Description
This is a presentation about an example of game theory and how it is applied in the business strategy.
PRESENTED BY
What is Game Theory?
• A tool that aids decision making while dealing with interdependence and uncertainty • More efficient if accurately estimates reactions in a market • E.g. The prisoners’ dilemma
Our playground
• Here we try and implement this theory to analyze a decision about whether or not to sell a plant
Analyze a Strategic Interaction
•
1. 2.
• •
• • •
Basically involves three steps:
Problem formulation Model Building
Who are the players? What are the actions available to the players and what is the timing associated with those actions? What information is available with each player? What are the strategies? What are the payoffs?
3.
Decision
Application
? Sale of United Cement’s B Plant • John Morgenstern’s preliminary assessment • Case facts
– – – – – – Two plants: A- 8,000 ton/year, B- 2,000 ton/year Competitor: Associated- 20,000 ton/year Significant overcapacity: 50% of total capacity Current market price: $5 million / thousand ton Variable cost: $2 million / thousand ton Pricing
• Assumption
Table A
? Profit implications of various pricing actions in Current Situation
United Profits Current($5 million) pricing United lowers to $4 million and Associated maintains price Associated lowers to $4 million and United maintains price Both lower price ($ million) Associated ($ million)
15 20 7.5 10
30 15 25 20
Table B
? Profit implications of various pricing Actions after Sale
United Profits Current($5 million) pricing United lowers to $4 million and Associated maintains price Associated lowers to $4 million and United maintains price Both lower price ($ million) Associated ($ million)
15 16 7.5 10
30 21 25 20
A Bi-matrix Game Analysis of the Sale Problem
Step 1: Problem Formulation
• What is the correct pricing strategy for United with and without the sale of the plant? • At what price should the plant be sold?
Step 2: Model Building • Since cement is a local market, we only consider the two local players – United and Associated • The actions to be considered – how the two companies set their prices and whether United should sell the idle plant or not
Step 3: The Decision • Assume both companies choose their prices simultaneously and are committed to that choice. • What are the payoffs of this simultaneous-move single-shot game?
United’s Profit
Associated Maintains Price
Associated Lowers Price
United Maintains Price United Lowers Price
15
7.5
16
10
• No matter what Associated does United makes a higher profit by choosing the lower price • United’s “lowers price” strategy dominates its “maintains price” strategy
Associated Maintains Price
Associated Lowers Price
United Maintains Price United Lowers Price
15 16
30 21
7.5 10
25 20
• Thus Associated’s “maintain price” strategy dominates its “lower price” strategy • • Both companies are expected to play the dominant strategy In this case United earns $16 million and Associated earns $21 million
Now, if we compare United’s new profit after the sale of the plant to its pre sale profit of $15 million, we see that United would be willing to pay a buyer to take the plant of its hands! Why is Associated willing to maintain its price even when it expects United to lower its price? • United cannot supply all the extra demand generated by lowering of prices • Judo strategy
A Game Tree Analysis of the Sale Problem
A
Lower to $4 Maintain at $5
U
U
Maintain at $5
Lower to $4 Maintain at $5 Lower to $4
20 10
25 21 7.5 16
30 15
Conclusion
• The Game theory allows strategists to analyze interdependencies
• It provides a framework for developing, testing, explaining strategic interactions
Thank You
doc_799476291.pptx
This is a presentation about an example of game theory and how it is applied in the business strategy.
PRESENTED BY
What is Game Theory?
• A tool that aids decision making while dealing with interdependence and uncertainty • More efficient if accurately estimates reactions in a market • E.g. The prisoners’ dilemma
Our playground
• Here we try and implement this theory to analyze a decision about whether or not to sell a plant
Analyze a Strategic Interaction
•
1. 2.
• •
• • •
Basically involves three steps:
Problem formulation Model Building
Who are the players? What are the actions available to the players and what is the timing associated with those actions? What information is available with each player? What are the strategies? What are the payoffs?
3.
Decision
Application
? Sale of United Cement’s B Plant • John Morgenstern’s preliminary assessment • Case facts
– – – – – – Two plants: A- 8,000 ton/year, B- 2,000 ton/year Competitor: Associated- 20,000 ton/year Significant overcapacity: 50% of total capacity Current market price: $5 million / thousand ton Variable cost: $2 million / thousand ton Pricing
• Assumption
Table A
? Profit implications of various pricing actions in Current Situation
United Profits Current($5 million) pricing United lowers to $4 million and Associated maintains price Associated lowers to $4 million and United maintains price Both lower price ($ million) Associated ($ million)
15 20 7.5 10
30 15 25 20
Table B
? Profit implications of various pricing Actions after Sale
United Profits Current($5 million) pricing United lowers to $4 million and Associated maintains price Associated lowers to $4 million and United maintains price Both lower price ($ million) Associated ($ million)
15 16 7.5 10
30 21 25 20
A Bi-matrix Game Analysis of the Sale Problem
Step 1: Problem Formulation
• What is the correct pricing strategy for United with and without the sale of the plant? • At what price should the plant be sold?
Step 2: Model Building • Since cement is a local market, we only consider the two local players – United and Associated • The actions to be considered – how the two companies set their prices and whether United should sell the idle plant or not
Step 3: The Decision • Assume both companies choose their prices simultaneously and are committed to that choice. • What are the payoffs of this simultaneous-move single-shot game?
United’s Profit
Associated Maintains Price
Associated Lowers Price
United Maintains Price United Lowers Price
15
7.5
16
10
• No matter what Associated does United makes a higher profit by choosing the lower price • United’s “lowers price” strategy dominates its “maintains price” strategy
Associated Maintains Price
Associated Lowers Price
United Maintains Price United Lowers Price
15 16
30 21
7.5 10
25 20
• Thus Associated’s “maintain price” strategy dominates its “lower price” strategy • • Both companies are expected to play the dominant strategy In this case United earns $16 million and Associated earns $21 million
Now, if we compare United’s new profit after the sale of the plant to its pre sale profit of $15 million, we see that United would be willing to pay a buyer to take the plant of its hands! Why is Associated willing to maintain its price even when it expects United to lower its price? • United cannot supply all the extra demand generated by lowering of prices • Judo strategy
A Game Tree Analysis of the Sale Problem
A
Lower to $4 Maintain at $5
U
U
Maintain at $5
Lower to $4 Maintain at $5 Lower to $4
20 10
25 21 7.5 16
30 15
Conclusion
• The Game theory allows strategists to analyze interdependencies
• It provides a framework for developing, testing, explaining strategic interactions
Thank You
doc_799476291.pptx