Coca-Cola, PepsiCo, and the Prisoner’s Dilemma
The prisoner’s dilemma is one of the most famous game theories of all time. While it may not have actually ever been used with actual prisoners, the framework for deciding between cooperation and competition can be a useful tool for strategic decision-making of all types.
In the soft drink market, Coca-Cola and PepsiCo’s combined market share is around 25% – they are essentially the only two players. Thus, if Coke or Pepsi decides to lower their price point, the other must respond or risk losing their share in the market. A prisoner’s dilemma situation arises here over what pricing strategy is the strongest: keeping higher prices or dropping prices to react to what the other company is doing. The payoff model for Pepsi and Coke deciding to cut prices with regard to potential profits looks something like this:
If both companies can manage to cooperate and keep an implicit agreement to not cut prices, they will end up both increasing their profits by the highest total amount. However, agreements among competitors to fix prices is illegal so neither side knows what the other is going to do. As the stronger strategy for both sides, without certified knowledge of the other’s actions, is to defect and cut price, both companies have repeatedly lowered their price point with respect to the other until they have now reached what seems to be an equilibrium at their lowest possible prices to remain competitive and still make a profit.
This scenario is ideal for consumers and shows why the government prevents collusion and price fixing among companies, forcing them to follow the strategy outlined by the prisoner’s dilemma game theory.
Article (May 16, 2019): https://www.investopedia.com/articles/investing/110513/utilizing-prisoners-dilemma-business-and-economy.asp