Week 4 - Game Theory

• Hotelling (1929); Stability in Competition

  Hotelling’s Linear City Model:

  • Consumers are uniformly distributed along a line [0,1]

  Prices:

  • Nash equilibrium follows Bertrand; firms will set prices P(A)=P(B)=c+t

  Quantities:

  • Cournot; firms will locate at [1/2, 1/2] in symmetric game
  • Moving closer has both positive demand, and negative strategic effects
• Hotelling (1929); Stability in Competition

  Stability in Bunching:

  • Ease of collusion
  • Skilled labour might be easier to recruit
  • Demand effects
  • Market size may become bigger; search costs
• Advertising:


  Persuasive advertising is over-produced at the margin (Business-stealing effects)

  Informational advertising is under-produced at the margin (appropriability effects)
• Fudenberg and Triole: Animal Taxonomies of Business Strategies

  1. Top Dog
  2. Lean and Hungry
  3. Puppy Dog
  4. Fat Cat

  In order to deter entry, firms will either invest, if investment makes them tough (e.g., rival profits decreasing in investment), or under-invest if investment makes them weak (to minimise the strategic effect of rival’s response on your profits)
• A strategic commitment strategy needs to be:

  1. Visible
  2. Understandable
  3. Credible

  “Burn ones bridges”
• Institutional Theory:


  Internal Differences:

  Functional forms and organisational behaviour 

  External Differences: 

  Varieties of capitalism and firm / market behaviour
• Liberal Market Economies (LMEs):

  • Financial Markets
  • Radical Innovation
  • Short-term profits
  • Easy hiring/firing
  • Control from the top
• Coordinated Market Economies (CMEs): 

  • Collaboration
  • Networks of inter-corporate linkages
  • Corporate governance insulates employees
  • Long-term outlook
  • Can take short-term profit losses
  • Encourages long-term employee skills
• Brandenburger and Nalebuff (1995); The Right Game

  • Precursor to ‘co-opetition’ (1996)
  • PARTS:PlayersAdded ValuesRulesTacticsScope
• Nagel (1995); Unravelling in Guessing Games

  Nash Eequilibrium: All players announce 0, and split the prize 

  Subgame PE: Again, all players announce 0

  Findings:

  1. Players use strategic thinking badly
  2. Players adjust their strategies based on observations
  3. Bounded Rationality
• Besanko et al (2007); Economics of Strategy

  Structure and Strategy

  1. Unitary: Organised by functions, such as production or marketing or finance (functional structure)
  2. Multidisional (M): Organised by geographic regions, product lines, or markets. Suitable for rapid decision-making and global focus
  3. Matrix: Combining functional and divisional forms. Encourages collaboration across departments, but can lead to power struggles
  4. Network: Modular strategy groups based on employee specialities. No clear hierarchy
• Chandler (1962); Strategy and Structure

  Strategic Phases of Firm Diversification:

  1. Expansion
  2. Diversification
  3. Rationalisation of resources/strategy
• Chandler (1962)

  Structure follows strategy, as strategy determines, and therefore must logically precede structure
• Teece (1978); Organisational structure and Economic Performance

  • A positive relationship between M-form structure and profitability is observed during the period in which the M-form innovation was being diffused
  • The relationship is no longer observed once an equilibrium is achieved

  Superior profits until firms catch up:

  Shifting out the productivity frontier (Porter, 1985)
• Teece (1978); Organisational structure and Economic Performance

  Findings:

  • OLS regressions on the different structures and profitability
  • Find strong statistical support for the M-form hypothesis
• North (1990); Institutions


  Institutions are the ‘rules of the game in a society’3 Views on why economies develop at different rates:

  1. Geography
  2. Culture and social norms/conventions
  3. Institutional view
• Hall and Soskice (2001); An introduction to varieties of capitalism


  CME

  LME
• Hancke (2010); Varieies of Capitalism in Business

  CMEs: Prevalence of non-market relationships

  LMEs: Consist of competitive relations with formal contracts
• Aldrich and FOI (1994); Do fools rush in?


  Two types of legitimacy that pioneered firms must achieve:

  1. Cognitive

  2. Sociopolitical

  
  

  Entering a new market before it is fully formed is risky, because there is a lack of legitimacy
• Coercive Pressures


  Political influence and legitimacy-seeking organisations utilise similar processes.
• Mimetic Pressures


  In response to uncertainty, firms may choose to mimic each other.

  Also, consulting firms play a large role in helping industries inuncertainty, and likely give similar advice
• Normative Pressures:


  Professional standards and professionalism lead to related behaviours in certain industries

  1. Formal Education: Business schools create pools of interchangeable individuals
  2. Professional Networks; Common 'Best-Practice'
• Lovallo (1999); Overconfidence and Excess Entry

  Most people are overconfident about their own relative abilities, and unreasonably optimistic about their futures.• Any positive trait, like driving, income prospects, or good health, people assume they are above average
• Powell (1983); The Iron cage revisited


  Weber's Iron cage (1905); Businesses are trapped in a system of control and predictabilityInstitutional Isomorphism: The tendency for businesses operating in the same industry to be utilising the same strategies