Game theory and competitor analysis Paul C. Godfrey Mark H. Hansen Brigham Young University

Why should we care what competitors are doing? One firm’s changes always evoke responses by competitors –A feature of markets as systems –Sometimes the response is to do nothing (rational or irrational) Game theory helps model rational behavior –Behavioral analysis helps model “irrational” behavior –Fundamental knowledge of competitors helps understand likely responses

Game Theory Game theory attempts to mathematically capture behavior in strategic situations, in which an individual's success in making choices depends on the choices of others. Initially developed to analyze competitions in which one individual does better at another's expense (zero sum games), and expanded to where there are joint gains to cooperation (Wikipedia, accessed 12/08) Game theory has several key assumptions –The players are rational maximizers –The players have full information about each other –The payoffs are known

Game Theory Simultaneous Games Enter Don’t Enter Don’t Enter In-n-Out Five Guys 200, 175 0, , 0 0, 0 Five Guys and In-n-Out are deciding, at the same time, whether to enter the market Is there a dominant strategy for Five Guys? In-n-Out?

Game Theory Sequential Games In-n-Out Enter Don’t Enter 0, 300 Five Guys Fight Accommodate 50, , 200 Five Guys is already in the market, In-n-Out is deciding whether to enter

The prisoners dilemma Two people are picked up by the police on suspicion of robbery and placed in separate cells. The evidence is sketchy and so the district attorney attempts to elicit a confession from each person separately. The district attorney presents each with the following payoff matrix, represented as years in jail. What will the accused persons do? Player 2 Not ConfessConfess Player 1 Not Confess 1,11,15,05,0 Confess0,50,53,33,3

The centipede game There are two players, A & B, who alternate in making choices. That is, A makes the decision in round 1, B in round 2, and so on. In each round, the player must decide whether to end the game by moving down, or continue the game by moving across. Below each round is a payoff matrix, showing the points awarded to A & B if the game ends in that round. The objective of the game is for each player to maximize their own payoff.

The Centipede Game, Structure Player AM P Player BN Q Decision Player AB 12

The Centipede Game, 1 Player A10 Player B02 Decision Player AB 12

The Centipede Game, 2 Player A1043 Player B Decision Player ABAB 1234

The Centipede Game, 3 Player A Player B Decision Player ABABAB

The Ultimatum Game You are given $5. The condition for keeping the money is that you have to propose a split between you and the other player and the other player has to agree to your split. If he or she agrees, you split the money. If he or she refuses, neither of you get the money. What split will you propose?

So, what do these games teach us about competitive behavior?

Questions to Ask About Competitors Future goals At all levels of management Assumptions Held about themselves and industry Current Strategy How do they currently compete? Capabilities Where are they strong? Weak?