition and coordination
COORDINATION/COMPETITION:
INSTANT MESSAGING TECHNOLOGIES

Venus Inc.

Orange Green

Orange S: 1.5 S: 1
Sol Corp. V: 1.5 V: 1
Green S: 1 S: 1.5
V: 1 V: 1.5
COORDINATION/COMPETITION:
FUTURE DVD STANDARD

Consumers

Blu-ray HD-DVD

M: 1, M: -1,
Blu-ray
DVD player C: 1 C: -1
manuf- M: -1, M: 1,
acturers HD-DVD
C: -1 C: 1
COORDINATION/COMPETITION:
FOCAL POINT

 Single Nash equilibrium - clear focal point

 Multiple Nash equilibria - look for focal point to see which
one to play
SEQUENCING
Game in extensive form – sequence of moves:
nodes
branches

outcomes
EXTENSIVE FORM: EQUILIBRIUM
backward induction
 final nodes  intermediate nodes  initial node
SEQUENCING:
EXTENSIVE FORM - TV NEWS
STRATEGIC MOVE
Action to influence beliefs or actions of other parties in a
favorable way
• credibility
– first mover advantage
– second mover advantage
EXAMPLES
 Examples:
 Evening TV news -- both stations want to move first: which one can?
 Use strategic move, eg, contracts with advertisers to deliver
news at 8pm.
 Famous Chinese general: after crossing a river, burnt his ships -- strategic
move to force soldiers to fight harder.

 Issue: Is the move credible? Will it convince the other players?

 Advantage doesn’t always go to first mover;

 In war, better to see opponent’s move, and then take action, eg is enemy
moving south or north?
 new product category -- let competitor test the market and educate the
customers
 LITHOGRAPHER
Make more prints

Buy
Make prints Litho

consumer Do not

Litho Do not

Do not (1) serial number

(2) destroying the plate
(3) other solution?
CONDITIONAL STRATEGIC MOVES

 Threats – if it succeeds, then it needn’t be carried out

 Promises – if it succeeds, then it needn’t be carried out
 Ideal strategic move doesn’t impose costs
MORGAN STANLEY:
“SHAREHOLDER RIGHTS PLAN”

If any party acquires 10% or more of company’s shares,

other shareholders get right to buy additional shares at 50%
discount.
Impact on hostile bidder?
SHAREHOLDER RIGHTS PLAN
This shareholder rights plan is a threat to potential
bidders:
 most hostile bidders begin with small stake;
 with shareholder rights plan, if bidder acquires
more than 15%, then rights triggered, and bidder
will be diluted.

Nickname: poison pill.

 Actually works against shareholder rights -- by
entrenching existing management.
 POISON PILL
Hilda loses on
initial stake +
cost of
activates rights
takeover rises
acquires 100,000
shares Sharon

Hilda
does not

doesn’t bid
 STRIKE
strike Lose current wage
and possibly gain in
reject union Union future wage
demand

Employer do not Maintain current

wage
accept

Why are strikes rare in

American professional football?
CONDITIONAL STRATEGIC MOVE:
WITHOUT DEPOSIT INSURANCE
depositor
bank remains principal
solvent + interest
maintains
deposit bank
insolvent zero
depositor
bank remains
solvent principal
withdraws
deposit
bank
insolvent principal
CONDITIONAL STRATEGIC MOVE:
WITH DEPOSIT INSURANCE
depositor
bank remains principal
solvent + interest
maintains
deposit bank
insolvent principal
depositor
bank remains
solvent principal
withdraws
deposit
bank
insolvent principal