In the last lesson we talked about the many meanings that the world

strategy can have.

In this lesson we're gonna talk about strategic situations.

And as it turns out, a strategic situation can be relatively precisely defined.

A strategic situation is a situation in which the outcomes for

each player depend not only on what he or she does, but also, what others do.

Now, think about that for a moment.

A strategic situation is one in which no matter how good you are or

how smart you are, depends on what others do I used to live in the Boston area.

On a nice weekend, when the weather's nice in the summertime,

if you drive north from Boston, you can be on the beach in Maine in an hour or so.

But when you start home later that day, it doesn't matter how fast your car is or

how skillful you are as a driver, you're gonna get caught in traffic with

all the people who are coming back to Massachusetts,

back to the Boston area from the beaches in Maine.

Now you do have something you can do in that situation,

even though how much traffic you get caught in depends on how many other people

are deciding to return home at the same time.

You can make some decisions that improve your situation.

You could, for example,

choose to leave early, you could leave during the best beach weather.

The very best beach weather will be the most pleasant time to be on the beach and

most people will choose to stay on the beach during the very best beach weather.

But that's the whole reason why you'll encounter less traffic as you come

back to Boston.

So you do have influence over strategic situations in the outcomes

you achieve in those situations, but you do not have complete influence.

What happens to you also depends on what other people decide,

that's a strategic situation.

The definition that we're using for

strategic situation is the same as the definition for a game in game theory.

We'll occasionally talk about games and game theory in this course.

Although this is not really a game theory course.

To give you a sense of why this is important,

we'll be talking about one of the most important and famous games in game theory,

one that represents a lot of strategic situations in business.

It's called the Prisoner's Dilemma.

So what's the story with the Prisoner's Dilemma?

Well, let's consider the situation of Joe and Henry.

Joe and Henry are bad guys, they're criminals.

Together, they commit a crime, but they're not great criminals so they get caught.

Now, the police grab them.

They put them each in a separate room but

the police realized they don't have enough evidence to convict them both for

the most serious crime that they believe Joe and Henry committed.

So they put them in separate rooms, and they offer each of them the same deal.

The deal they're gonna try to use to get Joe and Henry to confess.

Maybe you've seen this on television shows or

something like, but this is how the deal goes.

This is the deal that they offer separately to both Joe and Henry.

First, they say, if you confess and your partner doesn't, we'll let you off

with just a 1 year prison term, because you've been so cooperative.

Second, if he confesses and you don't, we're gonna throw the book at you,

you're gonna get a severe prison sentence of eight years

because you haven't been cooperative, and he has been.

Now, as it turns out, you're a pretty seasoned criminal.

And you know that if neither of you confesses,

they're not gonna be able to pin the biggest crime on you, but

they probably will be able to pin something more minor.

And you'll probably both end up getting about 3 years in prison.

You also know that if both of you confess, you won't get the book thrown at you,

you won't get the full eight year sentence.

But if both of you confess you'll probably end up with about 5

years in jail both of you.

So that's the situation, those are penalties,

that's the deal that you're facing.

What are you gonna do?

So what did you decide?

To help us analyze this situation, we can put the penalties in the choices

into a table that look something like this.

Now, if you're Henry, let's just take the situation from Henry's perspective.

You're gonna have ask yourself, what you would like to do if Joe doesn't confess.

Well if Joe doesn't confess,

then you would prefer one year in prison to three years in prison.

So you're gonna confess.

If Joe does confess,

then you prefer five years in prison to eight years in prison, so you'll confess.

So no matter what Joe does, you prefer to confess.

Now, unfortunately, exactly the same thing is true for Joe.

No matter what you do, he prefers to confess.

And what that means is if you're both rational actors,

you will both confess, and you'll both end up getting five years in prison.

This is an example of what's called a dominating strategy.

It is the strategy that is the best choice for you that pays higher rewards or

lower penalties, no matter what the other person does.

That’s said to be a Dominating Strategy.

Not all games, not all strategic situations have Dominating Strategies.

But in the prisoner’s dilemma, "Confess" is a dominating strategy.

Why? Because if Joe confesses,

Henry's better off confessing.

And if Joe doesn't confess, Henry is still better off confessing and

vice versa for Joe.

No matter what the other does, you get a lower prison sentence if you confess.

So both of you confess and that's that you end up with five years in prison.

By doing what is best for each of you, individually,

you end up in a situation that neither one of you like very much.

The police have of course, set it up this way.

They'd been very clever and what their going to achieve,or what they hoped

to achieve is that both of you will confess and

you'll both end up doing at least 5 years.

The ranking of the outcomes for Joe and Henry, well, they'd both like it best if.

Say you confess, and the other person doesn't because that gets you off light.

If neither person confesses, then you both get only three years,

which is better than five years.

We both confess, we end up with five years prison for both of you.

And if he confesses, but I do not, well, that's the very worst.

So the equilibrium situation is the third ranked choice for each player.

Now what does that have to do with business?

Well, that's a story about two prisoners in jail, but

it turns out that businesses face situations like this all the time.

Let's consider the situation of two candy companies competing in the same market.

Suppose, at first, they price their candy bars at just about the same level and

each of them has a certain market share.

One day, however,

the price of a commodity, say sugar, decreases and so both

companies face a decision about whether to reduce the prices of their candy bars.

What should they do?

We can express this situation in a table,

just like the situation that represented the Prisoner's Dilemma.

Company A can keep the current pricing or

drop prices Company B has the same choices.

If you work your way through this situation as well,

you'll find that the equilibrium Is that both companies will drop their prices, and

both will end up with lower profits than they had before.

Take a look at this matrix and convince yourself that that's the case.

Are there different outcomes that are possible in real life,

if you're two candy companies and you're having this problem?

Well one thing you could do is, if you are the CEO of one candy company,

you could called up the CEO of the other candy company, and

say how about if we don't reduce our prices?

How about if we agree not to reduce our prices?

There's one problem with that, that's mostly illegal

in most places because it's considered bad for consumers.

Lower prices are good for consumers that's called collusion, and

in most situations that's illegal.

Another way that it can unfold, that is legal,

is if both companies have a track record of these kinds of situations and

have developed a set of practices a way of implicitly cooperating.

In other words, it may be well understood that last time sugar prices dropped

neither of us dropped our prices.

And so we can read an implicit assumption into this situation

that neither of us will drop our prices.

This is an example of what's called a repeated game or

a repeated strategic situation.

And the strategies for repeated situations can be different than the strategies for

one time plays.

Robert Axelrod, a political science researcher, has shown

that one of the simplest strategies is the best strategy in a repeated game.

It's called Tit-for-Tat.

And Tit-for-Tat means you start by cooperating, and

then after that, you mimic whatever the other player did last time.

That's a surprising simple strategy that outperforms many many more sophisticated

strategies in strategic situations.

So, games like this reside in the background of many strategy situations.

But, in real life, things are more complicated.

There are more players, people might not behave rationally.

This matters in determining outcomes, that's a strategic situation.

As you can see, we can define that fairly cleanly and

we're gonna return to many strategic situations in the course.

Now we're gonna pause for a quiz about strategic situations.

What's a Strategic Situation (and what isn't)?

Strategic Management

Meet the Instructors