1. University of Cagliari, Faculty of Economics, a.a. 2012-13
Business Strategy and Policy
A course within the II level degree in
Managerial Economics
year II, semester I, 6 credits
Lecturer:
Dr Alberto Asquer
aasquer@unica.it
Phone: 070 6753399

2. Business Strategy and Policy
Lecture 4
The strategic interaction between firms

3. Introduction
1. Strategic interaction
2. Dominant strategies
3. Nash equilibrium strategies
4. Coordination strategies
5. Coordination and competition (co-opetition)
6. Mixed strategies
7. Sequential strategic games
-------------
8. Summary

4. 1. Strategic interaction
Within military field, strategy as winning manoeuvring in the battlefield

5. 1. Strategic interaction
Within game theory, strategy as the analysis of strategic interaction
What choice option do rational agents select in order to maximise their
payoff, taking into account the choice of other agents?
(in common-sense argumentation, put yourself “behind your rivals'
desk” in order to take into account what they do when you make
decisions that affect your interests)
Warning: every agents behaves rationally and takes into account the
choice of others
(in common-sense argumentation, take into account that also your
rivals make decisions taking into account what you do)

6. 1. Strategic interaction
Game theory: some basic lexicon
Game: the structure of interaction between agents (players). Typically,
in a game the payoff of agents depends on the choices made by all
agents (i.e. not by one agent alone)
Simultaneous games: agents make choices at the same time (i.e.,
one agent cannot wait and see the choice made by others)
Sequential games: agents make choices according to a pre-
determined sequence (i.e., who chooses later can see what other
agents, who chose earlier, did)
Repeated games: agents face again the choice situation over time.
Non repeated games: agents play the game only once.

7. 1. Strategic interaction
Game theory: some basic lexicon
Dominant strategy: the only choice that an agent rationally does, no
matter what other agents do (or did or will do)
Nash equilibrium: a set of strategies where each agent is rationally
choosing the best option, given the choice of other agents

8. 2. Dominant strategies
Firms may choose their course of action irrespective of what other
players do
Low B = 500 B = 1,000
price
A = 500 A=0
Boeing
B=0 B = 750
High
price A = 1,000 A = 750
Low High
Scenario: bidding for price Airbus price
10 aircrafts project

9. 2. Dominant strategies
Firms may choose their course of action irrespective of what other
players do
Low B = 500 B = 1,000
price
A = 500 A=0
Boeing
B=0 B = 750
High
price A = 1,000 A = 750
Low High
Scenario: bidding for price Airbus price
10 aircrafts project

10. 2. Dominant strategies
Firms may choose their course of action irrespective of what other
players do
Low B = 500 B = 1,000
price
A = 500 A=0
Boeing
B=0 B = 750
High
price A = 1,000 A = 750
Low High
Scenario: bidding for price Airbus price
10 aircrafts project

11. 3. Nash equilibrium strategies
But sometimes, firms behave depending on what other firms do
Low B = 500 B = 1,000
price
A = 500 A=0
Boeing
B = 600 B = 750
High
price A = 1,000 A = 750
Scenario: bidding for Low High
10 aircrafts project, but price price
Boeing can earn even if Airbus
losing the bid

12. 3. Nash equilibrium strategies
But sometimes, firms behave depending on what other firms do
Low B = 500 B = 1,000
price
A = 500 A=0
Boeing
B = 600 B = 750
High
price A = 1,000 A = 750
Scenario: bidding for Low High
10 aircrafts project, but price price
Boeing can earn even if Airbus
losing the bid

13. 3. Nash equilibrium strategies
But sometimes, firms behave depending on what other firms do
Low B = 500 B = 1,000
price
A = 500 A=0
Boeing
?
B = 600 B = 750
High
price A = 1,000 A = 750
Scenario: bidding for Low High
10 aircrafts project, but price price
Boeing can earn even if Airbus
losing the bid

14. 3. Nash equilibrium strategies
Airbus is playing 'low price' anyway (has a dominant strategy)...
Low B = 500 B = 1,000
price
A = 500 A=0
Boeing
B = 600 B = 750
High
price A = 1,000 A = 750
Scenario: bidding for Low High
10 aircrafts project, but price price
Boeing can earn even if Airbus
losing the bid

15. 4. Coordination strategies
Sometimes strategy is about cooperation rather than competition
Alpha B = 100 B = 50
A = 100 A = 50
Boeing
B = 50 B = 100
Beta
A = 50 A = 100
Scenario: Boeing and Alpha Beta
Airbus choose which
Comm technology invest Airbus
in

16. 4. Coordination strategies
Sometimes strategy is about cooperation rather than competition
Alpha B = 100 B = 50
A = 100 A = 50
Boeing
B = 50 B = 100
Beta
A = 50 A = 100
Scenario: Boeing and Alpha Beta
Airbus choose which
Communication Airbus
technology they invest in

17. 4. Coordination strategies
Sometimes strategy is about cooperation rather than competition
Alpha B = 100 B = 50
A = 100 A = 50
Boeing
B = 50 B = 100
Beta
A = 50 A = 100
Scenario: Boeing and Alpha Beta
Airbus choose which
Communication Airbus
technology they invest in

18. 5. Collaboration and competition (co-opetition)
Sometimes it is good to cooperate, but every firms has own interests
Alpha B = 100 B = 40
A = 50 A = 40
Boeing
B = 25 B = 50
Beta
A = 25 A = 100
Scenario: Boeing and Alpha Beta
Airbus choose which
Communication Airbus
technology they invest in

19. 5. Collaboration and competition (co-opetition)
Sometimes it is good to cooperate, but every firms has own interests
Alpha B = 100 B = 40
A = 50 A = 40
Boeing
B = 25 B = 50
Beta
A = 25 A = 100
Scenario: Boeing and Alpha Beta
Airbus choose which
Communication Airbus
technology they invest in

20. 5. Collaboration and competition (co-opetition)
Sometimes it is good to cooperate, but every firms has own interests
Alpha B = 100 B = 40
A = 50 A = 40
Boeing
B = 25 B = 50
Beta
A = 25 A = 100
Scenario: Boeing and Alpha Beta
Airbus choose which
Communication Airbus
technology they invest in

21. 5. Collaboration and competition (co-opetition)
Sometimes it is good to cooperate, but every firms has own interests
Alpha B = 100 B = 40
A = 50 A = 40
Boeing
B = 25 B = 50
Beta
A = 25 A = 100
Scenario: Boeing and Alpha Beta
Airbus choose which
Communication Airbus
technology they invest in

22. 6. Mixed strategies
Sometimes, there is really no equilibrium
Negative B = 10 B = -10
tones
A = -10 A = 10
Boeing
B = -10 B = 10
Positive
tones A = 10 A = -10
Scenario: Boeing and Negative Positive
Airbus choose their notes tones
advertisement campaign Airbus

23. 6. Mixed strategies
Sometimes, there is really no equilibrium
Negative B = 10 B = -10
tones
A = -10 A = 10
Boeing
B = -10 B = 10
Positive
tones A = 10 A = -10
Scenario: Boeing and Negative Positive
Airbus choose their notes tones
advertisement campaign Airbus

24. 7. Sequential strategic game
Sometimes, one player chooses before the other
Boeing: 100
Alpha Airbus: 50
Airbus
Alpha
Boeing: 40
Beta Airbus: 40
Boeing
Alpha Boeing: 25
Beta Airbus: 25
Airbus
Scenario: Boeing and Beta Boeing: 50
Airbus choose which Airbus: 100
Communication
technology they invest in
– but Boeing chooses first!

25. 7. Sequential strategic game
What will Airbus choose?
Boeing: 100
Alpha Airbus: 50
Airbus
Alpha
Boeing: 40
Beta Airbus: 40
Boeing
Alpha Boeing: 25
Beta Airbus: 25
Airbus
Scenario: Boeing and Beta Boeing: 50
Airbus choose which Airbus: 100
Communication
technology they invest in
– but Boeing chooses first!

26. 7. Sequential strategic game
What does Boeing choose – provided what Airbus will choose?
Boeing: 100
Alpha Airbus: 50
Airbus
Alpha
Boeing: 40
Beta Airbus: 40
Boeing
Alpha Boeing: 25
Beta Airbus: 25
Airbus
Scenario: Boeing and Beta Boeing: 50
Airbus choose which Airbus: 100
Communication
technology they invest in
– but Boeing chooses first!

27. 7. Sequential strategic game
What does Boeing choose – provided what Airbus will choose?
Boeing: 100
Alpha Airbus: 50
Airbus
Alpha
Boeing: 40
Beta Airbus: 40
Boeing
Alpha Boeing: 25
Beta Airbus: 25
Airbus
Note: Airbus would really
Scenario:to make a credible
like Boeing and Beta Boeing: 50
Airbus choose which
threat to choose Beta! Airbus: 100
Communication
technology they invest in
– but Boeing chooses first!

28. 8. Summary
Main points
Game theory provides a powerful analytic approach to strategic
interaction
The approach is especially relevant when the expected performance
(payoff) is dependent on the decisions (choices) made by players
(firms)
Game theory allows to model a wide range of strategic interactions:
competition, cooperation, co-opetition, uncertainty and mixed
strategies, and sequential games
It is enlightening for better understanding the interdependencies
between firms' decisions (e.g., issues of credible commitments and
sequence of moves)