David vs Goliath in Entry Decisions

1. 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 

2. 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?

3. 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!!

4. 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

5. 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

6. 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

7. 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!!!

8. 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?

9. 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!!!

10. 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

11. 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

12. 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

13. 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

14. 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!!

15. 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

16. 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%

17. 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!!

18. 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

19. 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 >

20. Game theory detour • The demands are and =1- • The profit functions are and • The optimal prices are , • And the optimal profits are ,

21. 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

22. 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