Walmart and Target: A closer look at strategic interaction
Maastricht University School of Business and Economics Maastricht, 4th December 2011 Bastian Hauk, BH ID number: i6034999 Study: International Business Course Code: EBC1009 Economics & Business Group Number: 31 Economics Tutor: Khan Writing Tutor: Hetty Bennink Writing Assignment: Main Paper
Table of Contents
Page 1. Introduction 2. Economic Principle: Game Theory 3. Applied Economic Principles 3.1. Theory of Game for simultaneously Decision Making 3.2. The extended Version for consecutive Decision Making 4. Conclusion References 4 6 7 8 2 2
1 Introduction In the United States of America there are only two very well-known discount retailers: Target and Walmart. Both are currently operating all over the country which places each of them among the biggest corporations in the United States. Nearly every American has been to at least one of them because they sell almost everything and E. Basker described this service “one-stop shopping” (2007). In 2007, Walmart operated more than 3,400 stores across the USA and a survey showed that by the end of 2005 46 percent of Americans lived within 5 miles of the nearest store; within 15 miles even 88 percent (Basker, 2007). Target operated 1,750 stores in January 2011 (Target Corp., 2011). Since their wide range of products is quite similar they are large competitors. Thus, they are constantly waging price war against each other. In addition, they make use of strategic interaction and especially of game theory which is a mathematical model describing a decisionmaking process and showing how the players make different decisions that potentially affect each other’s interests (von Stenge, & Turocy, 2001). This paper analyses strategic interaction between Walmart and Target with respect to the game theory and the extended version. In order to do so it introduces first the theoretic background of strategic interaction. Afterwards it applies game theory and the extended version to this case in order to show the impact of strategic interaction on both discount retailers. It concludes by stating the importance of strategic interaction to optimal decision making and its relevance for Walmart and Target.
2 Economic principles: game theory and extended version The theory of games describes certain concepts in which several players influence each other’s decisions in situations of conflict and competition (Moffatt, 2011). In order to apply game theory there must be at least two players. The three basic elements of a game are the player, the strategies he can choose from and the payoffs the players receive from each combination of strategy. The payoff matrix describes the outcomes in a certain game for each possible combination of strategies as shown in Figure 2.1. 2
Player One Strategy 1 Strategy 1 Outcome Player 1 Strategy 2 Outcome Player 1
Outcome Player Two Strategy 2 Player 2 Outcome Player 1
Outcome Player 2 Outcome Player 1
Outcome Player 2 Figure 2.1: Payoff matrix for a two player game
Outcome Player 2
If one player used a dominant strategy, his choice yields a higher payoff, regardless what the other player does and as a result he has no incentive to change his strategy. For this example, player one’s dominant strategy would be strategy one if he received a higher outcome no matter which strategy player two chooses, but only if he then receives the highest payout. There are also some particular outcomes; for example the Nash equilibrium which occurs when any combination of strategies is the best strategy with the best possible outcome for all players (McDowell, Thom, Frank, & Bernanke, 2009). An outcome created by two dominant strategies which is worse than the outcome created by two dominated strategies is called prisoner’s dilemma. The prisoner’s dilemma only occurs when each player’s dominant strategy results in a smaller payoff than it would have if they had chosen the...