Game Theory In Marketing

1. Game Theory In Marketing Group 7 Derryl George 05 Manoj Pathak 35 Santosh Shetty 44 Sudham Shetty 45 Santosh Singh 48 Rasesh Shah 60

2. Game Theory The study of rational behavior among interdependent players. The players have conflicting interest. The outcome of strategy of a player depends upon the particular pair of strategy chosen by the other player. The objective of Game theory is to determine the best decision for each player involved.

3. Prisoner’s Dilemma Prisoner 2 Confess Don’t Confess Prisoner 1 ( -8, -8) ( 0, -15) Confess ( -15, 0) Don’t Confess ( -1, -1)

4. Prisoner’s Dilemma Prisoner 2 Confess Don’t Confess Prisoner 1 ( -8, -8) ( 0, -15) Confess ( -15, 0) Don’t Confess ( -1, -1)

5. Prisoner’s Dilemma Prisoner 2 Confess Don’t Confess Prisoner 1 ( -8, -8) ( 0, -15) Confess ( -15, 0) Don’t Confess ( -1, -1)

6. Prisoner’s Dilemma Conclusion: The Prisoner 1 will confess. And Prisoner 2?

7. Prisoner’s Dilemma Prisoner 2 Confess Don’t Confess Prisoner 1 ( -8, -8) ( 0, -15) Confess ( -15, 0) Don’t Confess ( -1, -1)

8. Prisoner’s Dilemma Prisoner 2 ConfessDon’t Confess Prisoner 1 ( -8, -8) ( 0, -15) Confess ( -15, 0) Don’t Confess ( -1, -1)

9. Prisoner’s Dilemma • Equilibrium Prisoner 2 Confess Don’t Confess Prisoner 1 ( -8, -8) ( 0, -15) Confess ( -15, 0) Don’t Confess ( -1, -1)

10. Prisoner’s Dilemma Conclusion: Prisoner 2 confesses also Both get 8 years, even though if they cooperated, they could get off with one year each For both, confession is a dominant strategy: a strategy that yields a better outcome regardless of the opponent’s choice

11. Prisoner’s Dilemma What would the Prisoner 1 and Prisoner 2 decide if they could negotiate? They could both become better off if they reached the cooperative solution. Equilibrium need not be efficient. Non - cooperative equilibrium in the Prisoner’s dilemma results in a solution that is not the best possible outcome for the parties.

12. Equilibrium Nash Equilibrium: Neither player has an incentive to change strategy, given the other player’s choice Both confess is a Nash Equilibrium.

13. Conflict Vs Cooperation • Case of Cournot Ltd and Bertrand ltd (In Mineral Water Business). • Competing by choosing one of two possible prices, low or high. • Each firm’s profits depends not only on its own prices, but also on the price of its rival.

14. Conflict Vs Cooperation Cont. Situation one: Cournot believes that Bertnard charges high.

15. Conflict Vs Cooperation Cont. Situation two: Cournot believes that Bertnard charges low.

16. Conflict Vs Cooperation Cont. • Equilibrium of this game, the outcome of simultaneous rational decision by both players, has both charging the low price.

17. Cases • “Advanced Micro Devices (AMD) has slashed prices of its desktop and mobile Athlon processors just days after a similar move by rival Intel. ‘We’re going to do what it takes to stay competitive’ on prices, said an AMD representative. AMD’s aggressive price-chopping means the company doesn’t want to give up market share gains, even at the cost of losses on the bottom line, analysts said.” (CNet News.com, May 30,2002.) • Dell Computer is known for ruthlessly driving down PC prices, but competitors are working hard this week to catch up with the worldwide market leader. Possibly sparked by a 10 percent price cut on Dell corporate desktops earlier in the week, Compaq and Hewlett-Packard have fought back with sizable cuts of their own. HP announced Thursday that it would cut prices on corporate desktop PCs by as much as 28 percent. Compaq Computer reduced PC prices by as much as 31 percent Tuesday.” (CNet News.com News, May 3, 2001)

18. AMD – Game theory case • In this example, the companies compete on price in order to gain market share. Interestingly, the product under question is not a commodity, it is highly specialized, requiring a significant amount of innovation. As a result of price cuts, during the first quarter of 2002, AMD increased processor shipments from the fourth quarter of 2001, topping 8 million, but processor revenue declined by 3%. • In effect, the company sold more chips for less money than in the fourth quarter. Competing companies who go into such price wars do rarely, if ever, benefit from such competition. Clearly, rather than engaging in mutual price cuts, both Intel and AMD would have done better if they kept their prices higher. Cutting prices slightly might increase the overall market potential, i.e., the “pie” might get bigger. But decreasing the prices beyond a certain limit has a diminishing impact on the market potential. • Hence, eventually the size of the pie does not increase anymore and firms have to fight even harder to get a bigger portion of the pie by slashing prices, and profits. Why do firms behave this way? In this situation, and in many others, firms are caught in what is known as the “prisoner’s dilemma,”

19. Cases • “Burger King Corp. will put its flagship Whopper hamburger on sale for 99 cents. The move is likely to intensify and prolong the burger price wars that have been roiling the U.S. fast-food industry in recent months. Burger King officials had said earlier that while they were reluctant to discount the Whopper, they had little choice given a $1 menu at archrival McDonald’s Corp. that included a Whopper-like hamburger, called the Big ’N Tasty.” (Chicago Sun-Times, January 3, 2003) • “Tesco announced plans to slash £80 million from prices of more than 1,000 products,with some prices falling by more than 30%. The cuts came as rival Asda also said it was slashing selected prices.The cuts echo memories of the supermarket price wars played out in 1999 as stores fought to capture more customers and increased market share.” (Sunday Telegraph, January 5, 2003)

20. Dominant Firm Game This game is also know as “Rational Pigs” Case: Two firms, one large and one small. Either firm can announce an output level (lead) or else wait to see what the rival does and then produce an amount that does not saturate the market.

21. Dominant Firm Game Dominant Lead Follow Subordinate ( 0.5, 4) ( 3, 2) Lead ( 1, 8) Follow ( 0.5, 1)

22. Dominant Firm Game Dominant Lead Follow Subordinate ( 0.5, 4) ( 3, 2) Lead ( 1, 8) Follow ( 0.5, 1)

23. Dominant Firm Game Dominant Lead Follow Subordinate ( 0.5, 4) ( 3, 2) Lead ( 1, 8) Follow ( 0.5, 1)

24. Dominant Firm Game Conclusion: Dominant Firm will always lead….. But what about the Subordinate firm?

25. Dominant Firm Game Dominant Lead Follow Subordinate ( 0.5, 4) ( 3, 2) Lead ( 1, 8) Follow ( 0.5, 1)

26. Dominant Firm Game Dominant Lead Follow Subordinate ( 0.5, 4) ( 3, 2) Lead ( 1, 8) Follow ( 0.5, 1)

27. Dominant Firm Game Conclusion: No dominant strategy for the Subordinate firm. Does this mean we cannot predict what they will do?

28. Dominant Firm Game Dominant Lead Follow Subordinate ( 0.5, 4) ( 3, 2) Lead ( 1, 8) Follow ( 0.5, 1)

29. Dominant Firm Game Conclusion: Subordinate firm will always follow, because dominant firm will always lead.

30. Equilibrium Nash Equilibrium: Neither player has an incentive to change strategy, given the other player’s choice Dominant: Lead & Subordinate Follow is a Nash Equilibrium A player’s best option may be dictated by anticipating the rival’s best option

31. Battle of the networks Two television networks are battling for viewer shares. The networks make their programming decisions independently and simultaneously. Each network can show either sports or a sitcom. What should they do???

32. Battle of the networks

33. Battle of the networks

34. Battle of the networks

35. Conclusion • In Network 1's point of view, it is better to show a sitcom, irrespective of Network 2’s strategy. • The strategy “Show a Sitcom" is said to dominate the strategy “Show Sports" for Network 1. So Network 1 will show a sitcom.

36. Battle of the networks

37. Battle of the networks

38. Battle of the networks • Network 2 is better of showing sports, irrespective of Network 1’s strategy. • In other words, Network 2 also has a dominating strategy. • So Network 2 shows sports.

39. Battle of the networks

40. Conclusion The resulting outcome, namely 51% viewer share to Network 1 and 49% to Network 2, is an equilibrium, since neither of the two players in this game can unilaterally improve their outcome. If Network 1 were to switch from sitcom to sports, its viewer share would drop 5%, from 51% to 46%. & If Network 2 were to switch from sports to sitcom, its viewer share would also drop, from 49% to 44%.(Nash equilibrium) Each network is getting the best viewer share it can, given the competition it is up against.

41. A Sequential Game Migros Normal Aggressive Wal-Mart Wal-Mart Enter Enter Stay out Stay out 680 -50 730 0 700 400 800 0

42. Assumptions All players are rational. Players move sequentially. (Therefore, also called sequential games) Players have complete and perfect information Players can see the full game tree including the payoffs Players can observe and recall all previous moves

43. Solution of a sequential game Subgame Perfect Equilibrium: For an equilibrium to be subgame perfect, it has to be a NE for all the subgames as well as for the entire game. A subgame is a decision node from the original game along with the decision nodes and end nodes. Backward induction is used to find SPE

44. Advertising Example: 3 proper subgames Migros Wal-Mart Wal-Mart 680 -50 730 0 700 400 800 0

45. Solution of the Advertising Game Subgame 1 Subgame 2 Wal-Mart Wal-Mart Enter Enter Stay out Stay out 680 -50 730 0 700 400 800 0

46. Solution of the Advertising Game (cont.) Migros Normal Aggressive 730 0 700 400 SPE of the game is the strategy profile: {aggressive, (stay out, enter)}

47. Properties of SPE The outcome that is selected by the backward induction procedure is always a NE of the game with perfect information. SPE is a stronger equilibrium concept than NE SPE eliminates NE that involve incredible threats.

48. Cases • Coca-Cola is developing a vanilla-flavored version of its best-selling flagship cola, a report says, extending the company’s palette of flavorings from Cherry Coke and Diet Coke with lemon. But don’t expect to see a vanilla-flavored Pepsi anytime soon. ‘It’s not something we’re looking at,’ said spokesman Larry Jabbonsky of Pepsi. ‘We think it’s a bit vanilla.’ ” (USA Today, April 01, 2002) • “PepsiCo is launching Pepsi Vanilla and its diet version in stores across the country this weekend. Coke came out with Vanilla Coke in May 2002 and it was a resounding success, selling 90 million cases, according to trade publication Beverage Digest. ‘We’re a little surprised that Pepsi decided to enter the vanilla segment,’ said Mart Martin, spokesman for Coca-Cola. ‘When we came out with Vanilla Coke, Pepsi originally said the idea sounded ‘a bit vanilla.’ But, whatever.’ ”(CNN/Money, August 8, 2003)

49. Thank you.

50. The E.U. Airbus Subsidies • When Airbus Industries got its start, it was believed that there would not be enough total demand for two major aircraft manufacturers (viz., Airbus and Boeing) to both turn a profit developing a new mid‐size aircraft line (roughly 4000mi range with 150‐200 passengers). • Rather, because aircraft development involves such high fixed costs, world demand would make it economical for only one firm to produce a new aircraft in this size range. • The inter‐dependence of the two firms’ profit and decisions in this product line can be represented by the payoffs of the following game (payoffs in billion $):