Chapter 3: The marketing environment and a game theory perspective on competition

Chapter 3: The marketing environment

and a game theory perspective on
competition

Aims of the chapter

The aims of this chapter are:
• to identify the different elements of the marketing environment
• to distinguish between those elements
• to describe some of the elements
• to introduce you to some aspects of game theory.

Learning objectives
By the end of this chapter and the relevant reading, you should be able to:
• distinguish between the micro and macroenvironment of a firm
• describe how the different elements of the micro and
macroenvironment affect firms’ marketing activities
• distinguish between zero-sum and non-zero-sum games and the
implications for competitive behaviour
• explain the different methods firms can use to elicit co-operation.

Essential reading
Kotler, P. and G. Armstrong Principles of marketing. Chapter 3.
Note: You need to be aware of the impact of a changing population structure
but don’t need the level of depth or detail given by Kotler; for example, the
material dealing with baby boomers, millenials and the changing American
family is not needed; also not required is the material on geographic
shifts in population. You should understand the implications of increasing
diversity for marketers generally, but do not need to know the details of the
American situation. You need to know what secondary cultural values are
generally, but you do not need to know the specifics of the different types
that Kotler gives.

Further reading
Axelrod, R. The evolution of co-operation. (London: Penguin Books, 1990).
Deber, R.B., N. Kraetschemer, S. Urowitz and N. Sharpe ‘Patient, consumer,
client or customer: what do people want to be called?’ Health Expectations 8
(2005), pp.345–51.
McDonald, C. Challenging social work: the context of practice. (Basingstoke:
Palgrave Macmillan, 2006) p.115.
McLaughlin, H. ‘What’s in a name: ‘Client’, ‘Patient’, ‘Customer’, ‘Consumer’,
‘Expert by experience’, ‘Service user’ – what next?’ British Journal of Social
Work 1–17 (2008).
Redding, P. ‘The evolving interpretations of customers in higher education:
empowering the elusive’, International Journal of Consumer Studies 29(5)
2005, pp.409–17.

21
141 Principles of marketing

Useful websites
www.tutor2u.net/economics/content/topics/monopoly/game_theory.htm
(last accessed 29 April 2009).
This site has a diagram illustrating the prisoners’ dilemma.

Introduction
This chapter has two parts. In the first part we will look at the marketing
environment, both the micro and macroenvironments. In the second part
we will look in more detail at how game theory can be used to understand
the interactions between competitors.
This chapter focuses on the environmental factors which affect the
marketing activities of organisations. Such factors include demographic
changes, changes in fashions, changes in consumption due to economic
development and political changes. How marketers cope with such
changes is also covered. Another important theme that runs throughout
this course is the fact that marketers have to be aware of changes that take
place in the marketing environment, since these can have a major impact
on how marketers change and evolve their own marketing strategies.
You should note that while this chapter and the accompanying material
in Kotler and Armstrong (2010) draw attention to specific aspects of the
political, economic, social and technological environments, these are all
dynamic areas and for examination purposes you need to have your own
examples that illustrate, for example, how specific changes in the economic
environment have had an influence on marketers. Clearly there is a
similarity in concepts and their study in this chapter will repay when you
reach the end of the subject. Finally, you should remember that study of the
marketing environment is important insofar as the environment can have an
important impact on the activities of marketers. For this reason this topic has
important, though often unstated, links with the other topics in this subject.
You should be aware that examination questions on any of the other topics
may require you to have an awareness of the issues addressed in this topic.

Types of environment
Companies interact with two types of environment: the
‘microenvironment’ and the ‘macroenvironment’. The microenvironment
comprises the company’s suppliers, customers, marketing intermediaries
and competitors. The macroenvironment is made up of wider forces which
affect demand for a company’s goods. These forces include demographics,
economics, nature, technology, politics and culture.
1
Those of you who studied
The microenvironment1 Principles of sociology
should recall the coverage of
The microenvironment consists of five major factors:
‘Elements of organisations’.
1. The marketer’s ‘internal environment’ (i.e. its own management That topic considered the
structure). role of ‘missions and goals’;
these are an important
2. The ‘marketing channel’ used by the firm (for example, its suppliers). element of the internal
3. The markets in which the firm may be selling (these may be consumer, environment for an
organisation. For example,
producer, reseller, government or international markets).
the mission of an
4. The firm’s competitors (also contained in the ‘internal environment’). organisation explains what
the organisation is about
5. Those groups of people who have an interest in the marketer’s and what different
ability to achieve their objectives. As well as obvious groups such stakeholders can expect
as shareholders, interested publics can also include local interest from it.

22
 Chapter 3: The marketing environment and a game theory perspective on competition

groups who may have concerns about the marketer’s impact on the
environment or on local employment. The characteristics of the firm’s
internal environment affect its ability to serve its customers.

Customers, consumers or clients?

In standard marketing texts there is an initial distinction made between
business buyers and consumers. The latter are people who buy for their
own use. Within discussions relating to consumer markets, there is another
distinction that is made between consumers and customers (which is
unrelated to the business buyer and consumer distinction).
Consumers are understood to be people who actually use a product or
service and customers are the people who pay for these. In this sense, the
parent is the customer for baby food because they make the purchasing
decision and the payment, but the baby is the consumer. This distinction
is important because the customer will be making decisions about what
to buy, based on what they think the consumer will want. In the case of
babies marketers will need to make appeals to the customer (parent),
but in the case of young children marketers have found that it can make
sense to have advertising appeal to the consumer (the child) who can then
‘pester’ the parent to make the ‘right’ decision!
In organisational buying there is a distinction between ‘customers’ and
‘clients’. Customers are considered to be people who have a relatively high
ability to define what they need and want and the marketer has to respond
to these needs and wants. In contrast the term ‘client’ is generally associated
with the provision of professional services (such as accountancy and legal
services). In these businesses it is the marketer who is often in a position to
advise their customer as to what their needs and wants are, and then charge
fees for delivering services that meet these needs. The power balance
between the marketer and the people they are undertaking exchanges with
is quite different according to whether the latter are customers or clients.
Although Kotler and Armstrong take the term ‘customer’ for granted, you
should be aware that the very notion of calling people ‘customers’ has
attracted debate in recent years. Since the 1980s when there was a move
in developed countries to privatise industries and organisations that were
previously under government ownership, there has been an ideological
move towards introducing business concepts into such organisations.
The move has become more widespread with organisations still under
government ownership taking on business concepts and ideas as a means
of improving efficiency and responsiveness to the needs of the people they
deal with. One of the developments that has taken place is referring to
such people as ‘customers’, with the idea being that this will encourage
staff to be more focused on addressing their needs.
However, in the fields of health, education and social work, for example,
there has been a debate about the role of the service provider and the
people that they are trying to serve. Indeed the very notion of referring
to people as ‘customers’ or ‘clients’ has been questioned. The text below
highlights the nature of the debate in a number of different professions.
In a paper dealing with social work, McLaughlin (2008) says, ‘In the UK,
however, the term client came to be challenged both from within and
outside the (social work profession). From within, there was a concern
that the notion of a ‘client’ represented an objectification of the social work
relationship whereby it was assumed power laid with the professional to
identify what the passive client needed’. In this context the term ‘client’
was considered to be a negative – because it would lead to clients of
23
141 Principles of marketing

social services feeling disempowered. This may be a sensitive issue in a

profession where service providers deal with vulnerable sections of society,
such as the disabled.
In the education context, there has been a debate as to whether students
can meaningfully be referred to as ‘customers’. Redding (2005) says:
‘Customer-related truisms commonly touted in business include: ‘the
customer knows best’. Yet academics … are all quick to point out that this
is not, nor should it be the case with students.’ There is a perception that
the term ‘customer’ is misapplied in a context where there is a significant
information asymmetry between provider and receiver.
Finally in the field of health, Deber et al (2005) conclude: ‘The results
show that the respondents from the four clinical populations (breast,
prostate, fracture, HIV) tended to reject most of the labels suggested to
replace ‘patient’ (customer, survivor, consumer, partner, client). It must
also be recognised that the term patient tends to be moderately preferred,
rather than achieve strong support. Yet our results suggest that the
individuals we surveyed still place high value on a relationship with their
provider that is based on a model other than that between buyer and
seller. It seems to be captured by the label “patient”.’
The essence of this debate is captured in the following quotation: ‘The
words we use to describe those who use our services are, at one level,
metaphors that indicate how we conceive them. At another level such
labels operate discursively, constructing both the relationship and
attendant identities of people participating in the relationships, inducing
very practical and material outcomes.’ McDonald (2006:115).
The point you should take away from this discussion is that there will
invariably be a variety of ways in which marketers can refer to people
with whom they are exchanging goods and services. The term ‘customer’ is
not always a neutral one and it has connotations that not all people in all
organisations will appreciate.

The macroenvironment

Demographics
The demographic environment itself is affected by changes in the mix of
age groups in the population. If the population becomes older, this will
lead to rising demand for products and services consumed by older people
and a similar fall in demand for products consumed by younger people.
The development of ethnic markets can also be relevant. In a number of
countries, the ethnic mix of consumers is changing due to immigration
and other factors. This will be reflected in changing demands for various
goods not only from the specific ethnic group but from other consumers
whose tastes have been affected by them. Furthermore, as ethnic groups
emigrate to other countries, their own tastes can affect those of consumers
in the host nation (e.g. Asian foods are now sold within UK supermarkets).
The demographic environment is also affected by the level of education in
a country, since changes in education have an impact on the wealth of a
nation and the tastes of its people.
The lifestyles of a population also have an impact on the
macroenvironment facing marketers. In Western countries there has been
a growth in households made up of single people; a large proportion of
women go out to work. This has resulted in an increase in the sales of
convenience foods. There are also more couples whose children have
grown up and left home. Such couples have more disposable income to
spend on luxuries, holidays and home improvements.
24
 Chapter 3: The marketing environment and a game theory perspective on competition

Economics
The economic environment is important to marketers because it affects the
amount of money people have to spend on products and services. One of
the components of the economic environment is the distribution of income.
Economies around the world not only vary in their absolute or total level
of wealth but also how their wealth is spread within the population. For
example, poor countries may be classified either as those which have a
highly unequal spread of wealth or those where it is more evenly shared.
The former group of countries may be markets for luxury goods, despite
the level of poverty. In contrast, the second type of country may be more
attractive to marketers of inexpensive goods for the mass market.
Consumers around the world differ in the extent to which they save money
and the use they make of credit facilities. A high propensity to save will
result in a lower propensity to consume. However, these patterns will also
have a secondary effect on the overall macroeconomy of a nation. A country
where people have a high propensity to save is likely to be characterised by
low interest rates, which will affect industry’s borrowing costs.
The economic problems faced by some countries have meant that some
international marketers cannot be paid in hard currency. To make sales,
therefore, they have had to barter their products. An example of this is the
barter of Pepsi-Cola for Russian vodka by the Pepsi company and the old
Soviet government.

Nature
This is important to marketers insofar as it is the source of many raw
materials and fluctuation in supply can affect the prices paid for purchases.
Furthermore, the increasing cost of some raw materials has meant that
recycling of some materials, such as aluminium, has become economic.
There is increasing pressure from public opinion as to the sources of raw
materials and their effect on the natural environment. Paper manufacturers
have had to pay attention to sourcing pulp from renewable forests, where
trees are replanted to make up for those which have been felled. There is
also pressure on them not to use chemicals and bleaches in their processing
of paper. The increased cost of energy is also having an effect on the types
of products which appeal to consumers. For example, in some countries
there is a trend towards small cars and products which save energy.
Due to developments in technology, it is possible for manufacturers and
consumers to cause less damage to the environment. Various European
countries encourage the use of catalytic converters in cars to reduce the 2
Those of you who have
levels of poisonous gases which are emitted into the atmosphere. studied Principles of
sociology will recall
Technology2 the argument between
modernists and post-
Technological developments offer marketers both opportunities and modernists. The latter ar-
threats. While firms can offer customers a wider array of advanced gue that the information
products, changes in technology also mean that there may be more than explosion of recent years
one technical solution to a customer’s needs. Where a market converges has not led to increas-
ing conformity, as the
towards one technological standard, there can be problems for marketers
modernists have argued,
who had promoted an alternative standard. An example of such a situation but it has led to an
was illustrated by the fight between two alternative video formats: VHS increase in diversity and
(promoted by JVC) and Betamax (promoted by Sony). While Sony’s choice. This highlights
technology was considered superior, most other manufacturers adopted the issue that there can
be considerable debate
the VHS format and ultimately Sony stopped selling Betamax video
about the impact of
recorders and switched to making those using the VHS format. Today there changes in technology
is a similar struggle between suppliers of different types of hi-fi equipment. on society.

25
141 Principles of marketing

Increased technological development accelerates the speed of obsolescence.

Marketers have to consider how their product may need to be developed
over time if it is to remain competitive. For example, Apple Computer
gained an advantage over IBM and IBM-compatibles through the use of its
Graphic User Interface (GUI), which meant that the users can manipulate
pictures on the computer screen rather than use complex commands. This
made it much easier to use than IBM personal computers. However, the
introduction by Microsoft of Windows meant that IBM users could also
have a pictorial display on their screens; this reduced Apple’s advantage.
To regain the advantage Apple introduced a new computer chip (PowerPC)
which was supposed to be faster than the Pentium chip used by IBM.
Technological developments affect how people work and do business. For
example, the falling cost of telecommunications coupled with their increased
sophistication has meant that it is possible for individuals to work away
from the office. In the future this could lead to lower usage of transportation
systems. Furthermore, the falling cost of technology has meant that many
more small firms can function in areas such as publishing and film production,
which used to be the domain of large organisations. In a number of countries
this has resulted in the establishment of small firms in these areas.
The risks from technological changes have meant that firms are
increasingly entering into ‘strategic alliances’ with customers, suppliers 3
Those of you who have
and even competitors. Indeed, there has been an increasing emphasis studied Principles of
on open, long-term relationships, based on trust between customers and sociology will recall
suppliers. This is expected to help in the development of products and the the points made about
the size of transnational
management of technological risks.
corporations and the
impact that they can
Politics3 have on people. Indeed,
Marketers are influenced by the regulatory environment. This has implications some are argued to be
more powerful than
for their obligations to customers and the wider public. Customers are
some nation states.
increasingly able to seek redress for faulty products and those who live near
manufacturing plants are able to claim compensation for pollution. The 4
Those of you who have
political environment around the world has recently favoured the privatisation studied Principles of
of public companies. Such companies have also been able to compete more sociology will recall the
discussion about
freely in the private sector. Political changes in Eastern Europe have also
globalisation. One of
meant that these markets are now open to marketers from around the world. the definitions put
forward in that subject
Culture4 highlighted that as a
result of globalisation
People’s opinions and tastes are shaped by the society in which they
the constraints of
live. It should be noted that societies are not made up of homogeneous geography on culture
populations. They contain sub-cultures, which are beliefs and values recede and people act
shared by smaller groups of people. Such groups may arise out of a accordingly. Following
common race, religion, social activity or hobby. Sub-cultures are important that argument, if
to marketers insofar as they may have different consumption habits from globalisation is taking
place, it will have an
the rest of the population.
impact on the cultural
The following are some aspects of culture which influence people’s environment. You should
consumption: the ‘core’ culture is that set of values which is handed also recall the coverage
given to ‘religion’ and
down from generation to generation and which is reinforced by social
how this can influence
institutions such as schools and places of worship. Core values are behaviour. Specifically,
likely to be strongly held and it may be difficult for marketers to promote the subject mentioned
a message which runs counter to them. More susceptible to change are that substantive
secondary values, as people’s opinions are influenced by the media, definitions of religion
are based on religious
role models and changing tastes. Chapter 5 of Kotler and armstrong
beliefs – in terms of
(2010) ends with a discussion of how marketers can respond to the a marketing context
marketing environment. That is an important issue which is significant for such beliefs can drive
examination purposes and you should pay attention to it. consumption behaviour.

26
 Chapter 3: The marketing environment and a game theory perspective on competition

Figure 3.1 shows the different elements of the macro and micro
environments and also shows that the marketing organisation (represented
by the marketing mix) is directly influenced by the microenvironment and
that both are influenced by the macroenvironment.

Demographics
Technology

customers competitors
Economics management
Culture
External strategies & Internal public
Environment objectives Environment

suppliers other departments

Politics
marketing intermediaries

Nature

Figure 3.1: Macro and micro environment

Activity
Choose an industry about which you can get information from either newspapers or
books. Using Figure 3.1, describe any political, economic, social and technological
changes taking place which will affect the demand for the products/services produced by
that industry. Then explain what impact this is having on the marketing activities of the
firms in that industry. Where possible collect relevant statistics and collect details of the
source of the information. The examples you use and the sources of information can be
either local or international.
An example for using the above figure is as follows; it is based on an extract from
www.foodanddrinkeurope.com/news/ng.asp?n=62404-indian-packaged-foods-ethnic/
(last accessed 29 April 2009).
‘Average annual growth in consumer spending on ethnic packaged foods in Europe has
been running at 14 per cent since 1999 – a rate far higher than 5 per cent in the US.
Food formulators could delve deeper into Chinese offerings, with the report showing that
Chinese food is the leading pre-packaged ethnic cuisine, popular across all of Europe,
even where Chinese immigration is relatively low. “This reflects Chinese food’s relative
ease of consumption: it is not heavily spiced and it often features familiar ingredients,”
comments Band.’5 5
John Band, consumer
markets analyst at
The marketing impact of this information would be on producers of ethnic cooking Datamonitor.
ingredients, whose forecasts of sales could take into account the news of a healthy and
growing market.

Introduction to game theory

Game theory can be useful in helping marketers understand the external
environment, particularly the way in which firms can deal with competitors.
It uses the metaphor of a game to describe this situation, and the participants
are referred to as players. In our marketing context, game theory’s usual
references to players will instead be companies, and the possible gain will be
in terms of profits or sales. A game may consist of a single set of decisions,
or a round, or it may consist of many rounds. Although such games cannot
reflect all aspects of real life, they can give managers useful insights into
the strategies that may work in the real world and an understanding of why
some courses of action may be more effective than others.
27
141 Principles of marketing

The assumptions made by game theory are as follows:

• Players are self-interested in that they try to maximise their own pay-
off from the game.
• Players are rational – they can calculate pay-offs correctly and will
select the ones that maximise individual reward.
• The optimum decision for a player will depend on how the other
player(s) will react and, therefore, it requires a dynamic and interactive
approach to strategic decision-making.
In a marketing context, the objective is to identify marketers’ optimal
decisions under conditions of uncertainty and interdependence. Games
consist of the following characteristics and conditions, which are known to
the firms involved:
• a defined set of possible courses of action for the firms
• identifiable preferences of each firm among the possible outcomes of
the game
• relationships whereby outcomes are determined by firms’ choice.
Firms within a game choose strategies by rationally examining available
information, and by considering the actions open to them, the expected
pay-offs and their expectations of other players’ decisions. The resulting
equilibrium is the combination of best strategies for each player. In this
section, we shall consider some of the basic models and then show how
they can be used in actual marketing situations.

The basic models

First, we discuss the basic models and concepts of game theory. We explore
their relevance to marketing in the next section.

The prisoners’ dilemma

Two prisoners are accused of committing a robbery together. They are
held in separate cells and cannot talk to each other. If one confesses to the
robbery and the other does not, the one who confesses is released, and the
other receives a five-year sentence. If both confess, they receive three-year
sentences. If neither confesses, they receive one-year sentences for a lesser
crime.
Each player will identify the rational self-interested decision that gives the
best pay-off no matter what the other player decides to do. It is relatively
easy to show that, under these assumptions, the best decision for each
prisoner (the dominant strategy) is to confess.
The importance of the prisoners’ dilemma game lies in showing how
independent decision-making can lead to inferior results for the players,
since the optimal strategy for both would be not to confess. However, each
prisoner may feel that if they followed this strategy and the other person
confessed, they would end up being worse off. In such cases, collective or
co-operative decisions are more effective from the players’ point of view.
The model highlights how individuals can actually become worse off when
they pursue self-interested decision-making. The lessons from this game are
very wide-ranging, and they can be applied to many areas of marketing.
• Price control. If all firms competing in a particular market co-operate to
maintain prices at a high level, knowing that their competitors will do so,
overall profitability is maximised. But if one firm decides to drop prices
(this is called defecting) to increase its market share, its rivals will have
to follow suit, so reducing the overall profitability of the industry.

28
 Chapter 3: The marketing environment and a game theory perspective on competition

• Product development. If all firms competing in a particular market

co-operate to develop new standards, for example in mobile phones, the
ability of any individual company to differentiate its offering is reduced;
however, the benefits brought about by the collaboration mean that the
new standard can sell to many more people and thereby become accepted.
• See also www.dmnews.com/cms/dm-news/database-marketing/ 34403.
html (last accessed 29 April 2009) for a discussion of how game theory
can be an important consideration in direct marketing. The example
given is important not just in the direct marketing context discussed but
also in a wider range of situations where a firm can be releasing products
that compete with each other (e.g. a firm that makes many different
brands of breakfast cereal).

Activity
Give some examples of ‘standards’ that have helped competitors in an industry.

Answer
The following website gives an example of how standards can be commercially important:
www.udel.edu/alex/dictionary.html#sta (last accessed 29 April 2009).
In summary it explains how alliance-forming in the video market by JVC enabled the
company to have its standard VHS format accepted, even though the competitor format
developed by Sony was widely considered to be technically superior.

The tragedy of the commons

In this game farmers keep their cattle in a field (a common). At the start
of the game farmers agree that they should each only keep one cow there,
since too many cows will eat all the grass. Nevertheless, each farmer’s
goal is to maximise the selling weight of the cow at the end of the season,
so they will each have an incentive to make themselves better off at the
expense of the other farmers. But if every farmer does this, the land will
become overgrazed and each cow will weigh less than it would have done
if everyone had stuck to the original arrangement. The tragedy of the
commons is that the dominant strategy to maximise the common good is
not the same as that to maximise the individual good.
The tragedy can only be avoided by government intervention through
regulation – to restrain overuse. There are other means of ensuring
co-operation, without coercion, and government regulation does not
always achieve the desired outcome. There are lots of examples of this in
the commercial world, especially in developing countries where people
pursue their personal interests without regard for the long-term pay-off for
everyone and where governments may be too weak to impose regulations
that people have to follow. In contrast, there are countries where the laws
may seem restrictive to others, but the benefit is that the gains for the
wider community are maximised.

Activity
Identify current examples of the tragedy of the commons. What measures have or could
be taken to ensure that the outcome comes closer to maximising the common good?

Commentary
Planning and building laws restrict the ability of individuals and firms
to build their homes and shops however they like. The restriction on the
rights of individuals, however, means that the wider community is able to
29
141 Principles of marketing

gain from better planned towns and cities. Where shops adhere to such
laws the shopping experience can be more rewarding than situations
where people have been able to expand their businesses however they like.

Zero-sum games
Zero-sum games are those where one player’s gains can only be at the
expense of the others. Certain types of examinations are examples of a
zero-sum game. In such examinations there are only a limited proportion
of firsts and upper seconds. If one candidate gains a first, it means that
there is one fewer first-class result available for the other players (or
students). In marketing the competition for market share can be seen as a
zero-sum game: if one firm wins a 30 per cent share of a market, there is
less for everyone else.

Non-zero-sum games
Non-zero-sum games (which are also known as positive-sum games) are
those in which the total combined score of the players can vary, depending
on the different combinations of moves they make. This means that if
people co-operate they can all gain.

Activity
Are the prisoners’ dilemma and the tragedy of the commons, zero-sum games or non-
zero-sum?

Answer
The prisoners’ dilemma and the tragedy of the commons, and the examples of their
application, are all non-zero-sum games, which is why co-operation can evolve.

Other examples of non-zero-sum games include the following:

• When firms launched mp3 players, people knew very little about the
technology. However, the advertising and promotional efforts of the
different competitors meant that consumers were educated about the
benefits of the new format. As a result of their combined activities the
firms were able to increase the rate of expansion of the market than
would have been the case if they had been operating alone and as a
result all firms gained.
• The introduction of new technology may be seen by firms as zero-
sum in the short term, since all that happens is that they lose sales of
existing older products. But if it leads to increased market share and
accelerated growth, it can become non-zero-sum.
• In international marketing, regional trade agreements lower trade
barriers, thereby increasing competition for firms in individual
countries. But economic growth in all countries will be stimulated as a
result of the change and all companies stand to benefit.
Three further points need to be made:
1. Zero-sum games are win–lose, and offer no benefit from co-operation.
2. The status of a game can vary according to how the players are
defined. Thus co-operation between competing stores to maintain
prices will be seen as non-zero-sum for the participating stores. But if
the players are expanded to include the buying public, the game will
be zero-sum – the increased profit to the stores will be at the expense
of higher prices to the customers. It is essential, therefore, to be clear
about the boundaries of the ‘game’ that you are analysing and take into
account the different players who are involved.
30
 Chapter 3: The marketing environment and a game theory perspective on competition

3. There may be time-lags in the generation of benefits, which means

that for some of the players even a non-zero-sum game may appear as
zero-sum in the short term. For example, regulation of the advertising
industry may bring long-term benefits (as firms who make false claims
for their products are forced to stop) but will be seen as a zero-sum
game by advertisers in the short term.

Co-operative games
Zero-sum games are always going to be non-co-operative: win–lose offers
no opportunity for mutual benefit to be derived by co-operation. Non-zero-
sum games, on the other hand, offer the participants potential benefits
from co-operation. The challenge is how to establish the conditions and
processes whereby co-operation can be achieved.
It is possible to establish co-operation in various ways. The first, and
most obvious, is through direct communication between the parties. The
advantages of collusion to oligopolistic suppliers are obvious, matched by
the equally obvious disadvantages to the paying public. Most countries have
enacted legislation against collusion, prohibiting cartels among companies.
However, even where direct communication is not possible, co-operation
can be established through reciprocity and a pattern of behaviour. Axelrod
(1990) identifies four principles that can make for an effective strategy –
being:
• nice
• retaliatory
• forgiving
• clear.
Niceness prevents a player from getting into unnecessary trouble.
Retaliation discourages the other side from persisting whenever defection
is tried. Forgiveness helps restore mutual co-operation. And being clear
makes it obvious to the other companies which strategy a firm is adopting
and this can help develop long-term co-operation.
Eliciting co-operation can be achieved through the following methods:
Enlarge the shadow of the future… Mutual co-operation can be
stable if the future is sufficiently important relative to the present.
This is because the players can use an implicit threat of retaliation
against the other’s defection – if the interaction will last long
enough to make the threat effective… There are two basic ways
of doing this: by making the interactions more durable, and by
making them more frequent… Durability of an interaction can help
not only lovers, but enemies. The most striking illustration of this
point was the way the live-and-let-live system developed during
the trench warfare of World War I… The same small units of troops
would be in contact with each other over extended periods of time.
They knew their interactions would continue because no one was
going anywhere… This prolonged interaction allows patterns of
co-operation which are based on reciprocity to be worth trying and
allows them to become established.
Another way to enlarge the shadow of the future is to make the
interactions more frequent. In such a case the next interaction
occurs sooner, and hence the next move looms larger than it
otherwise would… frequent interactions promote stable co-
operation. (Axelrod, 1990, pp.126–30)

31
141 Principles of marketing

As well as enlarging the shadow of the future, Axelrod suggests that

participants should base their code of practice for interactions on reciprocity
(an eye for an eye, rather than turning the other cheek). Retaliation should
be proportional but immediate, so that there is no chance for the opponent
to receive false signals about the willingness to respond to defection.
Reciprocity can actually help not only oneself, but others as well. It helps
others by making it hard for exploitative strategies to survive. And not
only does it help others, but it asks no more for oneself than it is willing
to concede to others. A strategy based on reciprocity can allow the other
player to get the reward for mutual co-operation, which is the same pay-
off it gets for itself when both strategies are doing their best.
A further tactic for establishing co-operation can be to make your strategy
very clear to other player(s) from the start. An example used to illustrate
this is the game of ‘chicken’ (Axelrod, 1990). Two cars are driving fast
towards each other along a one-lane road with one passing space in the
middle. The driver who turns into the passing space loses (the chicken). To
be sure of winning, one driver should lock the steering straight ahead, take
off the steering wheel and throw it obviously out of the window. This will
ensure that the other driver gives way!
This shows a benefit of making your strategy clear in advance. It
is referred to as signalling and it is widely used by commercial
organisations to make their competitors aware of their intentions without
actively colluding (which can be illegal in many countries).
As we can see from the above discussion, effective co-operation depends
on the direct or indirect exchange of signals among players. Signals are
more likely to be given – and therefore co-operation is more likely to
be achieved – in a game with multiple rounds. In such games firms can
develop and signal a pattern of behaviour. This analysis can be used to
understand why relationship marketing can be effective.
There are some situations in which, strategically, it may still be in one party’s
interests to reject co-operation, even in a non-zero-sum game; for example,
where there is a large disparity in size or strength among the players and the
benefits of co-operation are spread unevenly among the players. In a price war,
for example, if one store has 80 per cent of the market and the other 20 per
cent, informal collusion to avoid price competition will bring four times the
benefit to the larger player. This will reinforce the market strength of the larger
player and place the smaller company at an ever-increasing disadvantage,
leading eventually to its elimination. In this situation the smaller company
may choose not to co-operate, and it will continue to cut prices even though
it knows that the larger company will retaliate since the cost of this price war
will be four times greater for the larger company. Who the long-term winner
will be will depend on the relative resources available to each.

Summary
The firm is affected by both its microenvironment and the
macroenvironment. The characteristics of the marketer’s
microenvironment affect its ability to serve its customers. The
macroenvironment comprises the wider societal forces which determine
the opportunities and threats facing a firm. Game theory presents
a number of models which show how it may pay competitors to co-
operate and/or cheat on each other. These models help to identify the
characteristics of situations when these different strategies may be
relatively effective. Game theory also presents various ideas as to how
firms can try and increase the possibility of co-operation.
32
 Chapter 3: The marketing environment and a game theory perspective on competition

A reminder of your learning outcomes

By the end of this chapter, and having completed the essential readings
and activities, you should be able to:
• distinguish between the micro and macroenvironment of a firm
• describe how the different elements of the micro and
macroenvironment affect firms’ marketing activities
• distinguish between zero-sum and non-zero-sum games and the
implications for competitive behaviour
• explain the different methods firms can use to elicit co-operation.

Sample examination question

1. What are the main components of the microenvironment of marketing?
With respect to each of these components identify the major questions
that the marketer should be asking him/herself when carrying out an
audit of the microenvironment.

33