firm internationalization, first mover advantage, and the nash equilibrium
TRANSCRIPT
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Firm Internationalization, First Mover
Advantage, and the Nash Equilibrium
Philip V. Fellman
Southern New Hampshire University
Manchester, NH
Nicholas Nugent
Southern New Hampshire University
Manchester, NH
David Doyon
Southern New Hampshire University
Manchester, NH
Jonathan Vos Post
Computer Futures
Altadena, CA
Roxana Wright
Plymouth State College
(Paper presented at the 14th
Annual Meeting of the Association of Japanese Business
Studies, Academy of International Business, Indianapolis, IN, May, 2009)
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Abstract: In the following paper we step outside of the traditional domain of
international business theory. Using techniques from mathematical economics and from
recent developments in game theory, we develop a predictive tool aimed at providing
elements of a prescriptive methodology for strategic international market entry.
Introduction – Firm Internationalization and First Mover Advantage
A recent Harvard Business Review Article by Suarez and Lanzolla (2005) entitled
The Half-truth of First Mover Advantage argued that the concept of first mover
advantage has so much intuitive appeal that its validity is generally taken for granted.
They explain this eloquently, noting:
Some management concepts such intuitive appeal that their
validity is almost taken for granted. First-mover advantage is one
such concept. Although the fate of its most convinced adherents,
the dot-coms, offers a cautionary lesson, managers 'faith that first-
mover status brings important competitive advantages, even when
network effects are not available to accelerate and entrench it,
remains undiminished. Business executives from every kind of
company maintain, almost without exception, that early entry into
a new industry or product category gives any firm an almost
insuperable head start.
Corporations, groups of corporations, and bureaucrats responsible for providing the
administrative guidance which supports many Asian countries’ national investment and
manufacturing strategies often rely on the bundled concepts of first mover advantage,
early market entry, targeted technologies, and market flooding. They adopt this set of
strategies in order to gain early brand loyalty with the expectation that these strategic
moves will, over the long, term yield above average profitability (Porter, 1996). One of
the problems we find with this strategy (again following Porter) is that it is often
excessively imitative in nature, and too frequently relies on unidimensional measures of
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product performance (such as zero defect manufacturing and other, similar quality control
measures). At the same time, best practice (as well as value chain reinforcement and
higher order strategic fit) may actually be rather poorly distributed or maladapted from
the sources of imitation. In this context, sustainable profitability receives insufficient
scientific and managerial consideration. For example, the practices associated with
market flooding can often provoke a series of counterproductive behaviors. As
Eisenmann (2003) argues:
“…The stakes can be enormous when firms race to acquire
customers: if winners take most, little is left for losers. In extreme
cases, racing can yield disastrous results for all parties. This was
true for many industries in which firms pursued learning curve
strategies. After cutting prices, these firms found it difficult to
gain sustainable cost advantages. Often they were unable to keep
their learning proprietary due to technological spillovers:
competitors copied their new and improved techniques.”
However, the ability of firms to profit from this approach is questionable along
several dimensions. For a start, let us consider Suarez and Lanzolla’s literature review:
…for every academic study proving that first-mover
advantages exist, there is a study proving they do not While some
well-known first movers, such as Gillette in safety razors and Sony
in personal stereos, have enjoyed considerable success, others,
such as Xerox in fax machines and eToys in Internet retailing, have
failed. We have found that the differences in outcome are not
random-that first mover status can confer advantages, but it does
not do so categorically. Much depends on the circumstances in
which it is sought. One possible explanation for Sony's success is
that its strong brand name, substantial financial resources, and
excellent marketing skills allowed it to make the most of its first-
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mover status. But Xerox, too, had a great brand name, deep
pockets, and many valuable skills. And Sony, despite its brand and
marketing muscle, could not translate being the first mover in
home VCRs into anything approaching its success with the
Walkman. Yes, a firm's resources – and luck-are important, but
certain other factors and conditions can be decisive as well.
Quality vs. Strategy
Porter explains some of those factors in terms of the rather unfortunate consequences
of excessive reliance on quality as a proxy for strategy as well as the outward movement
of the production frontier, resulting in a series of improvements in corporate performance
along virtually every dimension except profitability (Porter, 1996). Porter illustrates this
problem as shown in figure 1 below:
Figure 1: Operational Effectiveness vs. Strategic Positioning Along a Shifting
Productivity Frontier.
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We can see that as the productivity frontier moves outward margins are naturally
bound to shrink, as indeed is well known from Boston Consulting Group studies of the
product life cycle (Stern et al, 1998). Unfortunately, it is precisely the element of
profitability which we wish to explore, and which is central to the acquisition and
maintenance of sustainable competitive advantage. If we follow this line of reasoning
with Eisenmann’s graphical illustration of sustainable competitive advantage, it is easy to
see the result of the expanding production frontier (Figure 2, Eisenmann, 2003):
Figure 2: The NPV Impact of Investments in Customer Acquisition
As we can see from figure 2, Eisenmann is not insensitive to Porter’s analysis, and his
approach is to catalogue the standard requirements for competitive advantage as factors
which increase customer acquisition cost. He sees the main pitfall of the customer race,
or the race for first mover advantage to arise from attempts to broaden a company’s
products beyond the core demand characteristics of the bundle of goods and services
most likely to appeal to its customers. Understanding the structure of these bundles is not
prima facie terribly difficult. In Figure 3 we have developed a simplified chart designed
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to express the tradeoffs between price and quality that Porter explores more fully in his
cost-focus matrix.
This kind of analysis of market positioning can easily be related to Suarez and
Lanzolla’s arguments. Essentially, they distinguish between what they describe as
“durable” first mover advantages, where a firm obtains the type of first mover advantage
which allows it to gain a long term advantage over competitors, as compared to short-
term benefits, particularly shareholder value creation in U.S. companies, advantaged by
early positioning in competitive markets. A distinguishing factor is the question of
whether a short-term investment can, in fact, be translated into a long term competitive
advantage. One example of this which they use is the competitive positioning of
Netscape as an internet browser and its ultimate effect on Microsoft and Apple
Computer’s relative stock performance:
…even when a company cannot build a durable first-mover
advantage, it may obtain some benefits from early entry. The
pioneering efforts of Netscape, the first to market an internet
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browser, briefly produced enormous gains for shareholders until
the stock price plummeted in 1997 following the rise of
Microsoft's browser, Explorer. Apple declined more gradually-it
was profitable for several years before pressure from Microsoft
and Intel took a toll, forcing it to restructure in the early 1990s.
Whether the end comes suddenly or slowly, profits can be great
enough to make a short-lived first entry a worthwhile investment-
and perhaps to make it a strategic objective. Of course, a business
is free to choose not to enter a new market at all. But even a
runner-up's margins may look good compared to the opportunity
cost of staying out of a new market.
However, unlike Suarez and Lanzolla, and like Michael Porter, we believe that in
international markets the rush to gain first mover advantage, is too often imitative, too
often leads to destructive competition, and too often leads to all sorts of gains which
translate into everything but profitability. In this sense, our approach is rather critical of
the rush to first mover advantage in general, even before we apply the Nash equilibrium
to obtain what we believe is a novel mapping of where one can locate or, alternatively
positively rule out a first mover advantage. In a weaker form, we would agree with
Suarez and Lanzolla that it is almost always possible, in some form, for a firm to obtain a
first mover advantage. However where we disagree is that we feel it is categorically,
(and as we shall demonstrate later in this paper, mathematically) not always possible to
obtain a profitable first mover position.
Industry Dynamics
Much of Suarez and Lanzolla’s approach hinges on appraising industry dynamics.
They take a tactical approach to this and categorize industry strategies as falling into one
of three positions: (a) creating a technological edge; (b) pre-empting later arrivals’ access
to scarce access and (c) building an early base of customers who would find it
inconvenient to switch to the products of subsequent entrants. Our point of disagreement
with them is not that their analysis is wrong but rather that it is what physicists would
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describe as too grossly grained to capture the critical market dynamics. Suarez and
Lanzolla do illustrate some mechanisms of common market penetration, but their analysis
is quite primitive compared to that of Theodore Modis (1998) and others who have
approached the problem from a quantitative modeling direction rather than from a
comparative business, or qualitative history of economics direction. They raise some
interesting questions about product introduction and the relationship of the production
frontier to product introduction, but their comparative analysis of the pace of change (p.
123) falls far short of Modis systematic approach through the use of sigmoid growth
curves and their derivatives to explain product life cycles and product replacement. More
troubling, Suarez and Lanzolla do not look nearly deeply enough into the process of
technology shock, which can undermine the entire dynamics of all three of their strategies
and which has a characteristic shape to switching costs and the definition of adopter
practices. Most likely, they are simply unfamiliar with the simulation and evolutionary
economics literature which describes these processes, which is unfortunate, because
while their basic analysis is, in fact, relatively on target, they miss some of the most
important dynamics of technology replacement, which makes it difficult to apply their
reasoning on anything beyond a metaphorical or analytical level.
Mauro Guillen (2001) characterizes the problem with this approach when he cites the
largely imaginary homogeneity which most business authors attribute to the process of
globalization:
Conventional wisdom has it that the world is undergoing rapid
globalization and that this process compels countries, industries,
and firms to converge toward a homogeneous organizational
pattern of “best practice” or “optimal efficiency”. Those who fail
to conform are doomed to fail in the global economy. I argue
against this modernist, flat-earth view of globalization. Countries
and organizations do not gravitate toward a supposedly universal
model of economic success and organizational form as they
attempt to cope with globalization. Rather, the mutual awareness
that globalization entails invites them to be different, namely, to
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use their unique economic, political, and social advantages as
leverage in the global marketplace.
In our own research, we have used the non-equilibrium economic approach pioneered
by W. Brian Arthur to examine a more precise definition of what it means to introduces
new technologies, pre-empt a user base or attempt to control switching costs, including
pre-emption by first-mover market flooding. The Arthur approach allows us to introduce
network externalities, “open” systems and non-equilibrium dynamics, all features which
we believe are particularly characteristic of the global information revolution (see also
Katz, Shy, Shapiro and Varian, etc.) Arthur’s methodology can be used to develop a
more comprehensive treatment of technology diffusion and technology replacement, as
demonstrated by the work of Paul Windrum and Chris Birchenhall (2001) as well as that
of simulation experts at the New England Complex Systems Institute and the Santa Fe
Institute (Mertz et al., 2006; Bonabeau, 1999). When we combine the foregoing research
with insights from the Nash equilibrium, we arrive at both a more systematic treatment of
new technology introduction than that offered by Suarez and Lanzolla as well as a more
precise, and ultimately quite different characterization of first mover advantage than the
layman’s description provided by Suarez and Lanzolla.
For a start, the adoption of new technologies is not nearly as simple as Suarez and
Lanzolla make it out to be. Market advantage is driven by complex evolutionary
dynamics. These dynamics are perhaps best described by Stuart Kauffman (1993, 1996)
in his transfiguration of the neo-Darwinist evolutionary paradigm, particularly in his
explanation of the structure of “rugged fitness landscapes” and characteristic efficiencies
of search patterns in rugged multi-peaked dynamic fitness landscape type environments.
Effective search, which can be closely tied to core products, core competencies and
Michael Porter’s value chain (McKelvey, 1999) is very different on a rugged multi-
peaked environment than it is on the Kilimanjaro-like single peaked global optimum of
neo-classical microeconomics (Macready, 2006; Fellman, et al, 2009).
In particular, it appears that emergent patterns of technological networking typically
follow a “punctuated” collapse when a new technology is introduced. Paul Windrum
explains this process in his 1999 study, whose findings were subsequently verified in
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Windrum and Birchenhall’s 2001 simulation. Windrum and Birchenhall discovered and
subsequently mapped a strongly dichotomous grouping of technology adopters arising
after a technology shock or the sudden introduction of new technologies to the
marketplace (Windrum, 1999, Windrum and Birchenhall, 2001). What this means is that,
dependent on product characteristics1, some products produce a universal shift from the
old technology to the new technology, while other products result in some retention of
the old technology by old users while a new user population adopts the new technology
(Windrum and Birchenhall 2001).
This set of findings also suggests that in examining network relationships and
resource based strategies of international market entry, some of the relative network
characteristics may be rather different than those traditionally suggested in the literature.
The “punctuated collapse” finding, for example, suggests that with rapidly shifting
technologies, firm alliances across emerging technologies with, as yet, low market
penetration, may be of equal or greater importance than network relationships across
established clusters. Also, as Butts (2000, 2001) and Carley (2003) have suggested in a
slightly different, but nonetheless relevant context, differentiating between cohesive and
adhesive networks may likewise be an important function of addressing the behavior and
value of network relationships. For new technologies, adhesion to new standards, such as
open source software, or software as a service, may provide the foundation of emergent
relationships and network externalities, ultimately driving who gets the actual first mover
advantage (Fellman, Nugent and Mertz, 2007; Pring, 2007).
First Mover Advantage, Second Mover Advantage and the Nash Equilibrium
To help unravel the complexities surrounding technology evolution and its
relationship to first and second mover advantage in new, international markets we will
turn to a rather interesting explanation by game theorist Paul Hofer (Hofer, 1998), taken
in part from Cambridge University lectures by Sir Partha Dasgupta (see also Dasgupta,
2005), the first economist in its three hundred odd year history to be appointed as a
1 Variations in product characteristics are represented by Windrum and Birchenhall by their simulation of
non-linear design characteristics. While they have simplified this in the 2001 study, it does in fact
approximate Stuart Kauffman’s next nearest neighbor methodology used by the Ernst and Young Center
for Business Innovation in advising clients on new product development strategies.
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Fellow of the Royal Society. We provide a close reading of Hofer here because we feel
the importance of his work demands more than a brief summary or even a modest
synthesis.
In order to demonstrate the basic use of Nash equilibrium in strategic planning, Hofer
first provides an example of a game in normal form with independent Nash equilibria.
Here, players move independently and there is no differential advantage or disadvantage
arising out of sequential play or sequential implementation of strategies. This approach is
characteristic to the simplified explanation which Nash provides at the beginning of his
thesis where he notes that “it turns out that the set of equilibrium points of a two-person,
zero-sum game is simply the set of all pairs of ‘opposing good strategies” (Nash, 1950).
player 2
plan A plan B
player 1
plan A 7; 9 0; 1
plan B 3; 5 4; 2
Figure 4: Hofer’s first example: A normal, bi-matrix, zero-sum strategy game
Hofer then modifies the payoff matrices as shown below, giving the advantage to
whoever moves first, thus forcing the expansion of the game from normal form, where all
the moves may be played simultaneously to the extensive form, where strategies are
executed and outcomes are reaped sequentially:
Figure 5: The Bimatrix game in extensive form, expressed as a decision tree.
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Hofer’s next step, which is really the key step in exploring alternative strategies and
applying the model to the analysis of decisions under conditions of uncertainty, is then to
modify the payoff at the extreme lower right from 4;2 to 4;10. This modification
produces a new structure which contains not one but two Nash equilibria. What is
important here is that the sequential nature of the game, something which all students of
international trade and negotiations are familiar with, allows the player who moves to
determine which of the two Nash equilibria the game actually arrives at.
In being able to force a single, specific Nash equilibrium from one of multiple
outcomes, by an early mover choice, we now have a scientific explanation of what
constitutes an actual first mover advantage. We will further explain this process below.
In comparison to the example given above, Hofer argues that the traditional approach
to understanding the second mover advantage has generally been fallacious. Some of the
common errors in this regard are likely just the consequence of poor choices in
explanatory language, often coupled with a weak technical understanding of the
mathematics of game theory. However, the deeper point to be made here is that a proper
understanding of the application of the Nash equilibrium can, in fact, be used to replace
weak or questionable examples of “second mover advantage” with a new category of
arguments which properly define the second mover advantage position and process.
Naturally, we believe that this kind of scientific advance should be of some
considerable interest to those involved in strategic planning, particularly when that
planning involves new international market entry and a decision as to whether or not to
become the first entrant in a new, foreign market.
The Traditional View of Second Mover Advantage
Hofer’s example of the conventional treatment of second mover advantage uses as the
setting of the industrial revolution with England being the first mover and Continental
Europe being the second mover (a type of explanation familiar to students of political
economy). Coincidentally, this also happens to be the kind of over-generalized approach
of which Mauro Guillen is so rightfully critical in his analysis of the literature on
globalization. This example is illustrated below in figure 6.
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Continental Europe
industrialise don't industrialise
England
industrialise 20; 45 60; 10
don't
industrialise 10; 60 0; 0
Figure 6: Dasgupta and Hofer’s Game Theoretic Depiction of Early Industrialization
Hofer then points out that if one examines this game carefully, its form is not really
different from that of game 1. What is perhaps more significant is that upon close
inspection, there is no way to change these payoffs. Whether Britain industrializes first
or second, the payoff remains the same (i.e., 20 for England and 45 for Europe):
Figure 7: The industrialization problem expressed in extensive form as a game-theoretic
decision tree (the nodes are determined by game moves not by probabilities)
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This treatment demonstrates that, at least in a scientific or mathematical sense, there
is no meaningful way in which one can define the so-called “second mover advantage” in
such circumstances or a game theoretic framework in this kind of hypothetical setting.
The payoff for industrializing is simply higher for the second player. Choice, however,
the sine qua non of strategic planning, is simply not involved! This means that such
characterizations of second mover advantage cannot be measured, nor can they provide
meaningful decision heuristics for strategic planners. They are, at best, academic
fictions, and at worst, crackpot misrepresentations of game-theoretic metaphors which
confuse and confound serious strategic issues.
An even worse consequence of this choice of game metaphor is the fact that if one
tries to change the sequence of moves, then the outcome must change as must the
equilibrium payoffs. This leads a depressing set of “surprising, but irrefutable results”
(Hofer, 1998). Because this kind of game has only a single Nash Equilibrium, the payoff
remains at 20 for England and 45 for Europe no matter who moves first. Thus,
mathematically speaking, it is essentially nonsense to speak of a second mover, or at least
a second mover advantage or in mathematical language “an extensive form game” in this
context. If one attempts to get around this difficulty by incorporating other factors, such
as a postulated learning curve effect, then one can get different numbers, but the different
payoffs generated as the result of such modifications of the basic framework then mean
that the comparison is unavoidably being made between two entirely different games,
leading to an incommensurability which is even worse than the problems generated by
the initial case.
The best that such an approach can do is lead to a “fortuitous mistake”. In more
ordinary terms it means that this type of analysis will always provide a false rationale and
lead to false or unsupported strategic conclusions. In simple terms this kind of game
theoretic metaphor (in part because it is just metaphor and not proper mathematical game
theory) is the kiss of death to sound strategic forecasting. As a guide to international
market entry its shiny bells and whistles are inherently and profoundly misleading.
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A New View of the Second Mover Advantage
Fortunately, this is not the end of the story. Behind this foregoing analysis lies an
alternative second mover advantage of a very different kind. Something which one might
label “real second mover advantage”. This kind of second-mover advantage is one which
is mathematically and methodologically properly stated, and which is purely defined by
its Nash Equilibrium characteristics. That is, it is a market situation which has no Nash
equilibrium, but which constitutes a solvable game via backward induction.2
The example which Hofer uses is one where competing firms must decide whether to
use common or proprietary technologies. This is the kind of issue which has played a
strong role in the development of modern, information age technologies (Evans and
Wurster, 1997; Windrum and Birchenhall, 2001, Fellman, Mertz and Nugent, 2007).
Dasgupta and Hofer disguise the participants in the game by calling them Apple and
Microsoft. We have restructured their example to reflect the actual competitors,
Microsoft and Apple, and the game runs along the lines discussed below.
Two competing firms, Apple and Microsoft both produce similar products. However,
Apple has only a small market share, while Microsoft controls a major portion of the
market. Both companies want to bring a new product onto the market, which will require
them to introduce one of two new operating systems. In this regard Microsoft, despite its
size has also has an inferior product technology compared to Apple, something like the
current competitive situation between Apple’s iPod ™ and Microsoft’s Zune ™ system. If
both firms decide to launch their products using the same operating system (i.e. the same
digital storage, music and video download and playback formats), then the whole market
would be encompassed by that system (i.e. .mp3, .mp4 or .wma, etc.) and in terms of the
hardware (iPod vs. Zune), everybody would be able to choose between the two
technologies and the products of the two companies.
Both history and game theory show that such a situation would significantly favor
Apple. On the other hand, if the two firms operate different systems, Microsoft's
customers are stuck with Microsoft's system and hence have no access to Apple's
2 The caveat, which is both reasonable and relatively commonplace is that the sequence of moves must be
known. This is akin to mapping the set of possible strategy spaces for the particular problem, again
something often done on a two by two matrix.
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advanced technology, as well as Apple’s software distribution system, iTunes, which
could then only be sold to Apple's customers, thus limiting iTunes and presumably even
the iPod’s market share.
When Dasgupta and Hofer set up a problem of this type, they used the following game
theoretic payoffs for this type of bivariate matrix (Hofer, 1998):
Microsoft
iTunes Windows Media Audio (.wma) file
Apple
iTunes 10; 4 3; 6
.wma 2; 7 9; 5
Figure 8: iPod vs. Zune as a function of downloads and operating systems
Hofer’s argument is that even in a situation like this, where there is no Nash
Equilibrium, as long as the sequence of moves is know, we can calculate the outcome. If
Apple enters the market first, they will choose System A (.mp3 and .mp4 and iTunes), to
which Microsoft will respond by choosing system B (Microsoft Windows Media Audio
files and an alternative array of Windows compatible video files). If Microsoft had
moved first, they would still have chosen System B, but in that case, it would have been
to Apple’s advantage to have used the same (although admittedly inferior) system rather
than the iTunes format which they were able to choose to their considerable advantage as
the nominal first mover in the personal digital media player market.
What is, perhaps, most interesting about the game theory analysis is that both players
do better (i.e., enjoy a second-mover advantage, or a higher payoff) when they go second.
Unlike the counter-factual hypothetical explanation advanced for industrialization, this
type of setting possesses a real second mover advantage, precisely because the second
mover enjoys a higher payoff than if they had moved first. Microsoft would have had
higher hardware sales but all of the profits from their content would have accrued to
Apple through iTunes and the iTunes store. This is a model of second mover advantage
which can be measured and directly applied to strategic planning decisions, particularly
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those regarding first or second mover strategies not just for new product market entry but
for foreign market entry as well.
Conclusion: Identifying Real First Mover and Second Mover Advantage
In defining the game theoretic characteristics of authentic first mover advantage,
Hofer uses a simple game of “musical chairs” in the Princeton University dining hall to
illustrate how one can achieve an optimal payoff by moving second (see Hofer, 1998). In
the more complex setting of international business, anticipating one’s rival is often a
function of possessing accurate information. In this context, disinformation may well be
one of the most powerful tools available for developing competitive strategies where a
real second mover advantage is involved.
Here, the principal identifier for the second mover advantage is being able to
calculate the absence of a Nash equilibrium. However, there is also a second identifier
which can easily be observed, and that is the presence of mixed strategies. If a
competitive dynamic possesses mixed strategies, then the game will have at least one
Nash Equilibrium. This is a direct consequence of Nash’s proof where the
correspondence of mixed and pure strategies define the combinatorics of his argument
(Nash, 1950, pp. 2-3). This feature of the Nash equilibrium leads us to two important
conclusions. First, if we are attempting to formally define a true second mover
advantage, then we can immediately rule out any strategic situation with mixed strategies
(i.e., in order to satisfy the conditions of genuine second mover advantage, there must be
no Nash Equilibrium, which necessarily means no mixed strategies.)
In defining authentic and mathematically rigorous first mover advantage, exactly the
opposite situation obtains. If we are attempting to discover whether there is a real first
mover advantage in new market entry, then we should be looking for a situation which
demonstrates at least one Nash Equilibrium, and we should be looking for the kind of
competition which is characterized by mixed strategies (i.e., bundled goods and services,
strategic solutions, competition along more dimensions than simply price, etc.) As a final
thought, or perhaps even as an afterthought, from the standpoint of competitive
intelligence or what we might call the competitive strategy of market intelligence a
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company or a business group may quite possibly find it highly rewarding to inject a
deliberate element of disinformation into the marketplace, especially if they can do this
immediately prior to a new international product launch, simply to make conditions more
difficult for rivals attempting to determine and counter the first company or business
group’s strategy (Egnor 1999; Billings, 1999; Sato, Akiyama and Farmer, 2002).
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