Strategy and Competition – Part 1
Part 1
The Group B: Strategy and Competition Workshop research was on a company in both footwear and women’s businesses. Under Armour targets a niche market in the leisure and connected fitness sectors. The largest shareholder in the market is Nike, with 51%, while the entrant has a 15% share. Thus, Nike is the incumbent company, while Under Amour is the closest competitor in the industry. The economic concepts discussed in this essay are game theory, the Cournot game and Bertrand model, the critical time line, and Nash equilibrium.
Game theory is applied in strategic management by organisations with the aim of coming up with possible alternatives related to the prices and moves of competitors. It is from these patterns that a company could make decisions on the strategy to adopt to remain competitive. Game theory is concerned with the prediction of the outcome of the games of strategy in which a few participants compete. McNutt (2013) pointed out that the role of game theory is to identify the players involved in the game (such as Nike, Adidas, and Reebok) and the player’s type. In addition, it entails finding the patterns and trends adopted by rival behaviour. Thus, game theory is about the acquisition of information on the opponent type to establish action and reactions, belief systems, and recognised interdependence. In the workshop research, technology for sports apparel was established as the consumer’s preference in the game. The companies use information gathered via game theory to make rational decisions. Simon (1956) argued that the management of organisations was bounded rational in decision-making, whereas Penrose (1958) contended that management was, by nature, limited in its abilities.
Nike is the dominant incumbent because it has at least 40% of the market share (51%), which implies that it controls and determines the prices of the products in the industry. Technology is a major factor that is considered by the two companies in the industry. Turocy and von Stengel (2001) pointed out that "nash equilibrium, also called strategic equilibrium, is a list of strategies, one for each player, that has the property that no player can unilaterally change his strategy and get a better payoff” (p. 3). Thus, as an important concept in economics and management that is used to describe a situation where all the involved participants pursue their best possible strategies to remain competitive, For instance, both companies are based on wearable technology and have partnerships with companies in the technology industry such as Flextronics, Apple, HP, and IBM. As a first move, the goal of Nike is to win, while the goal of the goal of Under Armour is to be competitive and not to lose. According to the first-mover advantage, a player who is the market leader is not worse off when compared to the original game if the players act simultaneously (Rasmusen, 2001). In the case of Nike, the first mover game has become disadvantageous.
The critical time line entails observations of the behaviour of competitors in terms of actions in order to know the manner in which to react. The key to understanding the kind of strategy used by others in an industry is to understand the behaviour and subsequently infer from observed behaviour the most likely actions and reactions of management (McNutt, 2013). A failure to understand rival competitor behaviour could result in poor decision-making. Therefore, it is the role of the management to undertake a closer observation of the behaviour and patterns found in the signals. Although the patterns and trends could be hard to establish, clear observations are required. For example, in the Worship, the patterns were observed based on Under Armour and Nike in terms of their actions and reactions between 2013 and 2016. As pointed out by Samuelson (2002), patterns and trends emerge in the observed behaviours, patterns to achieve growth via acquisition, as in the case of both Under Armour and Nike. In this case, the patterns usually develop a critical timeline (CTL) that is composed of the observed actions (McNutt, 2009). It is through the unfolding of the CTL that a strategy is revealed.
Firms in a market can compete on various levels and variables; for example, the companies could compete based on their quantity, choices of prices, and quality (Rasmusen, 2001). In most cases, competition is based on pricing choices, and this is explained via the Bertrand Model. This model is used to assess the interdependence between the decisions of rivals based on pricing decisions (McNutt, 2009). In the workshop research, it was established that competition in the market is predominantly based on innovation and technology, as opposed to positioning themselves on price. Thus, the Bertrand Game was not applicable because the firms in the market are more than one, the goods produced are not homogenous, the firms do not set prices simultaneously, and the firms do not have the same marginal cost. In this case, Nike and other shoemakers use shoe innovation, while Under Armour's innovation is lacking, and this has caused Under Armour to remain less competitive in the industry (Derrick, 2017). Thus, for Under Armour, the possible strategy would be to invest more in technology and be innovative in its products in order to acquire more market share.
Introduced by Augustin Cournot, the Cournot Game is a simple model of duopolies used by companies. The model is based on the assumption that only a single market for the goods produced exists, collusive behaviour is not allowed, it is hard for new companies to enter the market, and few firms produce indistinguishable and homogeneous goods (McNutt, 2009). In the Cournot model, the output quantity is the strategic variable. For instance, in the case of Nile and Under Armour, they operate under the Cournot Game. For instance, both brands are using this as a de novo fighting ship in order to generate a user base to gather big data to support their core businesses. The implication is that firms make decisions on the quantity of goods to produce. In addition, both firms have knowledge of the market demand curve and understand the cost structures of each other.
Strategy and Competition – Part II
Part (b)
Introduction
When a firm enters a new market, it is more likely to face barriers to entry, competition from existing forms, and close substitution of products and prices. In this context, game theory could be applied to analyse the games in which players make choices in a sequential manner. A game tree can be applied in this form of analysis to establish the available choices for the firm when entering a new market (Samuelson, 2002). Management decisions in most cases lack adequate information and use the patterns and moves of competitors to determine their moves in the market. The purpose of the essay is to consider a firm contemplating entry into a new market and examine the contribution of game theory to the analysis of the economic viability of such a strategy.
The Game Theory/ Strategy
The internal consistency accompanied by the mathematical basis of game theory has made it a prime tool that can be used by firms to model and design automated decision-making processes in business environments (Rasmusen, 2005). The automation of strategic choices availed by the game theory enhances efficient decision-making from available alternatives. According to Turocy and von Stengel (2001), “as a mathematical tool for the decision-maker, the strength of game theory is the methodology it provides for structuring and analysing problems of strategic choice” (p. 1). Thus, the process of modelling a situation in a formal way as a game usually requires the decision-makers to explicitly enumerate the players and their available strategic options and to take into consideration their reactions and preferences. The game strategy allows firms to construct a mode that has the potential to offer the decision-maker a broader and clearer view of the situation, such as market entry. This approach could be considered a “prescriptive” use of game theory, aimed at improving strategic decision-making (Turocy & von Stengel, 2001; Jehiel, 2000).
Market Entry Decision Making and Entry Model
In case a new entrant tries to enter the market, the firm is required to play the game in two dimensions, namely product and geography (Samuelsson, 2002). For instance, the new entrant may be required to decrease the price from the market price in order to warrant a portion of the market share. Such a strategy is applied to have a section of market share from the incumbents. The two options for the incumbent are to accommodate and to compete.
The Extensive Game Dimension is a kind of game that provides a complete description of (a) the set of players; (b) who moves when and what their choices are; (c) what players know when they move; and (d) the players’ payoffs as a function of the choices that are made (Levin, 2001, p. 2). In this paper, Firm 1 is the incumbent monopolist company in the market, while Firm 2 is the one that is contemplating entry into the market. Thus, when Firm 2 enters the new market, Firm 1 will be compelled to compete aggressively (fight) or to cede part of its market share to the new entrant (accommodate). Based on the extensive model, Firm 1 has to fight or accommodate Firm 2, and this strategic situation is presented in Figure 1 below.
Figure 1: Strategic Entry Model
Based on Figure 1 above on the decision tree narrative, there is no form in the market that offers competition with this game. Thus, if the new firm does not enter the market, fight, and accommodate, it will yield the same payoffs for Firm 1 and Firm 2. The hypothesis made is that: (1) if the firm does not enter the market, it does not really matter the decision made by the incumbent; and (2) the incumbent (Firm 1) will not lower its prices in case Firm 2 does not enter. In this case, the game represented in this decision tree showed Firm 2 choosing to compete in a monopolistic market or not with Firm 1. Given that there are no competitors in the market, if Firm 2 chooses not to enter, then the payoff will be zero, while the existing monopoly payoff will be two. Nonetheless, if firm 2 chooses to enter the new market, node 2 is reached. In this node, the second decision must be made by the monopoly (Firm 1): whether to accommodate Firm 2, which is the competitor, or fight back as a way of preventing its market entry. If they fight, both players are expected to have a payoff of -1. On the other hand, if the monopoly chooses to accommodate Firm 2, then the monopoly will automatically become a duopoly and result in a decline in market prices. This would subsequently result in the creation of larger market demand, whereby the existing firm (Firm 1) will have to receive a payoff of one, while the entrant (Firm 2) will receive a payoff of two.
To ensure that the entrant does not become competitive, the incumbent must establish an access price at a level that would result in a higher profit for the entrant if it chooses to enter the market (Bloch & Gautier, 2012). For instance, the monopoly may lower its prices to be below the ex-post efficient level. When the prices are lowered, the aggressiveness of the firms at the price competition stage increases. This is needed for the firms to remain competitive in the market. As such, the entrant would have a lower production cost, whereas the incumbent would have a lower cost-making price. According to Greene (1996), predatory pricing entails the setting up of a price below the short-run marginal cost by the incumbent (Firm 1) with the expectation that when the rival exists in the market, then monopoly profits will be made. Therefore, predatory pricing is often directed towards entrants and is used by firms that have already entered the market.
In this case, limit pricing would be directed at the potential entrant (Firm 2) by Firm 1, whereby the incumbents want the entrant to lower its expected price (Hirschey, 2009). The American Bar Association (2005) pointed out that “limit pricing is a long-run profit maximisation strategy where a firm lowers its prices in an effort to deter entry and preserve higher profits over the long run” (p. 131). In essence, Firm 1, which is the incumbent, would artificially keep the prices low with the intent of making market entry unattractive for Firm 2. The assumption made is that new entrants have asymmetric information, and they would use current prices when making decisions related to the entry (Hirschey, 2009). In other markets, the incumbent may be forced to accommodate the entry of the new firm by cutting down its output in order for prices to fall slowly and not significantly. In addition, limit pricing has the potential to yield lower profits compared to accommodation at the pre-entry stage but possibly higher profits thereafter (Schlossberg & American Bar Association 2008).
With reference to the new entrant firm, such knowledge is important in decision-making, and it would provide information related to whether to enter or not to enter the market. The new entrant could, for instance, develop its own infrastructure in order to offer a network input that is more efficient compared to the incumbent (Sappington, 2005). Gayle and Weisman (2007) demonstrated that setting the access price by the incumbent determines the mode of competition. As pointed out by Mandy (2009), the new entrant could identify a set of access prices that, when adopted, would induce productive efficiency and enable the entrant to bypass the incumbent’s price in a cost-effective manner. In cutthroat competitive markets, the management of entrant firms has to look for the underlying trends and patterns in the strategic moves and changes of the incumbent firm (McNutt, 2013). Critical Time Lines (CTLs) are employed by entrant firms to identify the action and reaction moves and predict the next move in sequence, as illustrated in Figure 1.
Conclusion
The essay is based on an analysis of the contribution of game theory towards the economic viability of a firm's a firm's market entry strategy. The decision is based on whether or not to enter the new market. The new entrant has options that it can rely on when making the decision. For instance, when Firm 2 (entrant) enters the new market, the incumbent (Firm 1, which is a monopolist) can compete aggressively or cede part of its market share to a new entrant. When the firm enters the market, the Based on the extensive model, Firm 1 has to fight or accommodate Firm 2, and this strategic situation has been presented. The incumbent firm could use limited pricing to deter the entrant from entering the market. Thus, the new entrant could use game theory to study and analyse this critical timeline and forecast all the possible reactions of the incumbents, particularly the firm’s management. The patterns could be used to establish a strategy to be adopted.
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