Page 619 - Microeconomics, Fourth Edition

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14.3 SEQUENTIAL-MOVE GAMES AND STRATEGIC MOVES 593

Your Payoff Kodak's Payoff
Accommodate
4 20
Small
K
Price war
1 16

Y

Accommodate
8 10
Large
K
Price war
2 12
FIGURE 14.3 Game Tree for Entry into the Digital Camera Business
You move first by deciding whether to enter on a small scale or a large scale. Kodak then responds
by accommodating your entry or launching a price war. Your best choice is to enter on a small
scale, to which Kodak will respond by accommodating.

THE STRATEGIC VALUE OF LIMITING ONE’S OPTIONS
In the sequential-move capacity expansion game, Honda committed in advance to a
particular course of action, whereas Toyota had the flexibility to respond to Honda.
Yet, Honda’s equilibrium profits were twice as large as Toyota’s. The firm that tied its
hands in advance fared better than the firm that maintained flexibility.
This illustrates a profound point. Strategic moves that seemingly limit options can
actually make a player better off, or, put another way, inflexibility can have value. This
is so because a firm’s commitments can alter its competitors’ expectations about how it
will compete, and this, in turn, will lead competitors to make decisions that benefit the
committed firm. In the Honda–Toyota game, when Honda commits itself in advance
to an apparently inferior strategy (“build large”), it alters Toyota’s expectations about
what it will do. Had Honda not made the commitment, Toyota would understand that
it would have been in Honda’s interest to choose “build small,” which in turn would
have led Toyota to choose “build small” as well. By committing in advance to the more
aggressive strategy of building a large plant, Honda makes it less appealing for Toyota
to expand its capacity, moving the industry to an equilibrium that makes Honda better
off than it would have been in the Nash equilibrium of the simultaneous-move game.
Generals throughout history have understood the value of inflexibility, as the
famous example of Hernan Cortes’s conquest of Montezuma’s Aztec empire in Mexico
illustrates. When he landed in Mexico, Cortes ordered his men to burn all but one of
his ships. Rather than an act of lunacy, Cortes’s move was purposeful and calculated:
By eliminating their only method of retreat, Cortes’s men had no choice but to fight
hard to win. According to Bernal Diaz del Castillo, who chronicled Cortes’s conquest
of the Aztecs, “Cortes said that we could look for no help or assistance except from
God for we now had no ships in which to return to Cuba. Therefore we must rely on
our own good swords and stout hearts.” 19

19 This quotation comes from Chapter 2 of Richard Luecke’s book Scuttle Your Ships before Advancing:
And Other Lessons from History on Leadership and Change for Today’s Managers (New York: Oxford
University Press, 1994).