Look Forward, Reason BackOverviewAdvertising and EntrySpeed and flexibilityStrategies and PayoffsPayoffs:Game TreeBackward InductionRival’s ChoiceIncumbent’s ChoiceEquilibrium PredictionIs Flexibility an Advantage?Game Tree – Stodgy RivalBackward Induction - IncumbentBackward Induction – RivalSlide 16Do all games exhibit first-mover advantage?More PlayersLocation DecisionsMotivationSlide 21Mall AllocationTimingSlide 24Backward Induction - CBackward Induction - BBackward Induction – ASlide 28General PrinciplesWays to Change the GameLook Forward, Reason BackThe Cornerstone of Strategic ReasoningOverviewAdvertising and entryRetail location strategiesGeneral PrinciplesAdvertising and EntryAn established retailer is facing possible competition from a rivalThe established retailer can try to stave off entry by engaging in a costly advertising and price cutting campaignSpeed and flexibilityThe rival is fast and flexible, so its policy is to wait and decide at the last possible instant its entry choiceThus, the rival observes the initiation of this campaign before making its entry decisionStrategies and PayoffsIncumbent: Advertise or notRival: Enter or notPayoffs:Incumbent (Best to worst)No entry and no adsNo entry and adsEntry and no adsEntry and adsRivalEntry and no adsNo entry and adsNo entry and no adsEntry and adsGame TreeIRR1,13,32,44,2AdsNo adsInOutInOutBackward InductionLook to the end of the game tree and prune back Rationality assumption implies that players choose the best strategy at each node.Rival’s ChoiceIRR1,13,32,44,2AdsNo adsInOutInOutIncumbent’s ChoiceIRR1,13,32,44,2AdsNo adsInOutInOutEquilibrium PredictionThe prediction from this model is that the incumbent will run its ad campaign and this will effectively forestall entryNotice that even in absence of actual entry, the potential competition from the rival eats into the incumbent’s profits.Is Flexibility an Advantage?Suppose that the rival is less flexible in its management practices.It must commit to enter or not before the advertising decision of the incumbent.How does this affect the outcome of the game?Game Tree – Stodgy RivalRII1,12,43,34,2InOutAdsNo adsAdsNo adsBackward Induction - IncumbentRII1,12,43,34,2InOutAdsNo adsAdsNo adsBackward Induction – Rival RII1,12,43,34,2InOutAdsNo adsAdsNo adsEquilibrium PredictionNotice that now the prediction is that the rival will enter and the incumbent will not advertiseThe absence of flexibility on the part of the rival improves its outcome relative to the case where it retained flexibility.This game has a first-mover advantageDo all games exhibit first-mover advantage?NoProcurement contracts:Two firms are bidding for a procurement contract, which will be awarded to the low bidder.There is a cost to preparing a bidFirm 1 chooses its bid followed by firm 2.Clearly it pays to go second and undercut the bid of the first firmMore PlayersSame methods apply to more playersOnly the tree grows more complexLocation DecisionsThree retailers (A, B, and C) are deciding their location decisions for an emerging metropolitan areaTheir decision is whether to locate in an urban mall or a suburban mallThe urban mall has spots for 2 storesThe suburban mall has spots for all 3.MotivationThe urban mall has more traffic than the suburban mallThere are synergies in mall locationThe presence of 2 or more large stores drives disproportionate traffic to that mallStrategies and PayoffsEach retailer chooses where to locate: urban or suburbanPayoffs (Best to worst)Urban mall with other storeSuburban mall with other storesUrban mall aloneSuburban mall aloneNo mallMall AllocationThe malls are not strategic players.Urban: B and C have priority over ASuburban: Accept anyoneTimingFirm A is moves first, followed by B and then CGame TreeABB1,5,5CCCC5,5,25,2,53,4,42,5,54,3,44,4,34,4,4USUSUSSSSSUUUUBackward Induction - CABB1,5,5CCCC5,5,25,2,53,4,42,5,54,3,44,4,34,4,4USUSUSSSSSUUUUBackward Induction - BABB1,5,5CCCC5,5,25,2,53,4,42,5,54,3,44,4,34,4,4USUSUSSSSSUUUUBackward Induction – AABB1,5,5CCCC5,5,25,2,53,4,42,5,54,3,44,4,34,4,4USUSUSSSSSUUUUEquilibrium PredictionFirm C chooses suburban only if other 2 choose SFirm B knows that by choosing an urban location, C will follow suit, therefore it goes urbanFirm A knows that B will go urban regardless and that C will follow B’s lead, therefore if it goes urban, it will be shut outTherefore A goes suburban and ends up aloneGeneral PrinciplesSketch a game tree outlining who moves whenConstruct a ranking of outcomes for both you and your rivals. Look forward and reason backIf the outcome is not a desirable one, think about how you might change the gameWays to Change the GameContracting: Look ahead in thinking about the strategic implications of contract termsChange the order of moves (i.e. commitment) to gain a first-mover
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