Advantages And Challenges Of ExportingBy Tekle S.
7%-38%-55% Communications MythBy Robert P.
Top 10 Big Mistakes Of Big BusinessBy Francis T.
Climate Change Is Real! Act Now!By Kathrin G.
Improving The Quality Of Decision MakingBy Niladri R.
Advantages And Challenges Of ExportingBy Tekle S.
Top 10 Big Mistakes Of Big BusinessBy Francis T.
Best Practice Benchmarking - The Path To ExcellenceBy Robert C C.
What Is A Healthy Company?By Raymond H.
Challenges And Opportunities In The New EconomyBy Alkistis A.
Also Interesting ...
Don't Take It PersonallyBy Mike P.
Stress Management - What Choices Are You Making?By Simerjeet S.
Best Practice Benchmarking - The Path To ExcellenceBy Robert C C.
Budgeting And The Middle ManagerBy Henry G.
Coaching Virtual Multicultural TeamsBy Peter B.
Games Managers Should Play
The success of strategic investments depends largely on the subsequent moves of competitors. Uncertainty about competitive conduct can lead executives into a guessing game?a poor structure for decisions involving billions of dollars. Game theory provides a better framework for assessing the risks and opportunities involved in any major strategic move.
By understanding five key elements of competitive intelligence, executives can begin to get inside the minds of the other players in their industry. They can then use those insights to perform economic analyses, allowing them to make more informed decisions.
Call it revenge of the nerds if you like, but many high-school chess club presidents are landing the most coveted strategic-planning positions at major corporations. Chess players realize that good strategic decisions require you to take into account the likely moves and countermoves of other players. They study their competitors? approaches to the game and identify the likely sequence of moves that will follow any particular move they make. By looking forward and reasoning backward, they drive the game toward a checkmate victory.
This ability to look forward and reason backward is enormously valuable to strategic-decision makers. When a company builds a new chemical plant or paper mill, its profitability will often turn on whether or not competitors add capacity as well. Similarly, the success of new marketing or pricing strategies depends on whether competitors replicate them. In oligopoly markets, it is hard to identify a strategic decision that isn?t influenced by the retaliatory countermoves it sets off. The best business strategists must be skilled at predicting future rounds of competitive conduct.
Yet this is easier said than done. Uncertainty often surrounds competitive conduct, and many managers either expect the companies they compete against to engage in the kind of competitive behavior they see as normal or make some other educated guess. But such assumptions can be dangerous. Managers unwittingly set off value-destroying price wars, get buried when incumbents retaliate in markets those managers have attempted to enter, and cannibalize their own core markets because they have either ignored or made the wrong guesses about the reactions of competitors.
The good news is that game theory provides a structured process that can help managers make better strategic decisions when faced with the uncertainty of competitive conduct. Game theory isn?t new; economists, mathematicians, and political scientists have been developing it for more than 50 years. What is new is an increased emphasis on game theory as a practical tool that real-world managers can use for making strategic decisions. For example, most participants in the recent US personal communications services (PCS) spectrum auctions hired game theorists to develop their bidding strategies. What follows is a systematic game theory process that has been applied successfully in more than 100 company situations in the past five years.
The rules of the game
A good game theorist gets inside the heads of other players to understand their economic incentives and likely behavior. To do this, you should focus on five key elements of competitive intelligence.
Define the strategic issue
What decision are you trying to make: pricing, capacity, market entry? How is it related to other strategic decisions being made in the market? If you are trying to make a decision on capacity investment, for example, it is vital that you know whether others in the market are also considering entering or leaving it.
Determine the relevant players
Which players? actions will have the greatest impact on the success of your strategy? A common mistake is to assume that all your strategic games are played against competitors and that there is always a winner and a loser. Many of your strategic decisions turn on the actions of other players in the market?suppliers, distributors, providers of complementary goods?and "win-win" outcomes are attainable. For example, a computer hardware manufacturer attempting to stimulate demand for its product must focus on the economic incentives of software producers to provide products consistent with its operating system. A thorough understanding of these incentives allows the hardware producer to structure contracts, joint ventures, or alliances that make both parties better off.
Textbook game theory commonly assumes that the players seek rational, profit-maximizing objectives. However, in real business games players often base decisions, at least in the short run, on criteria such as market share or growth. It is extremely important to get such criteria right. If you make the decision to enter a new market in the belief that the incumbent players are profit maximizers when they are really driven primarily by short-run market share objectives, you might suffer unexpected losses when the incumbents slash prices to maintain share.
Identify the potential actions for each player
For each player in the game, including yourself, develop a list of potential actions on the strategic issue. Generate this list from the perspective of the other players, not just your own. What options might they be considering? How will they evaluate these options? Don?t assume that you and your competitors have the same set of strategic options. Competitive role-playing exercises involving external experts and your management team can help generate these lists.
Determine the likely structure of the game
Will decisions be made simultaneously, in isolation, or sequentially, over time? If sequentially, who is likely to lead and to follow? Will this be a one-shot decision, or will it be repeated? Most business games are repeated, sequential games; pricing decisions, for example, are made over and over in sequence in most markets.
Playing the game: Chemco vs. Matco
These five elements of competitive intelligence define your business game, but more work is generally required before such information can be used to "solve" it. A thorough economic analysis of the industry?including market research and estimates of your competitors? costs and capacity?is usually needed to estimate the payoffs of different strategies for different players, given their strategic objectives. This information is summarized in a payoff diagram (Exhibit 1) and can be used to guide strategic decision making.
The exhibit is based on a duopoly chemical market case in which two competitors?call them Chemco and Matco?are each deciding whether to build a new plant. It is unclear which will be the first to reach a conclusion, but the decisions will certainly be made sequentially; for simplicity, this diagram assumes that Chemco moves first. Each company?s long-term objective is to maximize profits, so the numbers in the payoff diagram represent calculations of net present value (NPV). For example, if neither builds a new plant, each player should earn an NPV of 100.
Chemco ought to look forward and reason backward to make its decision. If Chemco builds a new plant, the payoffs suggest that Matco will not; these decisions will earn Matco an NPV of 80 and Chemco an NPV of 125. However, if Chemco decides not to build the plant, Matco should choose to build instead; this will earn Matco and Chemco NPVs of 115 and 80, respectively. The diagram also shows that while it is profitable for one new plant to be built in the industry, two new plants will lead to significant excess capacity, deep price discounting, and lower profits for both players.
What strategic insights can be learned from this exercise? First, it illustrates the first-mover advantage in the game; by making a commitment to new plant capacity before Matco does, Chemco can influence Matco?s incentives to build and avoid a dismal outcome in which both players bring on new plants. It also demonstrates the symmetry of the first-mover advantage: Matco has its own incentives to move first, suggesting that Chemco must credibly commit itself?perhaps through real bricks and mortar?to new capacity as soon as possible. In addition, the case demonstrates how important it is for both players to understand the limited prospects for growth in market demand. If Matco believes, erroneously, that the market can profitably support both new plants, its plans to expand capacity won?t be influenced by Chemco?s commitments to build.
Learning from the game
Many business games are more difficult to define and solve. In fact, this duopoly chemical case was more complicated than shown here, because capacity decisions were repeated over time, and Matco and Chemco competed across a broad range of product lines. Some economists even argue that real-world business games are so complex, and their solutions so sensitive to model assumptions, that game theory is irrelevant for business decision making. This is not so. First, a surprising number of oligopoly strategy problems can be modeled as simple, quantifiable games: pricing, capacity management, marketing, new-entry, bidding, and contract design problems are particularly common.
Second, game theory applications need not identify unique, robust equilibrium solutions to be valuable strategic-decision-making tools. Since the process itself forces managers to think explicitly about the incentives and likely moves of other players, it can generate a breakthrough in strategic insight even when the game can?t be modeled explicitly. Qualitative role-playing exercises and structured game theory discussions may generate enough insight to lead to a change of direction on new-entry, capacity addition, pricing, and other fundamental strategic decisions.
Third, and perhaps most important, while attempting to model the current industry, game managers invariably develop insights about how to change games to drive more favorable outcomes. Unlike board games such as chess, business games don?t have fixed rules, players, and potential moves. Although game theory can help you play your current game better, its greatest value often comes from helping players define new games. In some cases, for example, game theory predicts that current market conditions make price wars highly likely because customers switch easily between competitors. The current game-modeling exercise identifies the need to change the game by implementing customer loyalty programs, such as frequent-flyer discounts, that create value for customers and companies and decrease incentives for destructive price competition.
Apply game theory the next time you need to make a strategic decision about which competitive interactions matter. Look forward and reason backward to generate insights about how to play your current business game more successfully. At the same time, make sure you leverage these insights to define better games to play. If you don?t change your game to gain advantage, one of your competitors will, and there is not much value in being the best chess player when everyone else is playing checkers.
About the Authors
Hugh Courtney is a consultant in McKinsey?s Washington, DC, office. This article is adapted from one that appeared in World Economic Affairs, Autumn 1997. Reprinted by permission of the publisher. Copyright ? 1997 World Economic Affairs. All rights reserved.
Got an opinion? Want to thank Albert?
54 more Articles by Albert
7 min. Sometimes we can all use a friendly reminder to keep us from backsliding into old ways of thinking about selling that lead us down the wrong path with potential clients.
17 min. How leading-edge companies are streamlining applications development.
21 min. Are you on board with enterprise risk management? You had better be. It's the future of how businesses will be run.
4 min. "Size is no guarantee of future success." What is strategically important is strength not size. Speed is more important than physical mass and flexibility ...
6 min. Trying to perfect a flawless presentation can result in disaster...
13 min. Everything that we do for our clients is based on the idea that improved communications will improve an organisation's performance and contribute to the ...
15 min. Five easy-to-use tools help negotiators in complex deals arrive at a negotiating position that is not only acceptable to them but also palatable to other ...
POP18 min. Looking for inspired leadership, passionate employees, unsurpassed productivity, and grateful customers? Forget the dispirited corridors of corporate ...
POP19 min. The art of leading deep corporate change can be learned. The trick is to help each member of the company discover a new reality...
5 min. Improving the customer-centricity of your organization isn't just good business, it's also good marketing.
12 min. Value created by knowledge is often not captured. Five accounts of knowledge strategies.
4 min. US Recruiting, Retaining & Developing Talent Statistics & Best Practises
15 min. By building social issues into strategy, big companies can recast the debate about their role in society.
8 min. Foresee the future, that's what your customers expect, that's what you need to deliver.
3 min. The aim of this guide is to prepare you for discussions with a bureau, and to get you thinking about all the factors that affect your Facilitator choice.
11 min. Lean Thinking is a highly evolved method of managing an organization to improve the productivity, efficiency and quality of its products or services. The ...
POP11 min. Somewhere in Corporate America, a human resources manager is tweaking her company's employee-incentive program. Maybe she's dumping last year's customized ...
8 min. Companies based in the GCC states are using their petrodollars to expand into global markets. But in the long run, these companies will have to develop distinctive capabilities and skills.
15 min. Further reform will be essential if one of the world?s fastest-growing regions is to seize a broader role in the global economy
13 min. Employees' personal connections can be as valuable as their individual knowledge base. Social network analysis, or SNA, helps maximize a company's collective smarts.
17 min. Over the next two decades, the country's middle class will grow from about 5 percent of the population to more than 40 percent and create the world's fifth-largest consumer market.
6 min. Once companies reach a certain size, setting realistic performance aspirations gets a bit trickier.
8 min. Organic search engine optimization has some distinct advantages over pay-per-click advertising. However, there are undoubtedly certain situations and scenarios ...
8 min. Gen X-ers want far more collaboration with companies - both as customers and as employees. CIOs are uniquely positioned to help their enterprises meet ...
17 min. An organization is much more likely to improve its current performance and underlying health by using a combination of complementary practices rather than ...
11 min. Reasons Why You Should Speak at and Attend Professional Seminars
14 min. Newspapers have tried a host of measures to halt the long-term decline in their readership, but they haven't stopped consumers from turning to TV and the ...
4 min. The proliferation of brands and channels is forcing companies to restructure their marketing efforts significantly.
15 min. The CEO helps a transformation succeed by communicating its significance, modeling the desired changes, building a strong top team, and getting personally involved.
5 min. Should work be fun? Must it be fun? Today, the answer to these questions is mostly yes. What else should it be? Yet however plausible this answer might ...
POP6 min. Two of today's buzzwords are Team and Teamwork. Those with a particular desire to conform to the spirit of the age portray them as the polar opposite of ...
16 min. For GCC states, liberalizing the labor market and developing the local workforce are the keys to moving beyond a reliance on foreign workers.
6 min. Valuable insights on using your speaker to maximise the success of your event
28 min. Surprisingly, many organizations lack a proper succession plan. One reason is that they do not have an effective succession planning process. This author ...
POP4 min. Recently, I came across a code of ethics for hackers (yes, it really does exist) that I'd like to share with you, because I think it really hits home with ...
11 min. Growth is necessary, but size is no guarantee of a successful future! Nevertheless, growth is needed. Without growth there is no life. In a certain sense, ...
7 min. In 15 seconds, a visitor to your site determines whether or not they are interested in your product or service. Web usability experts can provide all sorts ...
13 min. Talent can be bought, but the best companies develop their own.
6 min. Plenty are the professionals who are on the "front lines" of the industry, knowledgeable of the countless changes, and who are willing and able to speak ...
13 min. The days, weeks, or months between taking the job and assuming power are precious. Put them to good use.
20 min. What is success, what is failure, and how can you improve your odds for success?
9 min. The global talent war has seen organisational leaders scratching their heads to understand how they can attract and retain the very best talent that is ...
3 min. Over the last two years of working with hundreds of clients from all walks of life, I have noticed trends of what my clients want and need. This top ten ...
16 min. Services are more difficult to measure and monitor than manufacturing processes are but executives can rein in variance and boost productivity - if they implement rigorous metrics.
10 min. To get beyond survival and to grow both profits and margins, the successful companies of the future will be forced to become true customer experts.
4 min. Few companies have the skills to effectively manage procurement across all spending categories. Smart enterprises should examine their procure-ment strategies ...
12 min. Companies that rely on IT governance systems alone will come up short.
9 min. Complexity has been one of the most frequently used words for some years now. People talk about complex systems, complex interrelationships, complex problems ...
13 min. Of all the findings on business strategy yielded by the study of the businesses in the PIMS? database, the following is one of the most controversial: ...
4 min. How do you know if the speaker fits? How do you avoid embarrassing mismatches?
31 min. There appears to be plenty of room for much greater effort and involvement by companies and organizations around the world. Here a few thoughts and pointers.
POP19 min. Eight emerging trends are transforming many markets and businesses. Executives should learn to shape the outcome rather than just react to it.