Game Theory

Mike Shor Lecture 4

It is true that life must be understood backward, but it must be lived forward.
- Sren Kierkegaard

Review
Understanding the outcomes of games Sometimes easy

Dominant

strategies

Sometimes more challenging

I

know that you know

What if a game is sequential?

Market

entry
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Mike Shor Game Theory & Business Strategy

Very Large Airplanes: Airbus vs. Boeing

Airbus lacked a jumbo jet:

The problem is the monopoly of the 747 They have a product. We have none.
- Airbus Executive

Initiated plans to build a super-jumbo jet

Room for at most one megaseater Boeing, the worlds top aircraft maker, announced it was building a plane with 600 to 800 seats, the biggest and most expensive airliner ever.
- BusinessWeek, 1993
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Industry feasibility studies:

Boeing preemption:

Mike Shor Game Theory & Business Strategy

Sequential Games
The Game
$0, $0 $1 billion, $1 billion

Airbus Boeing
Mike Shor Game Theory & Business Strategy

$0.3 billion, $3 billion $4 billion, $4 billion

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Looking Forward

Airbus makes the first move:

Must

consider how Boeing will respond $0 billion

If stay out:
Boeing

$1 billion

Boeing stays out

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Mike Shor Game Theory & Business Strategy

Looking Forward

Airbus makes the first move:

Must

consider how Boeing will respond $3 billion

If enter:
Boeing

$4 billion

Boeing accommodates, stays out

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Mike Shor Game Theory & Business Strategy

 And Reasoning Back

Now consider the first move:

out

Airbus
out

$0, $0

Boeing

$0.3 billion, $3 billion

Only ( In, Out ) is sequentially rational

In

is not credible (for Boeing)

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Mike Shor Game Theory & Business Strategy

Airbus vs. Boeing What a Difference Seven Years Make

Boeing, the worlds top aircraft maker, announced it was building a plane with 600 to 800 seats, the biggest and most expensive airliner ever.
- BusinessWeek, 1993

Mike Shor Game Theory & Business Strategy

Solving Sequential Games

Thinking backwards is easy in game trees

Start at the end and trim the tree to the present

Thinking backwards is challenging in practice

Outline:

Strategic moves in early rounds The rule of three (again) Seeing the end of the game
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Mike Shor Game Theory & Business Strategy

Voting Revisited
Gore v. Bush before the U.S. Supreme Court

Recall member preferences:

4 (B>G>R)

3 (G>R>B)
;

2 (R>B>G)
;

Majority rule results:

B beats G

G beats R

R beats B

Voting results (example):

R beats G

then winner versus B

B
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Mike Shor Game Theory & Business Strategy

Voting as a Sequential Game

B B vs. R R vs. G R B

B vs. G
Mike Shor Game Theory & Business Strategy

G
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Looking Forward
B

B vs. R
R B

A majority prefers R to B

B vs. G G
Mike Shor Game Theory & Business Strategy

A majority prefers B to G

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 And Reasoning Back

Three judges prefer G to R to B. How should they vote in the first round?

B vs. R

R vs. G

R B

B vs. G
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What Happened?

Gore supporters have preferences

Gore > Remand > Bush Gore supporters prefer Gore But a vote for Gore is in effect a vote for Bush! Guarantee themselves second best choice

First round vote between Remand and Gore

So Gore supporters vote for remand.

Thinking forward misses chance for strategic voting Thinking forward leads us to pick the wrong game
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Mike Shor Game Theory & Business Strategy

Sequential Rationality
COMMANDMENT

Look forward and reason back.

Anticipate what your rivals will do tomorrow in response to your actions today

Mike Shor Game Theory & Business Strategy

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Examples of Strategic Voting

Not necessarily good to vote your true preferences

Amendments to make bad bills worse Crossing over in open primaries Centrist voting in primaries

Outcome is still predetermined:

B beats G then winner versus R B beats R then winner versus G G beats R then winner versus B
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Mike Shor Game Theory & Business Strategy

Accommodating a Potential Entrant

Do you enter?
Do you accommodate entry? What if there are fifty potential entrants?
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Mike Shor Game Theory & Business Strategy

Survivor Immunity Challenge

There

are 21 flags Players alternate removing 1, 2, or 3 flags The player to take the last flag wins

Mike Shor Game Theory & Business Strategy

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Sequential Games

You have a monopoly market in every state There is one potential entrant in each state

They make their entry decisions sequentially Florida may enter today New York may enter tomorrow etc.

Each time, you can accommodate or fight What do you do the first year?
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Mike Shor Game Theory & Business Strategy

The Game
E2 E3

E1 M M

Mike Shor Game Theory & Business Strategy

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Looking Forward

In the last period:

$0, $100 + previous

50,

50 + previous

M
50, 50 + previous

No reason to fight final entrant, thus ( In, Accommodate )

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Mike Shor Game Theory & Business Strategy

 And Reasoning Back

The Incumbent will not fight the last entrant

But then, no reason to fight the previous entrant But then, no reason to fight the first entrant All entrants play In Incumbent plays Accommodate

Only one sequential equilibrium

But for long games, this is mostly theoretical People see the end two to three periods out!
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Mike Shor Game Theory & Business Strategy

Game Theory

Example Sequential Entry

Market Opportunity Analysis

Assesses the potential of a geographic market for a specific set of products, providing a prioritization of market coverage voids and recommending market entry strategies.

Mike Shor Game Theory & Business Strategy

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Prioritization of Market Coverage

Break even point: 300 SBCs

700 SBCs

400 SBCs
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Extended Market Analysis

If enter 400 SBC market:

Next entrant, to break even, must expect market share of 300/400 Must expect market share of 75% Next entrant, to break even, must expect market share of 300/700 Must expect market share of 43% All of 400 or half of 700
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If enter 700 SBC market:

Real decision:

Mike Shor Game Theory & Business Strategy

Breakfast Cereals
A small sampling of the Kelloggs portfolio

Mike Shor Game Theory & Business Strategy

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Breakfast Cereals
product development costs: $1.2M per product
600 500

(in thousands) sales

400
300 200 100 000 1 2 3 4 5 6 7 8 9 10 11

less sweet
Mike Shor Game Theory & Business Strategy

more sweet
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First Product Entry

SCENARIO 1

Profit = 5(600) 1200 =

(in thousands)
600 500

300

400
300 200 100 000 1 2 3 4 5 6 7 8 9 10 11

sales

less sweet
Mike Shor Game Theory & Business Strategy

more sweet
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Second Product Entry

SCENARIO 2

Profit = 2 x 300 =
(in thousands)
600 500

600

400
300 200 100 000 1 2 3 4 5 6 7 8 9 10 11

sales

less sweet
Mike Shor Game Theory & Business Strategy

more sweet
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Third Product Entry

SCENARIO 3

Profit = 300 x 3 240 x 2 =

(in thousands)
600 500

420

400
300 200 100 000 1 2 3 4 5 6 7 8 9 10 11

sales

less sweet
Mike Shor Game Theory & Business Strategy

more sweet
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Competitor Enters
SCENARIO 4

Profit = 300 x 2 - 240 =

(in thousands)
600 500

360

400
300 200 100 000 1 2 3 4 5 6 7 8 9 10 11

sales

less sweet
Mike Shor Game Theory & Business Strategy

more sweet
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Summary

Thinking forward misses chances to make money Make sure to see the game through to the logical end Dont expect others to see the end until it is close
The

rule of three steps

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Mike Shor Game Theory & Business Strategy