How to Analyze Your Competitive Landscape Using Game Theory
Success in business is hinged on many factors that owners and managers must focus on. One of these factors is the competition or, in a broader sense, the competitive climate that the business is operating in. This calls for looking and understanding the competitive landscape of the company.
In this article, you will first 1) get a short overview ot techniques to investigate the competitive landscape, and learn then about 2) using game theory to analyze your competitive landscape.
THE COMPETITIVE LANDSCAPE
Competitive landscape is simply defined as the analysis of how a business compares to other similar or competiting businesses. This analysis is often seen as all-encompassing, as it takes a look at a company’s products, services, strengths, weaknesses, growth models, and even sales and market share levels. This also involves the identification of the company’s rivals in the industry or the niche it belongs to, understanding what makes them tick, and figuring out how to hold their own and, eventually, do better than the competition.
Why is there a need for businesses to know what their competitors are doing? Why should they care? Never forget that markets are essentially systems, where one action in one area may evoke responses from other areas. If a business hopes to have a solid footing in the market, it has to be aware of the possible responses of the competition. By knowing your competition, you are in a better position to understand why they responded in one way, instead of another way.
In order to analyze a company’s competitiveness in the face of its rivals and competitors, there are several techniques employed by the so-called competitive intelligence analysts. Here are some of the most commonly used techniques:
In this matrix, analysts look into a company’s level of industry maturity in relation to its competitive position, and how their relationship figures in the overall competitive strategy employed by the company. It tackles four stages in the industry life cycle: Embryonic, Growing, Mature, and Aging; while it named four competitive positions, namely: Weak, Tenable, Favorable, Strong and Dominant.
Porter’s Five Forces
In this framework developed by Michael Porter of Harvard Business School, the level of competitiveness of a company depends on the balance of power, or the 5 competitive forces that influences an industry: Rivalry or competition, Threat of New Entrants, Threat of Substitutes, Supplier Power and Buyer or Customer Power. In order for a company to have an advantage over its rivals in the industry, these forces have to be analyzed and used to determine the strengths and weaknesses of an industry.
The Space Matrix
This analysis method focuses mainly on the competitive position of a company, taking into consideration its competitive advantage, financial strength, environmental stability and industry strength. The results of the analysis of these dimensions will enable the company to determine whether its strategic strength is classified as aggressive, competitive, conservative, or defensive.
As the phrase implies, war gaming involves playing out various scenarios of probable business actions or moves by competitors, and the possible responses of the company to these tactics and strategic moves. It is a simulation method used by many businesses in anticipation of their competition’s actions. As a tool to analyze the competitive landscape, it is very useful in understanding barriers to entry, gathering competitive intelligence, validating competitors’ strategies, and optimizing operational parameters.
These are only a few of the techniques used by analysts to gain an understanding of the competitive landscape. Aside from the abovementioned techniques, there is one other method commonly used by analysts and even some of the largest companies in the world today, such as Microsoft and Chevron: the Game Theory.
USING GAME THEORY TO ANALYZE COMPETITIVE LANDSCAPE
Many are likely to think that War Gaming and Game Theory are one and the same or, at least, very similar.
In order to anticipate the future actions or strategic moves of competitors, Game Theory serves as the “systematic study of strategies for dealing with competitive situations where the results of one party will depend largely on that of the other parties or players”. Simply put, it recognizes that the success of making a choice or a decision will depend largely on the choices or decisions made by others.
The similarities seen by many between War Gaming and Game Theory is probably due to the fact that the latter traces its origins in military theory, based largely on several warfare strategies and tactics that were used during the cold war. Thanks to mathematics, it has evolved into something more structured; hence, the Game Theory that we know about today.
There is one important note to be aware of when using Game Theory to analyze the competitive landscape of a business: it is relevant only when there are relatively few players, or competitors, within that landscape. The results of the analysis becomes slightly irrelevant when there are a lot of players involved, since the impact of an action by one player will not be significant for the others. This method also entails looking hard at pay-offs and, with multiple players in the fold, there’s a chance that analysts will end up looking at a multitude of possible outcomes, which will eventually cloud the results of the analysis.
Through Game Theory, businesses can determine the probable strategies that will be employed by their competitors in order to maximize their business objectives. It is also a way for them to get into their competitors’ heads and understand how their own choices have influenced those strategies.
Elements of the Game
Let us first take a look at the concept of “game” in Game Theory. There are five components involved:
- A set of players, or the decision-makers;
- A set of available strategies, actions or moves that players can make at specific points in the game;
- A set of payoffs or outcomes that are determined by the sequences of strategies or moves made by the players;
- Sets of information or knowledge that players will base their decisions or choices on; and
- Equilibria, or a stable result, where players may have considered all the information and the actions and strategies of other players, but still did not change their earlier choice or decision.
A game of chess has often been likened to the game played in business or economics. There are the players squaring off against each other over a chessboard, with moves that they can use, all of which have been defined by the rules of chess. It is possible that the more experienced player wins while the other loses, or the other way around. But another possibility is that the game ends up in a draw, with neither team having a decisive win. This whole concept is also applicable in business, where you have two firms or companies pitted against each other, selling the same products or services in the same industry, and targeting the same market or audience. They have their own sets of strategies in order to sell more, or reach more of the market. The possible outcomes include one company outdoing or “outselling” the other, or both companies making the same impact to the market, more like a “draw” in a game of chess.
Knowing the elements of a game will help us better understand they key assumptions of Game Theory.
- The players are rational maximizers. The competitors are seen as individuals or entities that add up and look at the pros and cons of every action or decision, and make a choice based on the outcome, choosing that which maximizes the benefit in his favor. Essentially, the players are seen as egoists, tending to display rational behavior when it is their own interests at play.
The general argument against this assumption is on the presumed rationality of the players. After all, in the real world, not all humans do behave rationally, even if it is for their own benefits.
- The players have full information about each other. The Game Theory assumes that the competitors or players already understand everything that you are doing, as well as everything that they can do.
- All the payoffs are known. The players are fully aware of what the possible outcomes are, and what payoffs are expected.
In reality the full information and payoffs are not known with certainty.
Type of Games and Modes of Play
In Game Theory, there are two types of games: the simultaneous games and the sequential games.
1. Simultaneous Games
In this type of game, the moves are made at the same time. In a business context, it could mean two or three competitors making choices simultaneously, even before knowing what choices or decisions the other players are making.
An example would be two U.S. fast food chains – let us call them Company A and Company B – deciding whether to enter the Southeast Asian Market or not. Both are aware of the other contemplating on this entry, and they are also mulling over the decision at the same time.
The two companies make their own analysis on the market entry, and come up with a decision without waiting to hear what the other company has decided on. For instance, Company A may have decided to enter the market without knowing that Company B decided not to set up shop in the region.
2. Sequential Games
As the name implies, these are games where the strategies or moves are made in sequence. The classic example is a game of chess, where one player cannot make a move unless the other player is done with his turn. They will be making their move based on the action or move previously made by the competition. Logical reasoning often comes into play here, since the players strategize after the competition has made their choice.
In the example used in the Simultaneous Games, let us assume that Company A already has entered the Southeast Asian market, and Company B is contemplating on whether to follow suit or not. Company B saw that Company A is doing well in the region, so now it is seriously considering opening its fast food chain in the region as well. This is sequential, since Company B is only making a decision after Company A has made its move.
More than timing, what really differentiates these games is the availability of information before they make their own moves. In the real world, businesses actually play both games, combining elements of simultaneous and sequential games when making decisions.
There are two modes of play prevalent in Game Theory.
a. Non-cooperative Games
This approach assumes that each player aims to maximize its own profit, depending on how the other players will act. In these types of games, players have a ‘dominant strategy’, or that one strategy that provides a payoff higher than the others, regardless of the choice or decision made by the other players. When faced with several options or choices, Game Theory would hold that the company should pick that which is best, since it is its dominant strategy.
We have to take into account the so-called “Nash Equilibrium”, formulated by inventor John Nash. This is that state where “no player has an incentive to deviate from his chosen strategy, even after taking into consideration the choice or decision made by the competition or other players”. In short, even if the other players revealed their playing hand or their actions, it will not affect your own behavior or make you change your earlier decision or strategy, for the simple reason that it will not benefit you to do so. It becomes an equilibrium if the other player does the same, and neither of you has an incentive to change his chosen strategy.
In conjunction with the Nash Equilibrium, the Prisoners’ Dilemma concept was also tackled. It gave the classic example of two prisoners being held for questioning in separate cells, with each of them given two choices: betray the other by turning in evidence and get a lighter jail sentence for it, or choosing not to snitch and keep quiet. It is either Defect or betray the other prisoner, or cooperate with the other prisoner and say nothing.
The highest payoff is clear: getting a shorter jail sentence. However, there is a chance that the two prisoners may choose to defect and betray each other. This would result in longer jail sentences for both of them. If only one defects and the other cooperates, the latter will get the harsher punishment, while the former will get the higher payoff.
Nash equilibrium takes place when the two players choose to defect, because none of them is able to improve his situation or get the maximum possible payoff.
Non-cooperative games are often presented in two forms: the extensive form and the normal form.
- Extensive Form: Normally used to represent non-cooperative games, this representation makes use of trees, with nodes (or vertex) representing points where the players have to make choices. It is somewhat similar to a decision tree, with lines representing possible actions and the payoffs presented at the bottom.
In this form, the game is structured, with perfect information provided and decision-making done in a sequential manner. It begins with one player choosing one of a series of choices, and another player making a choice after having seen the decision by the first player. It ends when each player has obtained their payoffs.
- Normal Form: Also used for non-cooperative games, the normal form makes use of a matrix or a square with the main elements of the game – the players, actions/strategies, and payoffs – fully mapped out, with all the strategies or actions clearly associated with a payoff for each player.
This representation also works best in simultaneous games, or games where the players make decisions without knowledge of the choices of the other players.
b. Cooperative Games
These take on a cooperative behavior among players, where they collaborate and agree on their strategic decisions and choices. The choices are made jointly, instead of separately.
While there is no major argument against the overall cooperative approach, the main question arises with respect to the sustainability of its rewards. There are possibilities where a player can defect from what was agreed upon – after all, there is an incentive to do so, as the benefits could be greater for the player if it chooses to unilaterally alter its decision or switch strategies.
Framework of Game Theory
The applicability of the Game Theory varies, depending on the circumstances or the situations being evaluated or analyzed. However, over the years, analysts have been able to simplify its application. Here is a framework that can be followed by analysts when using the Game Theory to evaluate the competitive landscape.
- Defining the problem.
- Identifying the critical factors affecting competition, such as differentiated products, timing of entry, costs of entry and exit, and other variable costs.
- Building a game model. This would largely depend on the number of players involved, and what approach will be taken. Will it be cooperative, or non-cooperative?
- Development of intuition through the model built.
- Formulation of a strategy, after taking into account all the possible scenarios and situations.
At best, the Game Theory is designed to come up with optimal rather than maximum strategies. It may not be the best and most recommended competitive intelligence analysis tool – even now, there are some questions on its applicability – but it certainly helps in providing businesses a clearer picture of the competitive field.