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Choosing the Optimal Marketing Strategy: A Game Theory Application

Marketing strategy plays an extremely important role in a market where competitors are targeting the same customer base with exactly identical or similar products. Every firm or brand operating in a competitive market needs to choose from two main marketing strategies: advertisement expenditure and product discounting. While expenditure on advertisement helps the brand to differentiate its product, enhance customer perception about the product and ensure that people are exposed to the product’s value proposition, product discounting implies selling the product at a price lower than its actual price and helps the brand create a larger customer base that would want to purchase the product at the discounted price. Both these strategies have costs to the firm itself, such as expenditures and losses, and the firms need to decide the balance between these two strategies that will help them maximize profits and payoffs.

The article examined the interplay between the two strategies in predicting firm payoffs and identified the most profitable strategy for the firms from a game theoretic aspect. According to the model developed in the article, there are two firms that operate in the same industry and are therefore, competing for customers. They can choose the combination of the two marketing strategies that they want to employ. A lower ad spend implies a greater focus on the product discounting strategy and a higher ad spend implies a lower focus on the product discounting strategy. In the payoff matrix represented below, an ad spend of $75, implies the highest level of product discount and an ad spend of $125, the lowest.

 

It can be observed that there exist two Nash equilibria, where the payoffs are also maximized. This happens when one firm/brand concentrates on the ad spending marketing strategy and the other firm/brand focuses on the product discounting marketing strategy. In the payoff matrix, it happens when either Brand A chooses to spend $125 on ad (advertisement expenditure-intensive strategy) and Brand B chooses to spend $75 on ad (product discounting-intensive strategy), or when Brand A chooses to spend $75 on ad (product discounting-intensive strategy) and Brand B chooses to spend $125 on ad (advertisement expenditure-intensive strategy). In any case, they should avoid focusing on the same strategy, that is, when either both spend $75 on ad spending (Price War, as both the firms are discounting their products heavily) or  both spend $125 on ad spending (Ad war, as both the firms are spending heavily on ad), because that makes both the brands worse off and leads to losses.

I find this interpretation extremely interesting because this makes sense intuitively. By employing these opposite strategies, they will appeal to different customer segments who want to buy similar or exactly identical products. High ad spending and product differentiation will appeal to customers who value the product differentiation at the high price and those customers who have the required purchasing power, namely, upper middle class and upper class. Low ad spending and deeply discounted products will appeal to customers on a budget and those from the lower to lower middle income classes. As a result, they are no longer vying for the exact same customer base, as is the case with Walmart and Kohl’s for example. While Walmart focuses on product discounting, Kohl’s focuses on advertisement expenditure and product differentiation. In a multiplayer market, this finding implies that all price discounters must form a coalition and all product differentiators must form a coalition, in order to maximize payoffs and profits, because more than one players in the same strategic sphere will compete for the same customer segment.

Sources: http://www.digitaltonto.com/2010/a-marketers-guide-to-game-theory/

 

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