look forward reason back

8/2/2019 Look Forward Reason Back

1/30

Look Forward, Reason

Back

The Cornerstone of Strategic Reasoning


2/30

Overview

Advertising and entry

Retail location strategies

General Principles


3/30

Advertising and Entry

An established retailer is facing possiblecompetition from a rival

The established retailer can try to stave off

entry by engaging in a costly advertising andprice cutting campaign


4/30

Speed and flexibility

The rival is fast and flexible, so its policy is towait and decide at the last possible instant itsentry choice

Thus, the rival observes the initiation of thiscampaign before making its entry decision


5/30

Strategies and Payoffs

Incumbent: Advertise or not

Rival: Enter or not


6/30

Payoffs:

Incumbent (Best to worst)

No entry and no ads

No entry and ads

Entry and no ads Entry and ads

Rival

Entry and no ads

No entry and ads

No entry and no ads

Entry and ads


7/30

Game Tree

I

R

R

1,1

3,3

2,4

4,2

Ads

No ads

In

Out

In

Out


8/30

Backward Induction

Look to the end of the game tree and pruneback

Rationality assumption implies that players

choose the best strategy at each node.


9/30

Rivals Choice

I

R

R

1,1

3,3

2,4

4,2

Ads

No ads

In

Out

In

Out


10/30

Incumbents Choice

I

R

R

1,1

3,3

2,4

4,2

Ads

No ads

In

Out

In

Out


11/30

Equilibrium Prediction

The prediction from this model is that theincumbent will run its ad campaign and thiswill effectively forestall entry

Notice that even in absence of actual entry,the potentialcompetition from the rival eatsinto the incumbents profits.


12/30

Is Flexibility an Advantage?

Suppose that the rival is less flexible in itsmanagement practices.

It must commit to enter or not beforethe

advertising decision of the incumbent. How does this affect the outcome of the

game?


13/30

Game TreeStodgy Rival

R

I

I

1,1

2,4

3,3

4,2

In

Out

Ads

No ads

Ads

No ads


14/30

Backward Induction - Incumbent

R

I

I

1,1

2,4

3,3

4,2

In

Out

Ads

No ads

Ads

No ads


15/30

Backward InductionRival

R

I

I

1,1

2,4

3,3

4,2

In

Out

Ads

No ads

Ads

No ads


16/30


Notice that now the prediction is that the rivalwill enter and the incumbent will not advertise

The absence of flexibility on the part of the

rival improves its outcome relative to the casewhere it retained flexibility.

This game has a first-mover advantage


17/30

Do all games exhibit first-mover

advantage?

No

Procurement contracts:

Two firms are bidding for a procurement

contract, which will be awarded to the lowbidder.

There is a cost to preparing a bid

Firm 1 chooses its bid followed by firm 2.

Clearly it pays to go second and undercut thebid of the first firm


18/30

More Players

Same methods apply to more players

Only the tree grows more complex


19/30

Location Decisions

Three retailers (A, B, and C) are decidingtheir location decisions for an emergingmetropolitan area

Their decision is whether to locate in anurban mall or a suburban mall

The urban mall has spots for 2 stores

The suburban mall has spots for all 3.


20/30

Motivation

The urban mall has more traffic than thesuburban mall

There are synergies in mall location

The presence of 2 or more large stores drivesdisproportionate traffic to that mall


21/30

Strategies and Payoffs

Each retailer chooses where to locate: urbanor suburban

Payoffs (Best to worst)

Urban mall with other store Suburban mall with other stores

Urban mall alone

Suburban mall alone No mall


22/30

Mall Allocation

The malls are not strategic players.

Urban: B and C have priority over A

Suburban: Accept anyone


23/30

Timing

Firm A is moves first, followed by B and thenC


24/30

Game Tree

A

B

B

1,5,5

C

C

C

C

5,5,2

5,2,5

3,4,4

2,5,5

4,3,4

4,4,3

4,4,4

U

S

U

S

U

S

S

S

S

S

U

U

U

U


25/30

Backward Induction - C

A

B

B

1,5,5

C

C

C

C

5,5,2

5,2,5

3,4,4

2,5,5

4,3,4

4,4,3

4,4,4

U

S

U

S

U

S

S

S

S

S

U

U

U

U


26/30

Backward Induction - B

A

B

B

1,5,5

C

C

C

C

5,5,2

5,2,5

3,4,4

2,5,5

4,3,4

4,4,3

4,4,4

U

S

U

S

U

S

S

S

S

S

U

U

U

U


27/30

Backward InductionA

A

B

B

1,5,5

C

C

C

C

5,5,2

5,2,5

3,4,4

2,5,5

4,3,4

4,4,3

4,4,4

U

S

U

S

U

S

S

S

S

S

U

U

U

U


28/30


Firm C chooses suburban only if other 2choose S

Firm B knows that by choosing an urban

location, C will follow suit, therefore it goesurban

Firm A knows that B will go urban regardlessand that C will follow Bs lead, therefore if it

goes urban, it will be shut out

Therefore A goes suburban and ends up alone


29/30

General Principles

Sketch a game tree outlining who moveswhen

Construct a ranking of outcomes for both you

and your rivals. Look forward and reason back

If the outcome is not a desirable one, think

about how you might change the game


30/30

Ways to Change the Game

Contracting: Look ahead in thinking about thestrategic implications of contract terms

Change the order of moves (i.e. commitment)

to gain a first-mover advantage.

look forward reason back

Documents