facoltà di economia u niversità degli studi di parma cooperation and competition among firms

Facoltà di EconomiaUniversità degli Studi di

Cooperation and Competition Among Firms

Ch. 2Provisional Version (1)

2013-14

Check List

Individual Firm 0 1 3 5

Economie of Scale

Economies of Scope

Economies of Specialization

Reduction of Transaction Costs

Risk sharing

Collusion Payoffs

Internalization of Esternalities

Exploitation of Resource ComplementarityLower Market Incompleteness

Check ListExpected Gross Benefits of ……………………………

Interfirm Cooperation 0 1 3 5

Economie of Scale

Economies of Scope

Risk sharing

Collusion Payoffs

Acquisition & Merger 0 1 3 5

Economie of Scale

Economies of Scope

Risk sharing

Collusion Payoffs

Check ListGross Expected Benefits

• Individual Firm• Interfirm Cooperation• Acquisition&Merger

Costs of Cooperation

Inequality (1)

• Collective action is chosen by rational agents when collective benefit (Bc) for each agent (Bc/n=Bca) is higher than benefit from individual action (Bia):

Bca>Bia (1)

Cost of individual action(single agent/firm)

• Interdendence : No• Coordination by : Price/Contract/Market• Costs: Transaction Costs

Costs of cooperation

• Interdependence: High• Coordination by : Administrative structure /

Information exchange/ Planning and monitoring/ Incentive and sactioning mechanisms/Enforcing the rules/ Checking opportunist behaviour

• Costs: Regulation cost /Coordination costs

Inequality (2)

(Bca-(Cc+Cr))>(Bia-Ct)

with Cc, Cr>0 ; Ct0where Cc= Coordination costsCr= Regulation costs Ct= Transaction costs

Regulation Costs

Set up of incentive and sactioning mechanismsChecking opportunist behaviour

Enforcing the rules

Invisible Hand

•• Rational (self-interested, opportunistic or not ) individuals,

who maximize their utility, increase the collective aggregate welfare of the group

• A. Smith (WoN): “…. he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. “

Social dilemmas

Rational individuals, who maximize their utility, may decrease not only the collective welfare, but also their own individual utility.

The Tragedy of the CommonsHardin (1968) “ The Tragedy of the Commons”:

“The tragedy of the commons develops in this way.Picture a pasture open to all. It is to be expected thateach herdsman will try to keep as many cattle aspossible on the commons. Such an arrangement maywork reasonably satisfactorily for centuries becausetribal wars, poaching, and disease keep the numbersof both man and beast well below the carrying capacityof the land. Finally, however, comes the day ofreckoning, that is, the day when the long-desired goalof social stability becomes a reality. At this point, theinherent logic of the commons remorselessly generatestragedy.

The Tragedy of the CommonsAs a rational being, each herdsman seeks to maximizehis gain. Explicitly or implicitly, more or lessconsciously, he asks, "What is the utility to me ofadding one more animal to my herd?" This utility hasone negative and one positive component.1. The positive component is a function of the incrementof one animal. Since the herdsman receives allthe proceeds from the sale of the additional animal,the positive utility is nearly + 1.2. The negative component is a function of the additionalovergrazing created by one more animal.Since, however, the effects of overgrazing are sharedby all the herdsmen,the negative utility for any particular decisionmaking

herdsman is only a fraction of – 1

The Tragedy of the CommonsAdding together the component partial utilities, therational herdsman concludes that the only sensiblecourse for him to pursue is to add another animal tohis herd. And another.... But this is the conclusionreached by each and every rational herdsman sharinga commons. Therein is the tragedy. Each man islocked into a system that compels him to increase hisherd without limit -- in a world that is limited. Ruin isthe destination toward which all men rush, each pursuinghis own best interest in a society that believesin the freedom of the commons. Freedom in a commonsbrings ruin to all”

• Hardin:• http://www.youtube.com/watch?v=L8gAMFTAt2M• Glass:• http://www.youtube.com/watch?v=lwaNZgY9PCQ&feature=related• Ostrom: • http://www.youtube.com/watch?v=D1xwV2UDPAg

Social dilemmas

Rational individuals, who maximize their utility, may decrease not only the collective welfare, but also their own individual utility.

(The source of social dilemmas is self-regarding rationality as well as opportunism)

“Social dilemmas are situations in which individual rationality leads to collective irrationality. That is, individually reasonable behavior leads to a situation in which everyone is worse off than they might have been otherwise. Many of the most challenging problems we face, from the interpersonal to the international, are at their core social dilemmas” (Kollock 1998).

Social dilemmas

Social dilemmas • Social dilemma is “a situation in which: (1) two or more

individuals can behave so as to maximize personal interests or maximize collective interests, but (2) if all behave so as to maximize personal interests all are worse off than if all behave so as to maximize collective interests (Komorita & Parks 1994)

Social dilemmas

Social dilemmas are situations in which each member of a group has a clear and unambiguous incentive to make a choice that - when made by all members - provides poorer outcomes for all than they would have received if none had made the choice. Thus, by doing what seemsindividually reasonable and rational, people end up doing less well than they would have done if they had acted unreasonably or irrationally (Dawes & Messick 2000)

• “As individuals we are each better off when we make use of a public resource, such as public television, without making any contribution, but if everyone acted on this conclusion, the public resource would not be provided and we would all be hurt. Each farmer does best by taking as much irrigation water as possible, and each fisher benefits from catching as many fish as possible, but the aggregate outcome of these individually reasonable decisions can be disaster (groundwater exhausted and fish species depleted to the point of extinction) (Kollock 1998).

Social dilemmas

Examples of social dilemmas

• Supply of public goods • Exploitation of technological externalities• Collusion • Exploitation common pooled resources,• ecc.

Typologies of social dilemmas

• Social Traps• Public Goods

Social traps

Maximizing short term benefit leads to a reduced long term benefit

On the other hand, adopting a course of action that reduces short term benefit (without canceling it) can prevent the initial benefit from being replaced by a later disadvantage (eg, common pooled resources)

Social traps

Public Goods

•• Supporting a cost in the short term

produces a benefit in the long term.

Public Goods

•• Supporting a cost in the short term

produces a benefit in the long term.Refusing to bear the cost in the short term results in a more than proportional loss in the long run (eg. Environment safeguard).

The structure of social dilemmas: the prisoner’s dilemma

The cartel

Firm F1 and F2 are part of a cartel of producers. Payoff of different course of action are perfectly known by the parties

Fearing the intervention of the antitrust authoritiy, they give up to the mechanism of exchange of information that until then had ensured the coordination of their choices in terms of output (or price) supplied on the market.

Alternatives:cooperate (continuing with the cartel, share the monopoly profits);defect (exiting the cartel, lower prices, increase their market share and enhance profits at the expense of the other firm).

Outcome 1

Both companies cooperate, and their profits are equal to 4 (upper left quadrant)

Cooperation

Outcome 2

Firm F1 defects, while F2 cooperates. F1 obtains profits equal to 8 and F2 equal to 0 (lower left quadrant)

Defection of F1

Outcome 3

Firm F2 defects, while F1 cooperates. F2 obtains profits equal to 8 and F1 equal to 0 (upper right quadrant)

Defection of F2

Outcome 4

Both firms defect and get profits equal to 2 (lower right quadrant)

Defection of F1 and F2

Prisoner’s dilemma

4,4 0,8

Comparison between payoffs

F1 compares his own payoff to F2’s choices.

4,4 0,8

If F2 cooperates, the rational choice for F1 will be:

4,4 0,8

If F2 defects, the rational choice for F1 will be

4,4 0,8

F2 compares his own payoff to F1’s choices

4,4 0,8

If F1 cooperates, the best choice for F1 will be:

4,4 0,8

If F1 defects, the best choice for F1 will be:

4,4 0,8

Selected Payoff :

4,4 0,8

Considering it likely that the counterpart intends to maximize its benefit, both firms decide to defect in order to minimize their losses

4,4 0,8

Individually rational choices lead to collectively and individually irrational outcomes.

(D,D=2,2<C,C=4,4)

• http://www.youtube.com/watch?v=X0_RoPXI4UA

• https://www.youtube.com/watch?v=QYg8khfc9Fs

• http://www.youtube.com/watch?v=IotsMu1J8fA&feature=player_detailpage

• Game Simulator • http://www.gametheory.net/Mike/applets/NormalForm/

4,4 0,8

Generalization

R = “Reward”for mutual cooperation;P = “Punishment”for mutual defection;T = benefit from defection when the other cooperates (“Temptation to defect”);S = Benefit from cooperation when the other defects (Sucker’s payoff)

R,R S,T

Basic Assumption of Prisoner’s Dilemma

T>R>P>S(8>4>2>0)

Violations of assumptions

• If R = P, joint defection (P, P) shows no conflict between individual rationality and collective rationality;.

4,4 0,8

• If T = R, there will be no incentive to defect;.

8,8 0,8

• If P = S there will be more then one equilibrium and the final outcome remains unknown.

4,4 2,8

Cooperation and the payoff structure

• The higher the prize (R), the greater the likelihood that agents will continue to cooperate;

• The higher the value of the payoff of the punishment for mutual defection (P), the greater the likelihood that agents defect during the game;

The level of payoff(Experimental economics)

• Where an agent defects and the other cooperates (C, D or D, C ):

• the lower (S) is, the greater the probability that the cooperator will defect in the next round of the game;

• the greater (T) is, the greater the likelihood that the defector will continue to defect.

Impact of the payoff structure

• (T-R), p(c) • (R-P), p(c) • (P-S),

K (Cooperation) Index

K=(R-P)/(T-S)

(Rapoport 1967)

Postulates

a) when the benefits of individual defection (T) are particularly high, cooperation can be pursued only if R turns out to be much higher than P;

b) when R is similar to P, the likelihood of cooperation is high only if P is low and slightly higher than S.

Cooperation and the Role of Communication

Communication and the likelihood of cooperation

In a game theory context: no effect

In an experimental economics context: Dawes, McTavish and Shaklee (1977): a) No communication among interacting agents; b) Communication on the characteristics of the

players and issues not directly connected to the game;

c) Communication on issues relevant to the game;d) Notification of intention of the agents without

binding commitments.

Cooperation rate of A=B=28Cooperation rate of C=D=68.

Explanation

Effects of communication on :1) interpersonal trust;2) humanization of the group3) individual identity;4) understanding of the game;5) collective identity of the group;6) public commitments.

Cooperation and the Group Size

(Number of Participants)

“Too many cooks spoil the broth”

In a game theory context: no effect

The Prisoner’s Dilemma from 2 to N agents

3/2, 3/2 1/2, 2

2, 1/2

Payoff Matrix

No. of Cooperators

No. Of Defectors

Cooperators’ Payoff

Fedectors’ Payoff

2 1 2 4

1 2 1 3

0 3 - 2

Likelihood of Cooperation and Group Size

2 6 10

No. agents

Interpretative hypotheses of the (inverse) relationship between group size and

willingness to cooperation

• Bad apples

• Bad apples• Interpersonal control • Hume's Treatise:• “Two neighbors may agree to drain a meadow, which they possess in

common; because 'tis easy for them to know each others mind, and each may perceive that the immediate consequence of failing in his part is the abandoning of the whole project. But 'tis difficult, and indeed impossible, that a thousand persons shou'd agree in any such action ...”

• Bad apples• Interpersonal control • Effectiveness of individual action

Social Dilemmas and Regulation Costs

(Parkhe 1993) :

The performance of a strategic alliance will be negatively related to the extent to which the parties perceive each other as behaving opportunistically

The extent of the perception of opportunisticbehavior and the level of contractual safeguards embedded in a strategic alliance will be positively related.

Social Dilemmas and Regulation Costs

At the firm level: • Set up of internal mechanism of detecting opportunism• Writing contractual safeguards• Legal protection of industrial knowledge• Conflict prevention and management (Hostages)• Sanctioning procedures• Modify the payoff structure• Set up and management of government devices• etc.

Inequality (2)

with Cc, Cr>0 ; Ct0

where Cc= Coordination costs

Cr= Regulation costs Ct= Transaction costs

Coordination Costs

Coordination Game (1)Battle of the Sexes

3, 1 0, 0

F=Football MatchB=Ballet

Coordination Game (1)Battle of the Sexes

Paolo1, 3

3, 1 0, 0

F=Football MatchB=Ballet

Dimensions of the coordination problems:

1) the constraints that agents assume, by contract or by convention, to avoid conflicting decisions.

2) the procedures to identify a single equilibrium solution among different alternatives;

Main characteristics of the coordination problems (in comparison with PD) :

1) Information vs opportunism;2) More than one equilibrium.

Coordination Game (2)

Costs related to:

• information investment, • knowledge transfer, • comparison between feasible alternatives;• singling out the best course of action • negotiating investments ;• adjustment of individual conduct to the general

course of action (modifying individual plans, accomplishing time and space constraints (synchronization))

3, 3 2, 2

• https://www.youtube.com/watch?v=2sT_zaofuuE

Coordination Game (3) Stag Hunt Game (Assurance Game)

Jean-Jacques Rousseau

Stag Hare

2, 2 0, 1.5

1.5, 0

http://www.youtube.com/watch?v=C85jOlRt_88

Rousseau in A Discourse on Inequality:“If it was a matter of hunting a deer, everyone well realized that he must remain faithful to his post; but if a hare happened to pass within reach of one of them, wecannot doubt that he would have gone off in pursuit of it without scruple..."

Jean-Jacques Rousseau

Stag Hare

2, 2 0, 1.5

1.5, 0

http://www.youtube.com/watch?v=C85jOlRt_88

Stag Hare

2, 2 0, 1.5

1.5, 0

4, 3 2, 1

Coordination Difficulties(van Huyck, Battalio and Beil 1990)

Minimun value of chosen X

Chosen X by Agent N

7 6 5 4 3 2 1

7 1,3 1,1 0,9 0,7 0,5 0,3 0,1

6 - 1,2 1,0 0,8 0,6 0,4 0,2

5 - - 1,1 0,9 0,7 0,5 0,3

4 - - - 1,0 0,8 0,6 0,4

3 - - - - 0,9 0,7 0,5

2 - - - - - 0,8 0,6

1 - - - - - - 0,7 1

Dimensions of the coordination problems:

1) the constraints that agents assume, by contract or by convention, to avoid conflicting decisions.

2) the procedures to identify a single equilibrium solution among different alternatives;

3) the containment of the risk that, owing to strategic uncertainty, suboptimal equilibria will be chosen.

Ranking of the importance of specific factors for strategic alliances

Clearly understood roles Communication between partners Clearly defined objectives Relationships building Thorough planning Frequent performance feedback Clear payback timelines Integration of information system

(1) Assumption of imperfect information

If the economic and technological content of the goods to be produced is not known to the agents, there emerges a new constraint to collective action: before starting the production of the collective good, agents must decide which among different alternatives should be taken.

Most of the projects carried out in the present have only partial similarities with those carried out in the past

(Different technology, different availability of resources, changes in individual preferences, group size, etc.).

Hence obstacles to collective action consist of information and decision costs that individual agents have to sustain to identify which goods should be produced

as well as uncertainty on the distribution of net benefits

(2)Multipliplicity of equilibria

Collective action has its origin in the strategic complementarity which exists between the individuals who take part ('individual agents are more productive the higher the production level of other agents' (Cooper and Johri, 1996).

CCoord

N2 N3±

(2)Multipliplicity of equilibria

The existence of complementarity, on the one hand, determines incentive to collective action and justifies the greater efficiency of the choice of cooperative rather than individual action. On the other hand, it is the source of a multiplicity of equilibria. In fact, as we will see, the greater the size of the group of participants, the greater the value of its contribution and the more alternative technologies available, the wider the range of possible solutions.

The starting of collective action • The goods to be made become known only after

the agents have organized the alternatives and have managed to identify the optimum solution (of the many possible ones).

• The equilibrium selected will determine the amount of the individual investment (or its cost), the size of the group of participants and the technology.

• Only then will possible sanctions for non-observance of the agreement be decided and the production process start.

The starting of collective action

• Even before control of the risks of free riding, collective production of a good appears to be influenced by the costs of the search for the most efficient solution and the alignment of individual agents' plans to a single general plan (costs of co-ordination).

The beginning of collective action

• In logical time (and often in historical time) the failure of collective action depends firstly on co-ordination failure and secondly on benefit redistribution conflict.

• The problem of co-ordination is met before the control of opportunism and the seriousness of the problem appears to be independent of the entity of the second.

• In fact, if we had significant co-ordination costs and absence of opportunism, the level of co-ordination costs would nevertheless remain high and the likelihood of non-production would also be significant.

Types of coordination costs(information and decision making costs)

• Negotiating costs

• Synchronization costs

• Selection costs

Negotiating costs

• Known

Synchronization costs

Cost of formalizing a convergent and simultaneous decision.

Arising from:

• degree of anomie

• informational barriers (eg. distortions in the communication, ambiguity in the signals, physical distance);

• division of labor and role specialization.

Selection costsCosts of identifying the optimal equilibrium

Arising from:

• acquisition and transfer of information between the relevant players;

• adaptation of knowledge possessed by the players to the skills useful for the assessment of individual plans;

• identification and sorting workable options (equilibria).

Inequality (2)

with Cc, Cr>0 ; Ct0where Cc= Coordination costsCr= Regulation costs Ct= Transaction costs

Economie of Scale

Economies of Scope

Risk sharing

Collusion Payoffs

Economie of Scale

Economies of Scope

Risk sharing

Collusion Payoffs

Economie of Scale

Economies of Scope

Risk sharing

Collusion Payoffs

Transaction costs : Singling out the minimun price in the market Transaction costs : Negotiating the safeguardsTransaction costs : Writing a contract

Check ListCosts of ……………………………

Regulation costs

Negotiating costs

Synchronization costs

Selection costs

Transaction costs : Singling out the minimun price in the market Transaction costs : Negotiating the safeguardsTransaction costs : Writing a contract

facoltà di economia u niversità degli studi di parma cooperation and competition among firms

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