STRATEGIC THINKING
Managerial Economics
Jack Wu
Strategic Thinking
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 marketingbased competition”,
Andrew Conway, Morgan Stanley
COMPETITIVE DILEMMA
Pepsi
Raise price Discount
Raise
price
Coke
C: 3,
P: 3
Discount C: 5,
P: 0
What should Coke do?
C: 0,
P: 5
C: 1,
P: 1
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
Raise price
Coke
What
Discount
C: 3,
P: 3
C: 5,
P: 0
should Coke do?
Discount
C: 0,
P: 5
C: 1,
P: 1
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,
M: 40
J: 60,
M: 40
no change
J: 70,
M: 30
J: 50,
M: 50
Jupiter
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
Hot AC
Jupiter
no change
J: 60,
M: 40
J: 70,
M: 30
no change
J: 60,
M: 40
J: 50,
M: 50
NASH EQUILIBRIUM:
PRISONERS’ DILEMMA
Sam
Do not confess
Ian
Do not
confess
Confess
What
I: 0,
S: 0
I: 0,
S: -10
should Sam do?
Confess
I: -10,
S: 0
I: -5,
S: -5
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
We.com
NHL
NBA
W: 4,
C: 3
W: 3,
C: 4
NHL
W: 3,
C: 4
W: 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
High price J: 60,
Jaya
M: 40
Low price J: 50,
M: 40
Low price
J: 40,
M: 50
J: 50,
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
7.30pm
Zeta
8.00pm
A: 1,
B: 1
A: 4,
B: 3
8.00pm
A: 3,
B: 4
A: 2.5,
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
Orange
S: 1.5
Sol Corp.
Green
S: 1
V: 1.5
Green
S: 1
V: 1
S: 1.5
V: 1
V: 1.5
COORDINATION/COMPETITION:
FUTURE DVD STANDARD
Consumers
Blu-ray
DVD player
manufacturers
Blu-ray
HD-DVD
M: 1,
C: 1
M: -1,
C: -1
HD-DVD
M: -1,
C: -1
M: 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
consumer
Litho
Do not
Do not
Litho
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 15% 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
activates rights
acquires 100,000
shares
Hilda
Sharon
does not
doesn’t bid
Hilda loses on
initial stake +
cost of
takeover rises
STRIKE
reject union
demand
Employer
strike
Lose current wage
and possibly gain in
future wage
do not
Maintain current
wage
Union
accept
Why are strikes rare in
American professional football?
CONDITIONAL STRATEGIC MOVE:
WITHOUT DEPOSIT INSURANCE
depositor
bank remains
solvent
maintains
deposit
depositor
withdraws
deposit
principal
+ interest
bank
insolvent
zero
bank remains
solvent
principal
bank
insolvent
principal
CONDITIONAL STRATEGIC MOVE:
WITH DEPOSIT INSURANCE
depositor
bank remains
solvent
maintains
deposit
depositor
withdraws
deposit
principal
+ interest
bank
insolvent
principal
bank remains
solvent
principal
bank
insolvent
principal