To Develop or Not to Develop? That is The Question.
http://www.strategy-business.com/article/15872?gko=be9cb
In his article, “Game Theory: The Developer’s Dilema, Boeing vs. Airbus,” Kretschmer illustrates how multi-billion dollar decisions made by huge international corporations such as Boeing and Airbus can be explained using simple game theory similar to what we learned in class. In the early 1990’s The Boeing Company and rival Airbus (two of the World’s biggest competitors in the commercial aviation industry) were each interested in developing a “superjumbo” class of commercial airliners. The “superjumbo” is an entirely new class of aircraft capable of seating 500-1000 passengers. Here we have two rival companies, each looking to invest large sums of money (~$8 billion) into developing the same new market in the aviation industry. This situation can be described using game theory.
Kretschmer states that “the Developer’s Dilemma, a simple way to visualize investor choices when the market in unlikely to sustain rival investments” is at the heart of the scenario. This game theory model is based off of the same principles as the Prisoner’s Dilema game theory model discussed in class. The Prisoner’s Dilemma is based on the fundamental idea that one player’s payoff is dependent not only on his/her own decision, but on the other players decision as well. The Developer’s Dilema is modeled below (Boeing payoff, Airbus payoff):
|
Boeing/Airbus |
DEVELOP |
DON’T DEVELOP |
| DEVELOP |
(loss, loss) |
(superior profit, no profit) |
| DON’T DEVELOP |
(no profit, superior profit) |
(no profit, no profit) |
Boeing and Airbus are the two players in this game. Each has two options: to invest or not to invest in the development of the “superjumbo” jetliners. If only Boeing decides to develop, they will have a large, positive payoff due to the lack of competition from Airbus in the same market, and visa versa if only Airbus chooses to develop. If both Boeing and Airbus decide to develop, there will be losses in profit (negative payoff) for each of them. And lastly if neither develops, the market does not change and there are no gains or losses for each of them. These concepts are the essence of the Prisoner’s Dilema. The Nash Equilibriums [Boeing Airbus] for this case is [D, DD] and [DD, D]. Since [D, D] is not a Nash Equilibrium, both companies investing individually would result in losses.
To avoid such losses that are predicted through game theory, Boeing and Airbus formed an alliance in 1993 to develop a Very Large Commercial Transport (VLCT). The idea was that collaborating and working together towards the same goal would result in profit for both companies and reduce the possibility that one company would take serious profit losses. Nonetheless, Kretschmer states that the Developer’s Dilema still threatened Airbus because of the possibility that Boeing would leave the alliance and dominate the superjumbo market using some of Airbus’ ideas. As a result of Boeing’s lack of commitment in the alliance, Airbus backed out and decided to develop the “superjumbo” on its own. So what should Boeing now do?
Again it is clear from the analysis above that if Airbus develops, there is a high likelihood that Boeing will lose if they also develop. Therefore the best response strategy for Boeing is not to develop, and the article explains that they did just that. However, Kretschmer attests that Boeing did not commit in the alliance because they wanted dominance in the “superjumbo” market, but instead wished to preserve its monopoly in older market of “jumbo” aircraft. This spurred the creation of a different “superjumbo” game.
|
Boeing/Airbus |
DEVELOP SUPERJUMBO |
DON’T DEVELOP SUPERJUMBO |
| DEVELOP SUPERJUMBO |
(high risk, risk) |
(risk, loss) |
| DON’T DEVELOP SUPERJUMBO |
(loss, risk) |
(profit, loss) |
**Payoffs are related to the effects of the strategies pertaining to the superjumbo market have on the jumbo market for each company**
Game theory tells us that if the superjumbo market is untapped, Boeing will reap high profits from their jumbo line, while Airbus will suffer losses. In other words, “Boeing’s payoff for leaving the new market untapped is positive because of prior dominance in an older market, whereas Airbus’ payoff is negative.” Based on this particular game model, it would be advantageous for Boeing to stop Airbus from entering the new “superjumbo” market.
It turns out this is precisely what they did. Employing delay tactics in the VLCT alliance and threatening to undercut proposed Airbus designs with Boeing designs at a significantly lower cost were all part of “the psychological card in a game Boeing recognized it could not win.” In fact, Kretschmer also notes that Boeing’s reasoning behind the program cancellation (that the market is not ready yet) is another example of Boeing trying to prevent Airbus from making a decision that game theory states will result in losses for Boeing. It is very interesting to see how important business decisions can be justified and supported by the game theory models taught in class.