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Look Forward, Reason
Back
The Cornerstone of Strategic Reasoning
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Overview
Advertising and entry
Retail location strategies
General Principles
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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
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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
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Strategies and Payoffs
Incumbent: Advertise or not
Rival: Enter or not
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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
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Game Tree
I
R
R
1,1
3,3
2,4
4,2
Ads
No ads
In
Out
In
Out
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Backward Induction
Look to the end of the game tree and pruneback
Rationality assumption implies that players
choose the best strategy at each node.
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Rivals Choice
I
R
R
1,1
3,3
2,4
4,2
Ads
No ads
In
Out
In
Out
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Incumbents Choice
I
R
R
1,1
3,3
2,4
4,2
Ads
No ads
In
Out
In
Out
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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.
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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?
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Game TreeStodgy Rival
R
I
I
1,1
2,4
3,3
4,2
In
Out
Ads
No ads
Ads
No ads
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Backward Induction - Incumbent
R
I
I
1,1
2,4
3,3
4,2
In
Out
Ads
No ads
Ads
No ads
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Backward InductionRival
R
I
I
1,1
2,4
3,3
4,2
In
Out
Ads
No ads
Ads
No ads
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Equilibrium Prediction
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
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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
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More Players
Same methods apply to more players
Only the tree grows more complex
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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.
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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
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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
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Mall Allocation
The malls are not strategic players.
Urban: B and C have priority over A
Suburban: Accept anyone
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Timing
Firm A is moves first, followed by B and thenC
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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
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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
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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
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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
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Equilibrium Prediction
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
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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
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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.