Game Theory and Chain Restaurants
I have always wondered why competing businesses tend to locate themselves so close to each other, sometimes even right next to each other. Take, for instance, McDonald’s and Burger King. Wouldn’t that take away customers from each other? Wouldn’t it be better if they were spread apart so that more customers have access to their restaurants?
It turns out, however, that both McDonald’s and Burger King benefit more when their stores are built in the same area when they are choosing locations for their chain stores. Using the game theory concepts we learned in class help us see why this is the case.
The players in this scenario would be McDonald’s and Burger King. Both are trying to build 5 new chains in the city and are given 10 locations to choose from. Location 10 would be the best and most profitable location, giving 10 points as profit, and location 1 would be the least profitable location, giving only 1 point. The payoffs vary depending on the choices of the competitors; if both choose the same location, they split the value of the location, but if only one company builds a store at a location, then that company gets to take all the profit.
The Nash equilibrium in this game is actually when both companies choose the top 5 locations, from 6 to 10. Both would then be earning a total of 20 points of profit each ( 3+ 3.5 + 4 + 4.5 +5). If Burger King chose locations 5 to 9, it would still earn a total of 20 points (5+ 3+ 3.5 + 4+ 4.5), but McDonald’s is then earning 25 points ( 3 + 3.5 + 4 + 4.5 + 10). Even though Burger King is making the same amount of profit in both situations, in the long run it is losing to McDonald’s by allowing the latter to have the more profitable location. Because both companies do not want to give up the valuable locations, the dominant strategy for both companies is to build their chains in the most profitable areas, even if that means the two restaurants have to be next door neighbors.
Although at first it seemed strange that competitors would locate their stores right across from each other, game theory helps explain why this cluster actually forms. This game play reminded me of the Prisoners’ Dilemma that we learned in class and how each player should play the same strategy, “confess.” In the McDonald’s vs. Burger King problem, the two competitors also play the same strategy, choosing locations 6 to 10, hence forming the cluster. However, we have more than 2 strategies with this problem–10, in fact–which made the game play a lot more interesting. It made us consider not only the total number of points (profit) as we did in Prisoners’ Dilemma, but also other factors such as market share and long-term consequences. It served as a good example of how everyday situations that we normally do not take much time to think about are actually strategies that people use to gain the most profit possible.
Source: http://mindyourdecisions.com/blog/2012/10/23/why-are-mcdonalds-and-burger-king-usually-located-near-each-other-fast-food-location-game-theory/#.Vfk7Mp1Viko