Co-opetition — Brandenburger & Nalebuff

Co-opetition - Adam Brandenburger & Barry Nalebuff

Beyond war and competition

The ‘war of nature’, in which only the fittest survive, is a distorted view of evolution. Many organisms thrive in a Darwinian ecosystem because of the complex, mutualistic interdependencies they share with other lifeforms. This is doubly true in the world of business. In Co-opetition, game theorists Adam Brandenburger and Barry Nalebuff emphasise that complementarities are more common in business than we let on. If we want to understand the dynamics of industry and value, we must look not only at companies, competitors and customers, but at complementors too.

Game theory in PARTS

Game theory can help us to see beyond the “simple ideas of competition and cooperation”. To do this well, Brandenburger and Nalebuff encourage readers to think in PARTS: Players, Added Values, Rules, Tactics and Scope. PARTS capture the fundamental elements of any strategic interaction. It provides a simple but helpful checklist for holistic analysis.

Competitors and complementors

When talking about the players in business, we are quick to identify the company, and its customers, competitors, suppliers, substitutes, and government. But we mustn’t forget complementors, the “natural counterpart” to competitors.

While competitors and substitutes make a company’s products less valuable to customers, complementors make the company’s products more valuable. Microsoft, for example, is a complementor to Intel. An increase in demand for operating systems boosts demand for Intel processors.

“A complementor is the opposite of a competitor. It’s someone who makes your products and services more, rather than less, valuable… It’s mutual success rather than mutual destruction.”
Adam Brandenburger, & Barry Nalebuff. (1996). Co-opetition.

Changing PARTS of the game

Undergraduate courses in game theory tend to focus on solving strategic problems. They train students to look for equilibrium solutions. Brandenburger and Nalebuff, however, remind us that strategy is not just about playing the game. It’s also about playing the right game, and changing the game to your advantage.

In Co-opetition, the authors offer a questionnaire to help readers to think through PARTS of their strategic interaction. I paraphrase the questions that I found most helpful as follows:

Players: Who are the players in your game? This includes your customers, suppliers, employees, competitors, complementors, governments, and so on. Do you understand the level of cooperation and competition embedded in each relationship? How might a player’s entry or exit affect the game?
Added value: Do you have a sense of your added value, and the added value of other players? How might the added values of each player change over time?
Rules: What are the rules, laws, contracts, conventions, and customs of the game, and how do they affect your added value? How might you navigate or transform the rules into your favour?
Tactics: How might you increase your relative added value? How will other players perceive your actions? Given their perception and likely responses, are your tactic still viable?
Scope: What is the scope of your game? How is this game connected to other strategic situations? Are there cascading effects that come with your tactics or the tactics of others? Can you ‘link’ or ‘de-link’ games to influence outcomes and decision-making?

Added value and Cicero’s question

In most cases, decision makers know about the players, rules, and tactics that characterise their strategic situation. But added value (A) and scope (S), in my opinion, are often neglected in business decision-making. Let’s begin first with added value.

What does each player bring to the game?

Simply put, “added value measures what each player brings to the game”. The added value of a company is the difference between the “size of the pie” with that player in the game and the size of the pie when the player isn’t in the game. In theory, companies and employees cannot capture more value than the value they add. (Of course, this isn’t always true. Social conventions don’t always abide by economic theory. Look at the exorbitant salary packages that many executives enjoy today. Are they really worth a hundred hard-working employees? Some certainly earn their keep. But many don’t.)

What does each player stand to gain?

Added value is implicit in the way we think about competition, market power and bargaining. The added value of each individual company, for example, falls with the number of competitors and substitutes in the market. When thinking about added value, the authors remind us to “ask Cicero’s question: Cui bono? Who stands to gain?”

Value and obsolescence

The authors illustrate the point of added value with a fascinating case study on the strategy of obsolescence. Do you notice how automakers, smartphone makers, software authors, textbook publishers, fashion designers, and so on, launch new products on a rather manic cycle? And people, for whatever reason, feel compelled to buy their latest version? A mix of incremental improvements, savvy marketing and exercise of market power persuades consumers to buy and buy again.

In this way, added value is not an intrinsic quality. Sometimes, it is desire and perceived scarcity, drummed up in the minds of the collective. Nike shoes, for example, generate added value because their brand is difficult to replicate. Their manufacturing quality and star athletes make their products highly desirable. Yet, there’s nothing hyper valuable about Nike shoes in a physical sense. People think Nike shoes are desirable in part because others think it’s desirable, and so on.

A theory of value creation and capture

Any theory of value, Brandenburger and Nalebuff say, should recognise the “fundamental duality” between value creation and value capture. Value creation is a more cooperative and interdependent process, where customers and companies partake in an economic dance to generate demand, products, and markets.

Value capture, by contrast, is more competitive. Competition is a selection mechanism that markets use to divide the economic pie at each level of economic organisation. Customers and companies bargain, for example, on the price of goods and services, as do employees and employers on remuneration.

Humanity’s unique capacity for cooperation and competition is central to Brandenburger and Nalebuff’s idea of co-opetition. This tension between making and vying for value governs the dynamics of industries. For businesses to thrive, they have to understand both sides of their pie-making and pie-taking equation.

War, peace and complementors in business

Despite the dual nature of value, many executives see business as a game of war. This in turn may distort their strategic priorities. Scorched-earth price wars, for example, tend to do more harm than good for all involved. Some mutual restraint might benefit you and your competitors instead. And maybe that’s okay. Not everything in business, the authors say, is a zero-sum game. There are elements of “war and peace” in almost every interaction. More on this later.

Chicken-and-egg problem

When talking about business failure, people tend to focus on the competition. Poor complementarities, however, are common reasons for failure too. Alfa Romeo, the authors point out, struggled in their foray into the United States for this reason. Fewer mechanics and spare parts for Alfa Romeo models made their cars risky to American buyers. Poor sales, in turn, discouraged mechanics from servicing Alfa Romeos. A vicious cycle ensued between demand and supply.

This ‘chicken-and-egg’ problem is common to nascent industries and developing economies. Companies have to create a large market to induce complementors to enter. Sometimes, they’ll have to make the complementarities themselves. This is why General Motors and Goodyear, back in the 1913s, established the Lincoln Highway Association to fast-track highway construction. Michelin, likewise, published their Michelin guidebooks to encourage people to drive.

Clustering

We have an instinctive bias to view all newcomers as competitive threats. Such thinking might blind us to complementarities that exist between rivals. One of the best and simplest examples, I think, is the propensity for competitors to co-locate. Retail brands in luxury fashion like to cluster together. While this encourages head-to-head competition, their proximity creates a better shopping experience. In this way, the benefits from clustering outweigh the costs of competition.

“Companies are complementors in making markets [and] competitors in dividing up markets.”
Adam Brandenburger, & Barry Nalebuff. (1996). Co-opetition.

Indirect diffusion

The authors provide another great example of complementarities in the market for electronic and physical books. When e-books first launched, many analysts foretold the end of retail for physical books. What they missed, however, was the complementarity between both segments. Low-cost e-books improved the affordability and accessibility of reading. Like movies, video games and fashion, book sales are sensitive to word-of-mouth. So, increased readership actually helped some retailers to sell more physical titles, especially of books that went viral. It’s true, many physical retailers consolidated with the arrival of e-books and audiobooks. But the net impact, once again, was not entirely destructive.

The vagaries of scope

It’s impossible to predict the intended and unintended consequences of our actions in its entirety. There are just too many permutations. We are left with little choice but to divide our problems into bitesize chunks. Often, we do it without even realising it. As Brandenburger and Nalebuff writes:

“People draw boundaries and divide the world up into many separate games. … The problem is that mental boundaries aren’t real boundaries … Every game is linked to other games: a game in one place affects games elsewhere, and a game today influences games tomorrow. Even the mere anticipation of tomorrow’s game influences today’s. … [But] thinking in terms of a separate scope lever is very useful. It’s too complicated to think of everything as one large game.”
Adam Brandenburger, & Barry Nalebuff. (1996). Co-opetition.

Tactical cascades

While scope is critical to effective decision-making, it is, in my opinion, one of the most neglected aspects of business. In particular, failure to recognise scope can destroy even the most well-intentioned of strategies. The authors illustrate this with Epson’s tactical mistake in the printer market. During the 80s, Epson sought to undercut the market with the launch of its first laser printer. This, of course, prompted Hewlett Packard, Toshiba and other competitors to lower their prices too.

Unsurprisingly, the price war hurt Epson’s margins in the laser segment. What’s more, falling prices induced customers to switch from dot-matrix printers — Epson’s primary segment — to the laser market. Epson was now “doubly squeezed”. They had failed to see the full scope of the game, and the ripple effects of their actions. Fascinating stuff.

Value traps

It’s also easy to miss the hidden costs associated with competition for new customers and deals. There’s risk, for example, of the winner’s curse. If you win a new customer or contract because you have the lowest price, did you value the cost-of-doing-business correctly?

Then there’s the problem of expectations, anchoring and fairness. Sure, generous prices will bring in new customers. But existing and future customers may expect similar prices too. If you prioritise certain segments with no good reason, you risk overall customer satisfaction and loyalty. That’s not a recipe for enduring value. I’m sure many banks, insurers, and telecoms can attest to that.

Shattering glass houses

Companies should ask whether their tactics will shatter the “glass houses”, and whether that’s desirable. Remember that all interactions are interlinked. If you undercut a vindictive competitor on price, they may retaliate in future games or in neighbouring segments. And a company with nothing to lose and everything to gain will fight with desperation.

To discourage value destroying behaviour, it sometimes helps to clarify and/or enlarge your scope. Let’s consider, for example, a stylised case in international trade. If a trade partner seeks to impose new tariffs on your commodity, you might threaten back with comparable penalties in adjacent markets. By raising the stakes of the game, you might avoid the trade war altogether. Of course, this is inherently risky. A mix of pride, ego, anger, miscalculation and miscommunication can inflame and escalate things even further!

The more the merrier?

Related to players, tactics, scope, and industry dynamics is the idea of bringing more players into the game. Sometimes, to change the game, you have to change who plays. After all, more customer, suppliers and complementors tend to increase your company’s added value and/or bargaining power.

In all cases, we should try to see both sides of the equation. Newspapers, for example, generate their revenue from subscribers and advertisers. While free trials and discounts might hurt subscription revenue, the gain in readership and advertising revenue may offset it.

Likewise, more customers tend to mean two things: a larger economic pie, and a lower added value per customer (as each buyer is now more replaceable). While the latter may improve the company’s bargaining power, the former might attract new competitors. What’s more, attracting customers isn’t free, especially if it’s easy to jump ship. Growth is not always win-win.

Egocentrism, perception and rationality

The lessons above tell us that strategy is multifaceted and interdependent. Yet, many of us continue to make egocentric decisions. That is, we take actions with only ourselves and our immediate position in mind. It’s like playing chess without considering our opponent’s best response, our best response to their best response, and so on. This is myopic decision-making, and a common source of value destruction.

The reverse then is usually true — that allocentric analysis is necessary for effective decision-making. This requires us to understand how others think. This isn’t easy. We often impose our values in our assessment of others.

Nevertheless, it’s a reminder that people perceive things differently. Two individuals can face the same problem and information and arrive at different conclusions. Personality, knowledge, culture, incentives, and circumstance matter. Ask the same executive for a decision at two different points in time, and you might get two different answers. As Brandenburger and Nalebuff emphasise, we cannot “separate [the game] from the way the players perceive it”.

Rationality, sensibilities and beliefs

People presume that microeconomics works only when players are rational. While correct, it’s important not to conflate what is rational with what you believe is sensible. Rationality, in an economic sense, involves taking actions that maximise your payoffs given your beliefs, information, and assessment about the situation. Your beliefs may or may not be sensible. But you are rational if you act correctly on them.

Why the distinction? Because good strategic and industry analysis requires us to understand the motivations, beliefs, and incentives that drive choice and behaviour. Do not assume that every player you face will think in the same way you do.

“Two people can both be rational and yet evaluate the same outcome quite differently. People don’t just look at the dollars. They’re motivated by many things — pride, fairness, jealousy, spite, vengefulness, altruism, and charity are just a few of the possibilities. … Simply dismissing someone as irrational closes the mind. Much better is to work harder at seeing the world as the other person sees it. … In fact, if you try to impose your rationality on others, who’s the one who is really being irrational?”
Adam Brandenburger, & Barry Nalebuff. (1996). Co-opetition.

Sources and further reading

Brandenburger, Adam., & Nalebuff, Barry. (1996). Co-opetition. More articles from Brandenburger at < https://www.adambrandenburger.com/ > and Nalebuff at < https://som.yale.edu/faculty/barry-nalebuff >

Co-opetition — Brandenburger and Nalebuff on Complementors, PARTS and Egocentrism