David vs Goliath in Entry Decisions
• Suppose Goliath has $700 and David has
$300
• They are gambling types, and prefer
roulette
• Whoever ends up with more money after
the next round will win ultimately
• Suppose David moves first and makes the
safest bet
• He can never win 
David vs Goliath in Entry Decisions
• He should take one of the more risky
gambles
• Bets $300 that the ball would land on a
multiple of 3 – wins $900 w.p. 12/37
• What is Goliath’s best response
• To exactly imitate David’s bet
• Again, David can never win 
• Is there any hope for David?
David vs Goliath in Entry Decisions
• David should have gone second and
differentiated himself
• This situation is parallel to new product launch
decisions when a firm with shallow pockets
competes against a firm with deep pockets
• If going second is not feasible, then entrant
should take riskier bets – like launching a
product with some chance of failing!!
The idea behind a product line
• Consider a linear city
• It has several evenly spaced firehouses
• City closes every second firehouse and
doubles the speed of response
• Clearly the average response time
remains unchanged
• This increases efficiency: lower cost for
same average response
The old locations and response times
0
1
2
3
Maximum distance =0.5 miles
• Suppose the firehouses are one mile apart
• The maximum distance from a firehouse is 0.5
miles, and the average distance 0.25 miles
• Response time is 60 minutes per mile
• Average response time is 15 minutes and
maximum response time is 30 minutes
4
The new locations and response
times
0
2
4
• Maximum distance is 1 miles and average
distance is 0.5 miles
• Maximum response time is 30 minutes
and average response time is 15 minutes
• Consider a fire at a place 2/3rd of a mile
from a new firehouse
Variety, equity and efficiency
• The new response time is 20 minutes
• In the old system this place would be 1/3rd of a mile
away from the nearest firehouse
• It would have a response time of 20 minutes
• What about a place that is more than 2/3rd of a mile
from nearest firehouse
• New response time is 20-30 minutes, and old
response time would be less than 20 minutes
• Any change that increases efficiency by reducing
variety can reduce equity!!!
The limits of product differentiation:
customization
• Customized products are co-created by
consumer and producer
• Product comes into existence after first
interaction between consumer and firm
• A monopolist usually charges a higher
price for customized products than for
standard products
• What happens under competition?
Customization
• When two competing firms offer highly
customized products, they are not differentiated
• This intensifies competition
• Heightened competition can drastically reduce
prices
• Thus prices can be below what would obtain
with standard products
• Just because consumers are willing to pay more
doesn’t mean firms can charge more!!!
Differentiating strategies through
randomness
• Consider competition in the market for razors
• Suppose Gillette runs a coupon promotion on
the first week of every month
• Bic can preempt Gillette by running a similar
promotion a week earlier
• But then Gillette can preempt Bic the week
before
• The only sensible way to play this game is to run
promotions randomly
Baseball anyone?
• 1986 baseball National League
championship series
• The New York Mets won a crucial game
against he Houston Astros
• Len Dykstra hit Dave Smith’s second pitch
for a two-run home run
• Later the two players talked about this
critical play
Analysis of a home run
• Dykstra said, “He threw me a fastball on the first
pitch and I fouled it off. I had a gut feeling then
that he’d throw me a forkball next, and he did. I
got a pitch I saw real well, and I hit it real well”.
• Smith said, “What it boils down to is that, it was
a bad pitch selection…if I had to do it over again,
it would be [another] fastball”.
• Would Dykstra not have been prepared for a
fastball?
• Again, randomization is the only way to go
But how do you randomize?
• In a game of tennis, suppose receiver’s forehand
is stronger than backhand
• Consider following probabilities of successfully
returning serve
Server’s Aim
Forehand Backhand
Receiver’s Move
Forehand
90%
20%
Backhand
30%
60%
Reducing receiver’s effectiveness
by randomizing
• Suppose server tosses a coin before each serve
• Aims to forehand or backhand according to coin turning
heads/tails
• When receiver moves to forehand, his successful return
rate is 55%
• When receiver moves to backhand, his successful return
rate is 45%
• Given server’s randomization, receiver should move to
forehand
• The server has already an improved outcome compared
to serving the same way all the time!!
What is server’s best mix?
• Consider following graph
Percentage successful returns
90
60
48
30
20
0
40
Percentage of times server aims serve to forehand
100
The mixing probabilities
• The 40:60 mixture of forehands to
backhands is the equilibrium
• This mixture is the only one that cannot be
exploited by the receiver to his own
advantage
• With this mixture the receiver does equally
well with either of his choices
• Both ensure the receiver a success rate of
48%
Co-promotions as differentiation
• Consider two firms selling undifferentiated
products
• Price competition will be very fierce
• However one of the firms can bundle their
product with another product for which
consumers differ in their willingness to pay
• Thus both firms can benefit from the
resulting differentiation!!
Game theory detour
• Focal market (F):
-Two firms A and B selling
undifferentiated products at cost c and
quality q
-Consumers willingness to pay for
quality is a constant r
• Competition is intense and firms have to
sell at marginal cost c
• They make zero profits
Game theory detour
• Outside market (O):
- Has potential partnering brand with quality qC
and cost c C
-Consumers have heterogeneous willingness
to pay for quality given by  O
-  O is distributed uniformly on [0,  O ]
• Suppose A partners with C and B stands alone
• Let the prices be pB and pAC
• Consumers will prefer AC to AC if r  pB > r  o qC  p AC
Game theory detour
• The demands are d B  p AC  pB and d AC =1- d B
qC O
• The profit functions are  AC  ( pAC  c)d AC and
 B  ( p B  c )d B
• The optimal prices are p

AC
qC O
2qC O

c
, pB  c 
3
3
• And the optimal profits are 

AC
4qC O

9
,
qC O
 
9

B
Sources of differentiation
• Differentiation grows out of the firm’s value
chain
• A firm can also differentiate itself through
the breadth of its activities
• Differentiation is useful only if buyers value
it
• Buyer value operates through
- by lowering buyer cost
- by raising buyer performance
Buyer purchase criteria
• Buyer value applied to a particular industry can identify
Buyer Purchase Criteria
• Buyer purchase criteria
- Use criteria
- Signaling criteria
• Use criteria: supplier affects actual buyer value through
lowering buyer cost or raising buyer performance
• Signaling criteria: stems from signals that enable buyer
to judge what supplier’s value is, e.g. advertising,
attractiveness of facilities, branding and reputation