Walmart and Target a Closer Look at Strategic Interaction

Main topic Walmart and home run A closer look at strategical inter carry through Maastricht University School of concern and economic science 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 appointee Main Paper Table of Contents Page 1. Introduction 2. Economic Principle Game conjecture 3. Applied Economic Principles 3. 1. Theory of Game for concurrently conclusion Making 3. 2. The extended Version for serial Decision Making 4. Conclusion References 4 6 7 8 2 2 1 Introduction In the United States of America on that point ar only two very long-familiar discount retailers buttocks and Walmart. two be currently operating all over the country which places for each(prenominal) one of them among the biggest corporations in the United States. Nearly every American has been to at least(prenominal) one of them becau se they sell to the elevatedest degree 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 studyed that by the end of 2005 46 percent of Americans lived within 5 miles of the ne arst store within 15 miles change surface 88 percent (Basker, 2007). come out operated 1,750 stores in January 2011 (Target Corp. , 2011). Since their wide range of products is preferably similar they are large competitors. Thus, they are constantly waging price war against each otherwise. In addition, they urinate use of strategic interaction and in particular of game theory which is a mathematical model describing a decisionmaking process and showing how the shammers moderate diametrical decisions that potencyly affect each others interests (von Stenge, & Turocy, 2001). This paper analyses strategic interaction between Walmart and Target with respect to the game theory and the extended magnetic d eclination.In order to do so it introduces first the theoretic footing of strategic interaction. Afterwards it applies game theory and the extended version to this fiber in order to show the impact of strategic interaction on two 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 fakes influence each others decisions in situations of divergence 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 carry from and the payoffs the players fulfill from each combination of outline. The payoff matrix describes the outcomes in a certain game for each feasible combination of strategies as shown in Figure 2. 1. 2 Player One scheme 1 Strategy 1 issu ance Player 1 Strategy 2 consequent 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 2If one player used a predominant strategy, his pick yields a higher payoff, regardless what the other player does and as a result he has no incentive to change his strategy. For this fount, player ones dominant strategy would be strategy one if he throwd a higher outcome no matter which strategy player two chooses, but only if he then receives the highest payout. There are too some particular outcomes for example the Nash equilibrium which occurs when any combination of strategies is the beat out strategy with the exceed likely outcome for all players (McDowell, Thom, Frank, & Bernanke, 009). An outcome created by two dominant strategies which is worse than the outcome created by two dominate strategies is called prisoners dilemma. The prisoners dilemma only oc curs when each players dominant strategy results in a smaller payoff than it would have if they had chosen the henpecked strategy. Game theory also assumes that the decisions are made simultaneously. To illustrate a game in which the players specify interdependent, the economist uses the extended version of game theory which is displayed with a game tree (McDowell, Thom, Frank, & Bernanke, 2009). Company 1 Decision motion A or Action B Action A Company 2 Decision Action C or Action D Action C Outcome 1 Outcome 2 Action D Action B Company 2 Decision Action C or Action D Action C Outcome 3 Outcome 4 Action D Figure 2. 2 Decision tree Figure 2. 2 is an example of a game tree. Company 1 first decides which action they will take, which can be either A or B. Company 2 then has the choice how they want to fight back and whether they take action C or D. The best outcome can only be achieved with a backward nduction as a result of evaluating the results first and afterwards predicting the other players strategy. For example, outcome 3 would be the best outcome for caller 2 if company 1 chose action B and therefore company 2 chooses action C. Outcome 2 would gain the highest derive for company 2 if company 1 took action A. 3 Applied Economic Principles 3. 1 Theory of game for simultaneously decision making As stated in the introduction this two very large American retailers are competitors and have a very similar customer base.The income of Targets customer base is slightly higher but it is not pertinent for strategic interaction (Neuman, 2011). Theory of game helps to understand the dissimilar prices and how the different price strategies affect consumer behavior. This example is not based on any specific data. However, it is logic for somebody unstrained to buy a certain good to substitute the same good with an identical one if the price is small(a)er and there are not any additional efforts to make. By applying game theory, the three basic elements have to b e clear. 4 Walmart and Target are the players.Different pricing of a certain product -a television- are the strategies while the different profits are the results of each combination of the strategies. Both companies have two pricing strategies either to pick a low price of 300 or a high price of 500. They have to make the decision simultaneously, for instance before they release the television to the commercialize. It is important to know that the customers are also willing to purchase the television for the high price. Target High Price (500) High Price (500) Walmart Walmart sacks 10,000 profit lower-ranking Price (300) Walmart earns 15,000 profit Figure 3. Payoff matrix for Walmart and Target Figure 3. 1 shows a potential payoff matrix for this strategic interaction. It shows all possible outcomes for the two pricing strategies. Walmart and Target would both(prenominal) make 10,000 profit if they charged the high price and 7,500 profit if they charged the low price. If Walm art chose the low pricing strategy and Target used the high pricing strategy Walmart would gain 15,000 compared to the 5,000 profit Target would make. Target also makes 15,000 profit using the low price if Walmart decides to charge the high price.What does that mean for both companies? Since both of them would earn a higher profit by setting the price low in this scenario, both companies would choose Low Price as a dominant strategy. On the contrary, High Price would be the dominated strategy. Nash equilibrium can be found when both companies pick the low price strategy because they get dressedt have an incentive to change their strategy. This payoff 5 Low (300) Target earns 15,000 profit Walmart earns 5,000 profit Target earns 7,500 profit Walmart earns 7,500 profitTarget earns 10,000 profit Target earns 5,000 profit matrix also shows that the strategy combination of high price and high price would be the best possible outcome for both firms. But rather than applying the dominate d strategy Walmart and Target use the dominant strategy. This dilemma is called prisoners dilemma. Those dilemmas exist quite often and there are many reasons why they exist, for instance, both companies do not want the other one to make a higher profit or even to have the chance to receive a higher profit. 3. 2.The extended version for consecutive decision making Therefore Target and Walmart act and might change the strategy they had choosen. Both competitors often change their strategies. Although Singh (2006) stated that prices at Walmart are to the highest degree 15 percent lower than in traditional supermarkets, Neuman (2011) proved by comparing almost 60 items that Targets prices were a bit lower than Walmarts. It is hard to rely on data which are released with a 5 year time difference but it shows that both firms constantly adjust the prices to be competitive.High Price Target High Price Walmart Low Price 10,000 for Target 10,000 for Walmart 15,000 for Target 5,000 for Walm art 5,000 for Target 15,000 for Walmart 7,500 for Target 7,500 for Walmart High Price Low Price Target Low Price Figure 3. 2 Decision Tree for Walmart and Target 6 Since the decisions of both companies are not made simultaneously the reacting firm -in this case Target- has to find out what action to take in order to receive the highest profit for either stir up Walmart makes. Walmart moves first and selects either strategy.Target is in the position to decide and how it wants to react. Thus, Target uses backward induction. First it evaluates the best results for each action Walmart uses 15,000 profit if Walmart sets a high price and 7,500 profit if Walmart sets a low price. Afterwards it chooses the strategy how to get to that profit. Finally Walmart moves and selects the low or the high price strategy and Target is able to react sufficiently. Assume that Walmart chooses the high price strategy then Target sets low prices and due to that Target earns the highest possible profit. Con clusion Walmart and Target are large competitors on the American retailer market and therefore strategic interaction is very important for them. Both companies know the ways to decide how to act concerning different strategies. Both companies know that it is necessary for them to react and choose the best strategy. In the first example both companies simultaneously introduce a television to the market. Their dominant strategy is to set a low price because both of them hope that the other company chooses the high price strategy.This is one example of a free market wherein the customers always choose the low price if available. Walmart and Target would earn a larger profit if both set the high price. In the other case Walmart moves first and afterwards Target chooses the strategy which leads to the highest outcome. The reacting companys best strategy in the extended version of game theory is always the low price strategy. On the contrary, when two companies have to decide simultaneous ly it is not always the best choice to choose the low price strategy although it is their dominant strategy. References Basker, E. (2007). The Causes and Consequences of Wal-Marts Growth. The Journal of Economic Perspectives, 21 (3), 177-198. McDowell, M. , Thom, R. , Frank, R. , & Bernanke, B. (2009). Principles of Economics, second European Edition. Maidenhead, UK McGraw-Hill Education. Moffatt, M. (2008). What are Game Theory and Bargaining Theory? Retrieved December 4, 2011, from http//economics. about. com/cs/studentresources/f/game_theory. htm Neuman, S. (2011). Target Takes Aim At Walmart, With Some Success, NPR. Retrieved December 4, 2011, from http//www. pr. org/2011/08/19/139793948/target-takes-aim-at-walmartwith-some-success Singh, V. , Hansen, K. , & Blattberg, R. (2006). A Market Entry and Consumer Behavior An investigation of a Wal-Mart Supercenter. Marketing Science, 25 (5), 457-476 Target Corp. (2011). Target Annual Report 2010. Minnesota, US Target. Retrieved Decemb er 7, 2011 from http//www. sec. gov/ narration/edgar/data/27419/000104746911002032/a2201861z10k. htmbg11101a_main_toc Turocy, T. L, von Stenge, B (2001). Game Theory. Academic Press Limited, 2 (2), 69-73. 10. 1080/07430170152379371 doi 8