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## David vs Goliath in Entry Decisions

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David vs Goliath in Entry Decisions

- Suppose Goliath has $700 and David has $300
- They are gambling types, and prefer roulette
- Whoever ends up with more money after the next round will win ultimately
- Suppose David moves first and makes the safest bet
- He can never win

David vs Goliath in Entry Decisions

- He should take one of the more risky gambles
- Bets $300 that the ball would land on a multiple of 3 – wins $900 w.p. 12/37
- What is Goliath’s best response
- To exactly imitate David’s bet
- Again, David can never win
- Is there any hope for David?

David vs Goliath in Entry Decisions

- David should have gone second and differentiated himself
- This situation is parallel to new product launch decisions when a firm with shallow pockets competes against a firm with deep pockets
- If going second is not feasible, then entrant should take riskier bets – like launching a product with some chance of failing!!

The idea behind a product line

- Consider a linear city
- It has several evenly spaced firehouses
- City closes every second firehouse and doubles the speed of response
- Clearly the average response time remains unchanged
- This increases efficiency: lower cost for same average response

The old locations and response times

0

1

2

3

4

- Suppose the firehouses are one mile apart
- The maximum distance from a firehouse is 0.5 miles, and the average distance 0.25 miles
- Response time is 60 minutes per mile
- Average response time is 15 minutes and maximum response time is 30 minutes

Maximum distance =0.5 miles

The new locations and response times

0

2

4

- Maximum distance is 1 miles and average distance is 0.5 miles
- Maximum response time is 30 minutes and average response time is 15 minutes
- Consider a fire at a place 2/3rd of a mile from a new firehouse

Variety, equity and efficiency

- The new response time is 20 minutes
- In the old system this place would be 1/3rd of a mile away from the nearest firehouse
- It would have a response time of 20 minutes
- What about a place that is more than 2/3rd of a mile from nearest firehouse
- New response time is 20-30 minutes, and old response time would be less than 20 minutes
- Any change that increases efficiency by reducing variety can reduce equity!!!

The limits of product differentiation: customization

- Customized products are co-created by consumer and producer
- Product comes into existence after first interaction between consumer and firm
- A monopolist usually charges a higher price for customized products than for standard products
- What happens under competition?

Customization

- When two competing firms offer highly customized products, they are not differentiated
- This intensifies competition
- Heightened competition can drastically reduce prices
- Thus prices can be below what would obtain with standard products
- Just because consumers are willing to pay more doesn’t mean firms can charge more!!!

Differentiating strategies through randomness

- Consider competition in the market for razors
- Suppose Gillette runs a coupon promotion on the first week of every month
- Bic can preempt Gillette by running a similar promotion a week earlier
- But then Gillette can preempt Bic the week before
- The only sensible way to play this game is to run promotions randomly

Baseball anyone?

- 1986 baseball National League championship series
- The New York Mets won a crucial game against he Houston Astros
- Len Dykstra hit Dave Smith’s second pitch for a two-run home run
- Later the two players talked about this critical play

Analysis of a home run

- Dykstra said, “He threw me a fastball on the first pitch and I fouled it off. I had a gut feeling then that he’d throw me a forkball next, and he did. I got a pitch I saw real well, and I hit it real well”.
- Smith said, “What it boils down to is that, it was a bad pitch selection…if I had to do it over again, it would be [another] fastball”.
- Would Dykstra not have been prepared for a fastball?
- Again, randomization is the only way to go

But how do you randomize?

- In a game of tennis, suppose receiver’s forehand is stronger than backhand
- Consider following probabilities of successfully returning serve

Server’s Aim

Receiver’s Move

Reducing receiver’s effectiveness by randomizing

- Suppose server tosses a coin before each serve
- Aims to forehand or backhand according to coin turning heads/tails
- When receiver moves to forehand, his successful return rate is 55%
- When receiver moves to backhand, his successful return rate is 45%
- Given server’s randomization, receiver should move to forehand
- The server has already an improved outcome compared to serving the same way all the time!!

What is server’s best mix?

- Consider following graph

90

60

48

Percentage successful returns

30

20

0

40

100

Percentage of times server aims serve to forehand

The mixing probabilities

- The 40:60 mixture of forehands to backhands is the equilibrium
- This mixture is the only one that cannot be exploited by the receiver to his own advantage
- With this mixture the receiver does equally well with either of his choices
- Both ensure the receiver a success rate of 48%

Co-promotions as differentiation

- Consider two firms selling undifferentiated products
- Price competition will be very fierce
- However one of the firms can bundle their product with another product for which consumers differ in their willingness to pay
- Thus both firms can benefit from the resulting differentiation!!

Game theory detour

- Focal market (F):

-Two firms A and B selling undifferentiated products at cost c and quality q

-Consumers willingness to pay for quality is a constant r

- Competition is intense and firms have to sell at marginal cost c
- They make zero profits

Game theory detour

- Outside market (O):

- Has potential partnering brand with quality and cost

-Consumers have heterogeneous willingness to pay for quality given by

- is distributed uniformly on [0, ]

- Suppose A partners with C and B stands alone
- Let the prices be and
- Consumers will prefer AC to AC if >

Game theory detour

- The demands are and =1-
- The profit functions are and
- The optimal prices are ,
- And the optimal profits are ,

Sources of differentiation

- Differentiation grows out of the firm’s value chain
- A firm can also differentiate itself through the breadth of its activities
- Differentiation is useful only if buyers value it
- Buyer value operates through

- by lowering buyer cost

- by raising buyer performance

Buyer purchase criteria

- Buyer value applied to a particular industry can identify Buyer Purchase Criteria
- Buyer purchase criteria

- Use criteria

- Signaling criteria

- Use criteria: supplier affects actual buyer value through lowering buyer cost or raising buyer performance
- Signaling criteria: stems from signals that enable buyer to judge what supplier’s value is, e.g. advertising, attractiveness of facilities, branding and reputation

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