So we're discussing how to analyze games, and we discussed some of the considerations around symmetric versus asymmetric, single shot versus repeated. I'd like to raise a couple standard challenges you often see in these types of competitive games. At the heart of a lot of them is a debate, if you will, or a tension between cooperation versus competition. And how do we resolve that, especially when we have this kind of negative outcomes if we fail to cooperate and go to a competitive outcome? This ultimately gets to issues around trust and communication. How might we build that with our rivals? How might we build that with our partners to avoid these competitive outcomes? Now one way to think about this is through what is probably the most classic game, which is called the Prisoners' Dilemma. The Prisoners' Dilemma gets its name from the following scenario. Imagine you have two bank robbers. These bank robbers are brought in by the police under suspicion of robbing the bank. The police officers put the two suspected bank robbers in separate rooms, and they begin to interrogate them. Now what's the decision problem faced by each of these suspected bank robbers? Well, one, if they keep their mouths shut there's a good likelihood that they might get away with the bank robbery. However, the police give them incentives to rat out, basically argue and tell about the other one, so that they can then maybe get some leniency in sentencing. Now of course, the problem is the one prisoner doesn't know what the other prisoner is going to do and might be more likely to take the deal and rat out the other prisoner. And as a result, they might both end up admitting to the crime and then ultimately spending time in jail. Now what's the analogy here to the real world and to the markets that we might observe? Well, consider two firms competing on price. They're debating whether to engage in a price cutting or not. Now if they engage in a price cut, there's a chance they can gain greater market share and do quite well for themselves. So here we have a payoff matrix between the two firms where the decision is very simply to either cut prices or not cut prices. If they both decide not to cut prices, they'll actually do very well and make $100 within the market for some foreseeable time period. However, there's an incentive to cut your prices while the other one does not. The idea being that if I cut my prices, I'll increase demand. Even though the prices are lower, I'll engage more sales and, as a result, can profit more. So in our little example here, if Firm 1 cuts their prices and Firm 2 does not, they make $200. Firm 2, however, starts to lose money because now they're not price competitive within the marketplace here. This is a symmetric game, so the payoffs to Firm 2 are the same as they are for Firm 1 in these kind of off-diagonal situations. However, we have this bad competitive outcome that if both engage in a price cut, we end up with getting $0 for both players. What makes the Prisoners' Dilemma a dilemma is that, if you think about it from the perspective of each one, we have a tendency to go to the cut-cut situation, so consider the following. Firm 1 says if Firm 2 cuts their prices, I actually prefer to cut mine because I'd rather get $0 than the negative 30 I would get in that situation. And then similarly, if Firm 2 decides not to cut their prices, I would also prefer to cut my prices because $200 is better than $100. So in essence we have a dominant strategy by Firm 1 to cut their prices regardless of what Firm 2 does. Now it's a symmetric game, using the same logic for Firm 2, they'll also cut their prices. And so we end up here in the competitive outcome of both of us cutting our prices. Now fortunately, in the real world, these types of scenarios can be avoided. There's lots of experiential evidence that firms and industries and people can support cooperative outcomes, as one would expect. However, it often takes communication and commitment to be able to sustain the cooperative outcome. So we talk about cheap talk and costly action. It's one thing to say, oh, we're not gonna cut our prices. But how do you actually signal that's truly your intent, and that you're truly committed to that course of action? So we first think about signaling. So signaling is the selective communication of information to others, either to your rivals or to others that care about what you're doing. So take, for example, getting your MBA. That is a signal that you're providing to potential employers about your worthiness for the job and the type that you are. In a competitive situation here, signaling can be providing information to encourage coordination and restraint amongst the various players within the industry. Again, it might be signaling that you're gonna keep your prices high through some announcement or some action that you take. There are mechanisms that companies have used, industries have used, to try to increase the transparency of data to avoid maybe a price war or other type of behavior. In the airline industry there's something called the Sabre system which provides all the pricing data behind different airlines and the routes they're choosing. At one level this is a service to customer so they can do comparative pricing across airlines. On another level, though, it allows the airlines to see the pricing information of their rivals and hopefully avoid price wars and keep those prices up. Another thing to think about is selective release of information to influence competitors. A classic story along these lines had to happen in the 1980s with DuPont and the production of CFCs. CFCs are an agent that is used for cleaning electronics and other devices, and is also used as a refrigerant in things like air conditioners and the like. Unfortunately, it was found the CFCs were a major contributor to what at the time was a concern called the ozone hole and there was government effort to try to ban CFCs. First DuPont, as a large provider of CFCs, resisted the regulation and tried to argue that there should not be a ban on CFCs. But simultaneously they were investing in alternatives, and ultimately innovated an alternative that they used to then become dominant in the market. What's interesting there is they obviously kept that information private to signal to the other players in the industry that they were gonna fight for the preservation of CFCs, but then ultimately changed course once they had a viable alternative. The second thing we want to think about is this commitment idea. And the commitment idea is that you need to have some irreversible elimination of strategic options to make any threat credible here. So I've talked in the past about the historic story of Cortes coming over to the New World with his troops and immediately turning around and burning his ships. And as the story goes, he told them, you only have two options now, win or die. And what he eliminated was the possibility of retreat there by burning the boats. So there you have an irreversible commitment to a certain strategic action. A more recent example, especially around the idea of forgoing short-term opportunities, what we might call lock-out, was with Netflix and their attempt at least to move full bore into online streaming and to get rid of their legacy business, which was using the mail to deliver DVDs to various customers. Now what's interesting about that story is there was such a consumer backlash about getting rid of the old line business, they backed off those plans and decided to continue to go forward with both businesses. At the end of the day, however, I think they significantly showed their commitment to online and therefore were able to gain customers and support and continued to do quite well in that space. So at the end, game theory here is a very broad tool that can be used in a lot of different scenarios. But it can be very useful as we think about entry decisions and the rivalry that results from them as we try to analyze whether you can actually grow your value creation through entry.
