Games & Strategy
Lecture 1
Introduction
Introduction
- Strategy has a central role in business management
- Strategic decisions mean long-term commitments for the organization
- This suggests that strategy has to do with ‘big’ decisions an organization faces
- Hence, strategy is fundamental to an organization’s success
“Success is 20% skills and 80% strategy. You might know how to read, but more importantly
what’s your plan to read?”(Jim Rohn)
The Role of Business Strategy
“The essence of strategy is to choose what not to do.”(Michael Porter)
- Firm performance depends both on actions the firm takes and the context in which those
actions are taken.
- Although the firm chooses the actions it takes, some factors cannot be changed (at least in
the short run). These factors represent the context.
- We distinguish between factors that are internal or external to the firm.
o Internal context consists of the asset it owns and the way it is organized
o External context includes both industry characteristics as well as nonmarket factors
Example: Dell Computer and Compaq Computer Taken from Saloner, Shepard, and Podolny (2001)
Dell Computer
- Focuses primarily on direct sales of personal computers to end-users.
- Selling directly to the end-user entails low distribution costs.
- It can customize computers at low costs, because it produces to order, avoiding large
inventory.
- Furthermore installed system enables it to order parts shortly before needed, again avoiding
large inventory.
- This enables Dell to offer an attractive product and service at very competitive prices.
Given Dell’s strategy one would expect to see actions directed at cost-cutting and ensuring user-
friendly contact between Dell and end-users. Strategy: offer an attractive product at competitive
prices
Compaq Computer
- Compaq has adopted a different strategy.
- Differences between Compaq and Dell can be explained by two acquisitions Compaq made.
- Compaq acquired a firm manufacturing fault-tolerant computers, mostly used by financial
institutions and insurance companies.
- Furthermore Compaq acquired a company that had developed a significant know-how to
help customers use IT to solve their business problems.
- This made Compaq interesting for large corporations.
, Given Compaq’s strategy one would expect actions directed at producing robust technologies that
can be useful to large corporations.
Dell Computer versus Compaq Computer
- Both companies manufacture computers and face many common contextual factors (e.g.
face same trends in demand, same (potential) competitors).
- But, there are also differences.
- Each faces other as competitor, making competitive environment different.
- Companies have a different internal context (i.e. different areas of expertise).
- This might explain the different strategies adopted by Dell and Compaq.
A strategy describes what actions will most likely enhance the organization’s goals given the internal
and external context.
Why Economic Approach?
- Almost all theory in strategic management has been via broad conceptual frameworks.
- Most do not use mathematical modeling, but proceed by verbal argument.
- Saloner (1991) lists three benefits of formal modeling:
o Formal modeling provides an ‘audit trail’.
▪ So you can track the arguments and how the arguments lead to the outcome
o Formal modeling is a methodology capable of creating novel insights.
o Formal modeling provides a common language.
- Game theory is an appropriate tool to study strategic interaction between agents with
different goals
- his is key to many interesting strategic management issues
“Since many business strategy decisions involve interdependent outcomes, game theory would seem
to apply to business strategy.”(Camerer, 1991, p. 138)
Literal Interpretation Formal Models?
- The objective of formal modeling is not to calibrate a model that is quantitatively true in a
particular setting.
- A model only captures selected features of interest.
- The objective is to create a model that qualitatively simulates the environment that is being
studied (abstracting from other factors).
o Focus on one element and within this one particular element we want to explain
what is driving the decision in this environment
- The primary interest is to understand how the model works and why the results are obtained
(which assumptions are driving the results).
o We really target small problems instead of explaining everything. So the objective of
formal model is to generate predictions that are qualitatively correct and hold in
different environments
Game Theory
- Game theory studies strategic decision making.
- Strategic decision making is key to many interesting strategic management issues.
- Firms almost never operate alone in the market.
- They usually interact with other firms, often as competitors but sometimes also in a
cooperative way.
Lecture 1
Introduction
Introduction
- Strategy has a central role in business management
- Strategic decisions mean long-term commitments for the organization
- This suggests that strategy has to do with ‘big’ decisions an organization faces
- Hence, strategy is fundamental to an organization’s success
“Success is 20% skills and 80% strategy. You might know how to read, but more importantly
what’s your plan to read?”(Jim Rohn)
The Role of Business Strategy
“The essence of strategy is to choose what not to do.”(Michael Porter)
- Firm performance depends both on actions the firm takes and the context in which those
actions are taken.
- Although the firm chooses the actions it takes, some factors cannot be changed (at least in
the short run). These factors represent the context.
- We distinguish between factors that are internal or external to the firm.
o Internal context consists of the asset it owns and the way it is organized
o External context includes both industry characteristics as well as nonmarket factors
Example: Dell Computer and Compaq Computer Taken from Saloner, Shepard, and Podolny (2001)
Dell Computer
- Focuses primarily on direct sales of personal computers to end-users.
- Selling directly to the end-user entails low distribution costs.
- It can customize computers at low costs, because it produces to order, avoiding large
inventory.
- Furthermore installed system enables it to order parts shortly before needed, again avoiding
large inventory.
- This enables Dell to offer an attractive product and service at very competitive prices.
Given Dell’s strategy one would expect to see actions directed at cost-cutting and ensuring user-
friendly contact between Dell and end-users. Strategy: offer an attractive product at competitive
prices
Compaq Computer
- Compaq has adopted a different strategy.
- Differences between Compaq and Dell can be explained by two acquisitions Compaq made.
- Compaq acquired a firm manufacturing fault-tolerant computers, mostly used by financial
institutions and insurance companies.
- Furthermore Compaq acquired a company that had developed a significant know-how to
help customers use IT to solve their business problems.
- This made Compaq interesting for large corporations.
, Given Compaq’s strategy one would expect actions directed at producing robust technologies that
can be useful to large corporations.
Dell Computer versus Compaq Computer
- Both companies manufacture computers and face many common contextual factors (e.g.
face same trends in demand, same (potential) competitors).
- But, there are also differences.
- Each faces other as competitor, making competitive environment different.
- Companies have a different internal context (i.e. different areas of expertise).
- This might explain the different strategies adopted by Dell and Compaq.
A strategy describes what actions will most likely enhance the organization’s goals given the internal
and external context.
Why Economic Approach?
- Almost all theory in strategic management has been via broad conceptual frameworks.
- Most do not use mathematical modeling, but proceed by verbal argument.
- Saloner (1991) lists three benefits of formal modeling:
o Formal modeling provides an ‘audit trail’.
▪ So you can track the arguments and how the arguments lead to the outcome
o Formal modeling is a methodology capable of creating novel insights.
o Formal modeling provides a common language.
- Game theory is an appropriate tool to study strategic interaction between agents with
different goals
- his is key to many interesting strategic management issues
“Since many business strategy decisions involve interdependent outcomes, game theory would seem
to apply to business strategy.”(Camerer, 1991, p. 138)
Literal Interpretation Formal Models?
- The objective of formal modeling is not to calibrate a model that is quantitatively true in a
particular setting.
- A model only captures selected features of interest.
- The objective is to create a model that qualitatively simulates the environment that is being
studied (abstracting from other factors).
o Focus on one element and within this one particular element we want to explain
what is driving the decision in this environment
- The primary interest is to understand how the model works and why the results are obtained
(which assumptions are driving the results).
o We really target small problems instead of explaining everything. So the objective of
formal model is to generate predictions that are qualitatively correct and hold in
different environments
Game Theory
- Game theory studies strategic decision making.
- Strategic decision making is key to many interesting strategic management issues.
- Firms almost never operate alone in the market.
- They usually interact with other firms, often as competitors but sometimes also in a
cooperative way.
