1. Game Theory and Pricing Strategy

2. As industry grows, the number of firms operating within it also reduces Structure of the market transitions from competitive to oligopolistic The conduct of the market also becomes more interdependent. INTRODUCTION

3. this section provides insights in making decisions under this type of market [oligopolistic]. These decisions are; pricing strategy, entering/developing markets, advertising strategy etc. the basic tool to use for this; Game theory is the basic tool INTRO…

4. Sample of Games Overview of the Games and Strategic Thinking -Tic-Tac-To - Poker -checkers/dama -Hawk-Dove (chicken)game -Prisoners’ dilemma, etc.

5. Game theory is actually a much more general framework to aid in decision making when your pay- off depends on the actions taken by the other player. Overview…

6. Players- are participants or individuals in a game which make decisions Strategies- these are the planned decisions of the players Payoff- the resulting benefit/revenue given the actions or decisions Terminologies…

7. The pay-off table or matrix Terminologies…

8. Simultaneous-Move, One-Shot Games Players must move/ make a decision at the same time. Players must decide without the knowledge of the decision made by the other players One-shot means (the game is played once) Two General Types of Games

9. Sequential-Move,Games Players must move/ make a decision after the opponent has made a move. Players must observe what the opponent is doing and determine his course of action given the move of the other E.g. Chess, checker, etc. Types of Games…

10. Sequential-Move,Games Players must move/ make a decision after the opponent has made a move. Players must observe what the opponent is doing and determine his course of action given the move of the other E.g. Chess, checker, etc. Types of Games…

11. Simultaneous-Move, One-Shot Games The most relevant to mgr’l decision, Deciding without the knowledge of other player is the essence of this game. This is important to managers making decisions in an environment of interdependence

12. Simultaneous-Move… Theoretical Scaffolds We define the following; Strategy- a decision rule that describes the actions of a player will take at each decision point Normal-form game - a representation of game indicating the players, their possible strategies, and the payoff resulting from alternative strategies.

13. Simultaneous-Move… Player A Player B Given (Figure 2);

14. Simultaneous-Move… What are the strategies of each player? What are the P/O for each player? What is the optimal/dominant strategy of A or B? Questions??

15. Simultaneous-Move… Player A Player B Given (Figure 2);

16. Simultaneous-Move… In a game-theoretic situation, it is essential to know the Optimal strategy. Depending on the nature of the game, we can characterize the optimum by a situation involving a Dominant strategy.

17. Simultaneous-Move… What is a dominant strategy?? Dominant strategy - a strategy that results in the highest pay-off to a player regardless of the opponents’ action

18. Simultaneous-Move… Player A Player B Given (Figure 2);

19. Simultaneous-Move… In the game illustrated in Fig 2, the dominant strategy for player A is UP!! (pls. verify! Does B has a dominant strategy?) Principle: “Always check if you have a dominant strategy, if you have then play it!”

20. Simultaneous-Move… Player A Player B Given (Figure 2);

21. Simultaneous-Move… In case a dominant strategy is absent, the player plays a Secure strategy; a strategy that guarantees highest pay-off given the worst possible scenario.

22. Simultaneous-Move… Principle: “When playing; always put yourself in your rivals shoes” If you don’t have a dominant strategy, see if your rival has, then anticipate it!”

23. Given this situation, a very natural way of formalizing the end result is captured by Nash Equilibrium (Dr. John Nash, 1994) Nash Equilibrium- a condition describing a set of strategies in which no player can improve his/her payoff by unilaterally changing his/her own strategy, given the other player strategies.

24. Again we have the pay-off table; StrategyLeftRight Up10,2015,8 Down-10,710,10 (B) (A)

25. What are the NE strategies for player A and B? Answer: (UP/LEFT)… Check using the P/O matrix above!!

26. Again we have the pay-off table; StrategyLeftRight Up10,2015,8 Down-10,710,10 (B) (A)

27. Application!! 1.Pricing decisions 2. Coordination decisions 3. Monitoring of employees 4. Advertising decision

28. Example: StrategyLow PriceHigh Price Low Price0,050-10 High Price-10,5010,10 Required: -Dom Strat -N.E (B) (A)

29. Example: StrategyLow PriceHigh Price Low Price0,050-10 High Price-10,5010,10 Answer: - Both the Dominant and the N.E. strategies are the same. (B) (A)

30. a. Block pricing- is a pricing strategy in which identical products are package together in order to enhance profits by forcing customers to make an all-or-none decision to buy. This is designed to maximize the consumers surplus to the customers. Pricing Strategies for Managerial Decisions 1. Pricing strategies for firms with relative market power

31. Principle!! -forces customers to make an all-or-none purchase none decision.

32. b. Commodity bundling- The practical way of bundling several different products together and selling them at a single “bundled price” e.g. -telephone and DSL internet -airfare and hotel accommodation -etc.

33. a. Peak-load pricing - pricing strategy which a higher prices are charged during peak hours and /exam during off-peak hours 2. Pricing strategies for special cost and demand structures. Purpose: To maximize profit To allocate them and Discriminate customers

34. a. Peak-load pricing

35. b. Cross-Subsidies- a pricing strategy in which profit gained from the sale of one product are used to subsidize sales of a related product. Example: Adobe suite developer (PDF) Acrobat reader- free Adobe Acrobat-pay/for sale To enjoy economies of scope

36. a.Price Matching - a strategy in which a firm advertises a price and a promise to match any lower price offered by competitor. This will tend to create a monopolistic pricing service if all firm are offer same price. Then it will just end up sharing the market. 3. Price strategies in markets with intense price competition

37. There are two cautions if we use this strategy; Devise a truth revealing mechanism for customer not to shirk. Cumbersome if competitors have lower cost than your firm.

38. b. Inducing Brand Loyalty-stimulate the customer to think that your product is different than the other. Example: Frequent- flyer-buyer promo. Comparative advertising

39. c.Randomized pricing- Pricing strategy in which the firm intentionally varies its price in an attempt to hide price info from consumers and rivals. Advantage: Reduces customer switching to other products Reduces price cutting/ price wars

40. Costly Can work only if done on-line through computer simulation Disadvantage

41. What do all these pricing strategies say about the traditional cost plus mark up pricing approach??

42. 1. Determine the cost AC=AVC+AFC 2. Determine the mark up over cost Let X= Target profit in peso Q= Number of units to be produce X/Q= Mark up Therefore: P/unit=AVC + AFC + X/Q Mechanics…

43. Then, if; P/unit=AVC + AFC + X/Q; ….and knowing that Q is uncertain, then there goes the problem of “Cost + Mark Up” pricing strategy!!! Mechanics…

44. T hank You..