EC 491 I dont skate to where the puck is, I skate to where its going to be. - Wayne Gretzky February 2, 2011 Putting Theory into Practice

Mike Shor Game Theory & Business Strategy 2 Toys R Us Competitive Landscape Toy & department stores Do not compete with TRU on price (50% markups) General discounters (Wal-Mart, Target) Cannot compete with TRU on selection (9% markups) Toys exhibit high product differentiation Specialized discounters(only TRU) Enjoyed 20% market share nationally Warehouse clubs (Costco, Pace) Introduced in the 1980s By 1989, about 200 items in competition Cause of concern for Toys R Us!

Mike Shor Game Theory & Business Strategy 3 Toys R Us Other examples of specialty discounters? Petsmart Staples (competitors Office Depot, Office Mart) Best Buy (Circuit City gone) Itunes

Mike Shor Game Theory & Business Strategy 4 Toys R Us (continued) Market research into the future of warehouse clubs Manufacturers estimated 3-5% annual growth rate Toys R Us conducted comprehensive but proprietary study Manufacturers were aware of the study, but not its results Toys R Us expected warehouse clubs to grow quite fast Idea! Issue statement to manufacturers: You may not sell to warehouse clubs without losing Toys R Us as a customer Effectively, choose between a $5 billion market (TRU) and a less than $500M market (warehouse clubs)

Mike Shor Game Theory & Business Strategy 5 Toys R Us (continued) Issues for the Manufacturers?: What about for Toys R Us?

Mike Shor Game Theory & Business Strategy 6 Toys R Us (continued) What would you do?

Mike Shor Game Theory & Business Strategy 7 Toys R Us (continued) Manufacturers agreed to TRU deal Warehouse club toy sales decreased Pre-agreement growth of 51% per year Overall growth of clubs of over 10% per year But …

Mike Shor Game Theory & Business Strategy 8 Defining the Game CAVEAT Predict opponents reaction to your behavior. BUT Be sure you understand who your opponents are. (Do you know everyone who may react to your decisions?)

Mike Shor Game Theory & Business Strategy 9 Summary Defining the Game The strategic environment Who are the players? (Decision makers) What strategies are available? (Feasible actions) What are the payoffs? (Objectives) Rules of the game What is the time-frame for decisions? What is the nature of the conflict? What is the nature of interaction? What information is available?

The Assumptions Rationality Players aim to maximize their payoffs Players are perfect calculators Common Knowledge Each player knows the rules of the game Each player knows that each player knows the rules Each player knows that each player knows that each player knows the rules Each player knows that each player knows that each player knows that each player knows the rules Each player knows that each player knows that each player knows that each player knows that each player knows the rules Etc. Etc. Etc. Mike Shor Game Theory & Business Strategy 10

Common Knowledge Do people really behave as the theory predicts? If not, what good is the theory? Mike Shor Game Theory & Business Strategy 11

The Stock Market & Rationality I can calculate the motions of heavenly bodies, but not the madness of people - Sir Isaac Newton (upon losing £20,000 in the South Sea Bubble in 1720) QUESTION: When would a sell-off occur if we knew the exact date of a bubbles burst? Mike Shor Game Theory & Business Strategy 12

Greater Fool Theory He who panics first wins You may be a fool to pay as much as you did, but you are betting that theres a greater fool down the road. And if youre right, then of course you arent being foolish. Mike Shor Game Theory & Business Strategy 13

_________ Which Month Am I? often is a good month for stocks is typically a strong month for stocks tends to be a good month for stocks is usually a good month for stocks is typically a bad month for the stock market is usually the worst month for stocks is traditionally a cruel month for stocks is the worst month for stocks Mike Shor Game Theory & Business Strategy 14

Fun with Probabilities If, in each month, the stock market is equally likely to go up or go down, then there is over an 80% chance that some month will be bad three years in a row! Why is October so bad? Mike Shor Game Theory & Business Strategy 15

October 1987 Mike Shor Game Theory & Business Strategy 16

October 2008 Mike Shor Game Theory & Business Strategy 17

– Wall Street Journal, quoting Mark Twain The Worst Month for Stocks October. This is one of the peculiarly dangerous months to speculate in stocks. Mike Shor Game Theory & Business Strategy 18

Wall Street Journal May 1988 Front Page Story: Clear Road Ahead … Will record gains through the fall October looms on the horizon … the dreaded though inevitable slide. Mike Shor Game Theory & Business Strategy 19

1988 Mike Shor Game Theory & Business Strategy MAYMAY

Excess Returns prior to IPO Lock-Up Expiration Mike Shor Game Theory & Business Strategy 21 Event Day Cumulative Abnormal Return

Summary Youre always in a game The rules are likely to be flexible Think one step ahead The rule of three steps Looking ahead: Equilibrium: What are the outcome of games? Mike Shor Game Theory & Business Strategy 22