In pursuing his or her objectives, how should a decision maker choose a course
of action in competition with rivals who are acting in their own interests? This
is the essential question addressed by the discipline of game theory. We will
apply this approach to the specific problem of firms competing within a mar-
ket. In this context, we could just as well call our approach strategic profit analy-
sis. Nonetheless, the more general term, game theory, remains apt. This name
emphasizes the kind of logical analysis evident in games of pure strategy—
chess, poker, even war games. As we shall see, strategic considerations are
equally important when firms vie for market share, engage in patent races,
wage price wars, and enter new markets. Indeed, it is fair to say that over the
last 25 years, the game-theoretic approach has been at the heart of the most
important advances in understanding competitive strategies.
The key presumption of game theory is that each decision maker (or
player) acts rationally in pursuing his or her own interest and recognizes that
competitors also act rationally.^1 Although rational behavior may be directed
toward a variety of goals, the usual operational meaning is that all players pur-
sue profit-maximizing strategies and expect competitors to do likewise. (In this
sense, the models of quantity and price competition discussed in the preced-
ing chapter are game-theoretic models.)SIZING UP COMPETITIVE SITUATIONS
A convenient way to begin our discussion is with an overview of the basic game-
theoretic elements of competitive situations. We begin with elements common
to allcompetitive situations.
1 .Players and Their Actions. If it is to have a strategic interest, the
competitive situation must involve two or more players whose choices
of actions affect each other. (It is customary to use playeras a catch-all
term. Depending on the context, a player may be a private individual,
a manager, a firm, a government decision maker, a military leader, a
representative of a group or coalition, you name it.) In the example
opening this chapter, the players are the managers of three
competing airlines. Each must decide what action to take—what
number of daily departures to fly along the air route in question. By
deliberate intent, this example considers only one kind of action.
Generally, an airline’s operations on a single air route involve
decisions about prices, schedules, plane configurations, in-flight398 Chapter 10 Game Theory and Competitive Strategy(^1) The publication in 1944 of The Theory of Games and Economic Behavior,by Oskar Morgenstern and
John Von Neumann, launched the discipline of game theory. The first 35 years were marked by the-
oretical advancements and applications to economics, international relations, and conflict studies.
The last 25 years have seen an explosion of interest in extending and applying game theory in
such diverse areas as management science, economics, political science, evolutionary biology, and
especially competitive strategy.
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