Competitive Strategy: Options and Games

517 Pages·2011·4.583 MB·English

by  Benoit Chevalier-Roignant, Lenos Trigeorgis, Avinash K. Dixit

Competitive Strategy

Competitive Strategy
Options and Games
Beno î t Chevalier-Roignant
Lenos Trigeorgis
The MIT Press
Cambridge, Massachusetts
London, England
© 2011 Massachusetts Institute of Technology
All rights reserved. No part of this book may be reproduced in any form by any electronic
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T his book was set in Times Roman by Toppan Best-set Premedia Limited. Printed and
bound in the United States of America.
Library of Congress Cataloging-in-Publication Data
Chevalier-Roignant, Benoit, 1983 –
Competitive strategy: options and games/Benoit Chevalier-Roignant and Lenos
Trigeorgis; foreword by Avinash K. Dixit.
p. cm.
Includes bibliographical references and index.
ISBN 978-0-262-01599-8 (hardcover: alk. paper)
1. Options (Finance) 2. Investment analysis. 3. Game theory. I. Trigeorgis, Lenos.
II. Title.
HG6024.A3C48535 2011
332.6 — dc22
2010053619
10 9 8 7 6 5 4 3 2 1
Contents
Glossary xi
Symbols xix
Foreword by Avinash Dixit xxiii
Preface xxv
1 The Strategy Challenge 1
1.1 The Changing Corporate Environment 3
1.2 What Is Strategy? 10
1.3 Two Complementary Perspectives on Strategy 15
1.3.1 Corporate Finance and Strategy 15
1.3.2 Game Theory and Strategy 20
1.4 An Integrative Approach to Strategy 35
1.5 Overview and Organization of the Book 41
Conclusion 43
Selected References 43
I STRATEGY, GAMES, AND OPTIONS 45
2 Strategic Management and Competitive Advantage 47
2.1 Strategic Management Paradigms 48
2.1.1 External View of the Firm 48
2.1.2 Internal View of the Firm 50
2.2 Industry and Competitive Analysis 50
2.2.1 Macroeconomic Analysis 57
2.2.2 Industry Analysis: Structure – Conduct – Performance
Paradigm 58
2.2.3 Porter ’ s Industry and Competitive (Five-Forces)
Analysis 59
vi Contents
2.3 Creating and Sustaining Competitive Advantage 66
2.3.1 Value Creation 66
2.3.2 Generic Competitive Strategies 70
2.3.3 Sustaining Competitive Advantage 72
Conclusion 73
Selected References 74
3 Market Structure Games: Static Approaches 75
3.1 Monopoly 76
3.2 Duopoly 81
3.2.1 Bertrand Price Competition 86
3.2.2 Cournot Quantity Competition 92
3.2.3 Strategic Substitutes versus Complements 97
3.3 Oligopoly and Perfect Quantity Competition 99
3.4 Market Structure under Incomplete Information 102
Conclusion 107
Selected References 107
4 Market Structure Games: Dynamic Approaches 109
4.1 Commitment Strategy 110
4.1.1 Concept of Commitment 111
4.1.2 Taxonomy of Commitment Strategies 118
4.1.3 Sequential Stackelberg Game 131
4.2 Bargaining and Cooperation 135
4.2.1 Bargaining 135
4.2.2 Cooperation between Cournot Duopolists in
Repeated Games 138
4.2.3 Co-opetition: Sometimes Compete and Sometimes
Cooperate? 147
Conclusion 151
Selected References 151
5 Uncertainty, Flexibility, and Real Options 153
5.1 Strategic Investment under Uncertainty — The Electricity
Sector 154
5.1.1 Need for New Investment in Europe 154
5.1.2 Sources of Uncertainty 156
5.1.3 Generation Technologies and Business Risk
Exposure 159
5.2 Common Real Options 162
Contents vii
5.3 Basic Option Valuation 169
5.3.1 Discrete-Time Option Valuation 176
5.3.2 Continuous-Time Options Analysis 184
Conclusion 189
Selected References 189
Appendix 5A Multistep Cox – Ross – Rubinstein (CRR) Option
Pricing 190
II OPTION GAMES: DISCRETE-TIME ANALYSIS 193
6 An Integrative Approach to Strategy: Option Games 195
6.1 Key Managerial Issues: Optimal Timing and Flexibility
versus Commitment 196
6.1.1 Optimal Investment Timing under Uncertainty 196
6.1.2 The Trade-off between Flexibility and
Commitment 197
6.2 An Illustration of Option Games 197
6.3 Patent-Fight Strategies 206
6.4 An Application in the Mining/Chemicals Industry 209
Conclusion 217
Selected References 217
7 Option to Invest 219
7.1 Deferral Option of a Monopolist 219
7.2 Quantity Competition under Uncertainty 224
7.2.1 Cournot Duopoly 224
7.2.2 Asymmetric Cournot Oligopoly 235
7.3 Differentiated Bertrand Price Competition 238
Conclusion 240
Selected References 242
8 Innovation Investment in Two-Stage Games 243
8.1 Innovation and Spillover Effects 243
8.2 Innovation and Patent Licensing 253
8.2.1 Patent Licensing: Deterministic Case 253
8.2.2 Patent Licensing under Uncertainty 261
8.3 Goodwill/Advertising Strategies 264
Conclusion 271
Selected References 272
viii Contents
III OPTION GAMES: CONTINUOUS-TIME MODELS 275
9 Monopoly: Investment and Expansion Options 277
9.1 Option to Invest (Defer) by a Monopolist 278
9.1.1 Deterministic Case 281
9.1.2 Stochastic Case 284
9.2 Option to Expand Capacity 298
9.2.1 Additional (Lumpy) Capacity Investment 299
9.2.2 Incremental Capacity Investment 303
Conclusion 306
Selected References 307
Appendix 9A Contingent-Claims Analysis of the Option to
Invest in Monopoly 308
10 Oligopoly: Simultaneous Investment 311
10.1 Oligopoly: Additional Capacity Investment 312
10.1.1 Existing Market Model: Expansion Option 312
10.1.2 New Market Model: Investment (Defer) Option 314
10.2 Oligopoly: Incremental Capacity Investment 317
10.3 Perfect Competition and Social Optimality 322
Conclusion 325
Selected References 325
Appendix 10A Derivation Based on Dynamic
Programming 326
11 Leadership and Early-Mover Advantage 331
11.1 A Basic Framework for Sequential Investment in a
Duopoly 331
11.2 Duopoly with Sequential Investment under
Uncertainty 339
11.3 Oligopoly with Sequential Investment under
Uncertainty 348
11.4 Option to Expand Capacity 352
Conclusion 357
Selected References 357
12 Preemption versus Collaboration in a Duopoly 359
12.1 Preemption versus Cooperation 360
12.1.1 Preemption 363
12.1.2 Cooperation in an Existing Market 370
12.2 Option to Invest in a New Market under Uncertainty 372
Contents ix
12.2.1 Symmetric Case 373
12.2.2 Asymmetric Case 379
12.2.3 Size of Competitive (Cost) Advantage 382
12.3 Option to Expand an Existing Market 389
12.3.1 Symmetric Case 389
12.3.2 Asymmetric Case 393
Conclusion 395
Selected References 396
Appendix 12A Strategy Space and Solution Concept 397
Appendix 12B Perfect Equilibrium in Deterministic
Setting 398
Appendix 12C Perfect Equilibrium in Stochastic Setting 400
13 Extensions and Other Applications 403
13.1 Exogenous Competition and Random Entry 404
13.2 Real-Estate Development 405
13.3 R & D and Patenting Applications 407
13.4 Investment with Information Asymmetry 411
13.5 Exit Strategies 415
13.6 Optimal Capacity Utilization 417
13.7 Lumpy Capacity Expansion (Repeated) 419
13.8 Other Extensions and Applications 421
Conclusion 423
Selected References 423
Appendix: Basics of Stochastic Processes 425
A.1 Continuous-Time Stochastic Processes 426
A.1.1 Brownian Motion 427
A.1.2 Mean-Reversion Process 438
A.1.3 General It ô Processes 440
A.2 Forward Net Present Value 441
A.3 First-Hitting Time and Expected Discount Factor 447
A.3.1 Exercise Timing and First-Hitting Time 447
A.3.2 Expected Discount Factor 448
A.3.3 Profi t-Flow Stream with Stochastic Termination 452
A.4 Optimal Stopping 453
Conclusion 458
Selected References 458
References 461
Index 473