Competitive strategy : options and games

Corporate managers who face both strategic uncertainty and market uncertainty confront a classic trade-off between commitment and flexibility. They can stake a claim by making a large capital investment today, influencing their rivals' behavior, or they can take a "wait and see" approach to avoid adverse market consequences tomorrow. In Competitive Strategy , Benoît Chevalier-Roignant and Lenos Trigeorgis describe an emerging paradigm that can quantify and balance commitment and flexibility, "option games," by which the decision-making approaches of real options and game theory can be combined.

The authors first discuss prerequisite concepts and tools from basic game theory, industrial organization, and real options analysis, and then present the new approach in discrete time and later in continuous time. Their presentation of continuous-time option games is the first systematic coverage of the topic and fills a significant gap in the existing literature.

Competitive Strategy provides a rigorous yet pragmatic and intuitive approach to strategy formulation. It synthesizes research in the areas of strategy, economics, and finance in a way that is accessible to readers not necessarily expert in the various fields involved.

Author Notes

Benoit Chevalier-Roignant has been an industry consultant and holds a PhD from WHU in Germany. Lenos Trigeorgis is the Bank of Cyprus Chair Professor of Finance in the School of Economics and Management at the University of Cyprus and Visiting Professor of Finance at the London Business School. He is the author of Real Options (MIT Press, 1995), Strategic Investment , and other books.

Avinash Dixit

Glossary	p. xi
Symbols	p. xix
Foreword	p. xxiii
Preface	p. xxv
1 The Strategy Challenge	p. 1
1.1 The Changing Corporate Environment	p. 3
1.2 What Is Strategy?	p. 10
1.3 Two Complementary Perspectives on Strategy	p. 15
1.3.1 Corporate Finance and Strategy	p. 15
1.3.2 Game Theory arid Strategy	p. 20
1.4 An Integrative Approach to Strategy	p. 35
1.5 Overview and Organization of the Book	p. 41
Conclusion	p. 43
Selected References	p. 43
I Strategy, Games, and Options	p. 45
2 Strategic Management and Competitive Advantage	p. 47
2.1 Strategic Management Paradigms	p. 48
2.1.1 External View of the Firm	p. 48
2.1.2 Internal View of the Firm	p. 50
2.2 Industry and Competitive Analysis	p. 50
2.2.1 Macroeconomic Analysis	p. 57
2.2.2 Industry Analysis: Structure-Conduct-Performance Paradigm	p. 58
2.2.3 Porter's Industry and Competitive (Five-Forces) Analysis	p. 59
2.3 Creating and Sustaining Competitive Advantage	p. 66
2.3.1 Value Creation	p. 66
2.3.2 Generic Competitive Strategies	p. 70
2.3.3 Sustaining Competitive Advantage	p. 72
Conclusion	p. 73
Selected References	p. 74
3 Market Structure Games: Static Approaches	p. 75
3.1 Monopoly	p. 76
3.2 Duopoly	p. 81
3.2.1 Bertrand Price Competition	p. 86
3.2.2 Cournot Quantity Competition	p. 92
3.2.3 Strategic Substitutes versus Complements	p. 97
3.3 Oligopoly and Perfect Quantity Competition	p. 99
3.4 Market Structure under Incomplete Information	p. 102
Conclusion	p. 107
Selected References	p. 107
4 Market Structure Games: Dynamic Approaches	p. 109
4.1 Commitment Strategy	p. 110
4.1.1 Concept of Commitment	p. 111
4.1.2 Taxonomy of Commitment Strategies	p. 118
4.1.3 Sequential Stackelberg Game	p. 131
4.2 Bargaining and Cooperation	p. 135
4.2.1 Bargaining	p. 135
4.2.2 Cooperation between Cournot Duopolists in Repeated Games	p. 138
4.2.3 Co-opetition: Sometimes Compete and Sometimes Cooperate?	p. 147
Conclusion	p. 151
Selected References	p. 151
5 Uncertainty, Flexibility, and Real Options	p. 153
5.1 Strategic Investment under Uncertainty-The Electricity Sector	p. 154
5.1.1 Need for New Investment in Europe	p. 154
5.1.2 Sources of Uncertainty	p. 156
5.1.3 Generation Technologies and Business Risk Exposure	p. 159
5.2 Common Real Options	p. 162
5.3 Basic Option Valuation	p. 169
5.3.1 Discrete-Time Option Valuation	p. 176
5.3.2 Continuous-Time Options Analysis	p. 184
Conclusion	p. 189
Selected References	p. 189
Appendix 5A Multistep Cox-Ross-Rubinstein (CRR) Option Pricing	p. 190
II Option Games: Discrete-Time Analysis	p. 193
6 An Integrative Approach to Strategy: Option Games	p. 195
6.1 Key Managerial Issues: Optimal Timing and Flexibility versus Commitment	p. 196
6.1.1 Optimal Investment Timing under Uncertainty	p. 196
6.1.2 The Trade-off between Flexibility and Commitment	p. 197
6.2 An Illustration of Option Games	p. 197
6.3 Patent-Fight Strategies	p. 206
6.4 An Application in the Mining/Chemicals Industry	p. 209
Conclusion	p. 217
Selected References	p. 217
7 Option to Invest	p. 219
7.1 Deferral Option of a Monopolist	p. 219
7.2 Quantity Competition under Uncertainty	p. 224
7.2.1 Cournot Duopoly	p. 224
7.2.2 Asymmetric Cournot Oligopoly	p. 235
7.3 Differentiated Bertrand Price Competition	p. 238
Conclusion	p. 240
Selected References	p. 242
8 Innovation Investment in Two-Stage Games	p. 243
8.1 Innovation and Spillover Effects	p. 243
8.2 Innovation and Patent Licensing	p. 253
8.2.1 Patent Licensing: Deterministic Case	p. 253
8.2.2 Patent Licensing under Uncertainty	p. 261
8.3 Goodwill/Advertising Strategies	p. 264
Conclusion	p. 271
Selected References	p. 272
III Option Games: Continuous-Time Models	p. 275
9 Monopoly: Investment and Expansion Options	p. 277
9.1 Option to Invest (Defer) by a Monopolist	p. 278
9.1.1 Deterministic Case	p. 281
9.1.2 Stochastic Case	p. 284
9.2 Option to Expand Capacity	p. 298
9.2.1 Additional (Lumpy) Capacity Investment	p. 299
9.2.2 Incremental Capacity Investment	p. 303
Conclusion	p. 306
Selected References	p. 307
Appendix 9A Contingent-Claims Analysis of the Option to Invest in Monopoly	p. 308
10 Oligopoly: Simultaneous Investment	p. 311
10.1 Oligopoly: Additional Capacity Investment	p. 312
10.1.1 Existing Market Model: Expansion Option	p. 312
10.1.2 New Market Model: Investment (Defer) Option	p. 314
10.2 Oligopoly: Incremental Capacity Investment	p. 317
10.3 Perfect Competition and Social Optimality	p. 322
Conclusion	p. 325
Selected References	p. 325
Appendix 10A Derivation Based on Dynamic Programming	p. 326
11 Leadership and Early-Mover Advantage	p. 331
11.1 A Basic Framework for Sequential Investment in a Duopoly	p. 331
11.2 Duopoly with Sequential Investment under Uncertainty	p. 339
11.3 Oligopoly with Sequential Investment under Uncertainty	p. 348
11.4 Option to Expand Capacity	p. 352
Conclusion	p. 357
Selected References	p. 357
12 Preemption versus Collaboration in a Duopoly	p. 359
12.1 Preemption versus Cooperation	p. 360
12.1.1 Preemption	p. 363
12.1.2 Cooperation in an Existing Market	p. 370
12.2 Option to Invest in a New Market under Uncertainty	p. 372
12.2.1 Symmetric Case	p. 373
12.2.2 Asymmetric Case	p. 379
12.2.3 Size of Competitive (Cost) Advantage	p. 382
12.3 Option to Expand an Existing Market	p. 389
12.3.1 Symmetric Case	p. 389
12.3.2 Asymmetric Case	p. 393
Conclusion	p. 395
Selected References	p. 396
Appendix 12A Strategy Space and Solution Concept	p. 397
Appendix 12B Perfect Equilibrium in Deterministic Setting	p. 398
Appendix 12C Perfect Equilibrium in Stochastic Setting	p. 400
13 Extensions and Other Applications	p. 403
13.1 Exogenous Competition and Random Entry	p. 404
13.2 Real-Estate Development	p. 405
13.3 R&D and Patenting Applications	p. 407
13.4 Investment with Information Asymmetry	p. 411
13.5 Exit Strategies	p. 415
13.6 Optimal Capacity Utilization	p. 417
13.7 Lumpy Capacity Expansion (Repeated)	p. 419
13.8 Other Extensions and Applications	p. 421
Conclusion	p. 423
Selected References	p. 423
Appendix: Basics of Stochastic Processes	p. 425
A.1 Continuous-Time Stochastic Processes	p. 426
A.1.1 Brownian Motion	p. 427
A.1.2 Mean-Reversion Process	p. 438
A.1.3 General Itô Processes	p. 440
A.2 Forward Net Present Value	p. 441
A.3 First-Hitting Time and Expected Discount Factor	p. 447
A.3.1 Exercise Timing and First-Hitting Time	p. 447
A.3.2 Expected Discount Factor	p. 448
A.3.3 Profit-Flow Stream with Stochastic Termination	p. 452
A.4 Optimal Stopping	p. 453
Conclusion	p. 458
Selected References	p. 458
References	p. 461
Index	p. 473

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