Decision Making and Business Strategy

8/3/2019 Decision Making and Business Strategy

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DECISION MAKING AND BUSINESSSTRATEGY:

The Crisis of the U.S. Auto Industry

Mathematic Methods and Models in Economics

Teacher: Elena Igorevna Smirnova

Report written by:

Oksana Letyago

24.02.2011, Moscow, Russia

Subject: Mathematic methods and models in economics


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Contents

Introduction....................................................................................................................3

1 The Notion of Game Theory.....................................................................................4

2 Decision Making Process..........................................................................................4

3 Methods of Decision Making....................................................................................5

3.1. Multi-attribute Decision Making Methods....................................................5

3.1.1. Cost-benefit Analysis.........................................................................6

3.1.2. Elementary Methods..........................................................................6

3.1.3. Pros and Cons Analysis.....................................................................63.1.4. Maximin and Maximax Methods......................................................6

3.1.5. Conjunctive and Disjunctive Methods........................................................6

3.1.6. Lexicographic Methods .............................................................................6

3.2. MAUT Methods.............................................................................................7

3.2.1. Simple Multiattribute Rating Technique (SMART)..........................7

3.2.2. Generalized Means............................................................................7

3.2.3. The Analytic Hierarchy Process........................................................8

3.3. Outranking Methods......................................................................................8

3.3.1. The ELECTRE Methods...................................................................83.3.2. The PROMETHE Methods...............................................................9

4 Auto Industry Crisis of 2008.....................................................................................9

4.1. Introduction and Cause..................................................................................9

4.2. Likely Scenarios for the Automotive Industry.............................................10

4.3. Sales and Trends..........................................................................................12

4.3.1. Car Sales..........................................................................................12

4.3.2. Truck Sales......................................................................................12

4.3.3. Long-Term Sales Trends..................................................................12

4.4. Investor Confidence in Domestic Automakers and Suppliers.....................134.5. Discussion of Potential Scenarios................................................................13

4.5.1. The Most Likely Scenario...............................................................13

4.5.2. Other Likely Scenarios....................................................................14

4..6 Strategies......................................................................................................15

Conclusion....................................................................................................................18

Bibliography.................................................................................................................19

7.1. Books...........................................................................................................19

7.2. Web Sites.....................................................................................................19


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Introduction

What is business all about? Some will say it is all about providing a servicethat the customers like. Some will say it is all about innovation, developing cutting-edge technology. Some will say it is all about being first to the market. Some will sayit is all about reaching the right people. Some will say it is all about building value forcustomers and managing risk. Some will say it is all about partnerships. Some willsay it is all about being ahead of your competitors. The overarching theme in all ofthese statements is interactions. In any business, interactions with customers,suppliers, other business partners, and competitors, as well as interactions across

people and different organizations within the firm, play an integral role in anydecision and its consequences. Advances in information technology (IT) and e-

commerce further enrich and broaden these interactions, by increasing the degree ofconnectivity between different parties involved in commerce. Thanks to globalization,now the entire world is the playground for many firms, increasing the complexity ofthese interactions.

Given that each firm is part of a complex web of interactions, any businessdecision or action taken by a firm impacts multiple entities that interact with or withinthat firm, and vice versa. Ignoring these interactions could lead to unexpected and

potentially very undesirable outcomes. Game theory is a very useful tool for studyinginteractive decision-making, where the outcome for each participant or playerdepends on the actions of others. Each decision maker, such as yourself, is a player in

the game of business; hence, when making a decision or choosing a strategy it isnecessary to take into account the potential choices of others, keeping in mind thatwhile making their choices, other players are likely to think about and take intoaccount the strategy of a particular firm as well.

In this work I am going to describe how business strategy and decision makingis interacted with game theory.


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1 The Notion of Game Theory

Game theory is a branch of applied mathematics that is used in the socialsciences, most notably in economics, as well as in biology (particularly evolutionary

biology and ecology), engineering, political science, international relations, computerscience, social psychology, philosophy and management. Game theory attempts tomathematically capture behavior in strategic situations, or games, in which anindividual's success in making choices depends on the choices of others (Myerson,1991). While initially developed to analyze competitions in which one individual does

better at another's expense (zero sum games), it has been expanded to treat a wide

class of interactions, which are classified according to several criteria. Today, "gametheory is a sort of umbrella or 'unified field' theory for the rational side of socialscience, where 'social' is interpreted broadly, to include human as well as non-human

players (computers, animals, plants)" (Aumann 1987).Traditional applications of game theory attempt to find equilibria in these

games. In an equilibrium, each player of the game has adopted a strategy that they areunlikely to change. Many equilibrium concepts have been developed (most famouslythe Nash equilibrium) in an attempt to capture this idea. These equilibrium conceptsare motivated differently depending on the field of application, although they oftenoverlap or coincide. This methodology is not without criticism, and debates continue

over the appropriateness of particular equilibrium concepts, the appropriateness ofequilibria altogether, and the usefulness of mathematical models more generally.

2 Decision Making Process

Decision making is the study of identifying and choosing alternatives based onthe values and preferences of the decision maker. Making a decision implies that thereare alternative choices to be considered, and in such a case we want not only to

identify as many of these alternatives as possible but to choose the one that best fitswith our goals, objectives, desires, values, and so on. (Harris (1980))

According to Baker et al. (2001), decision making should start with theidentification of the decision maker(s) and stakeholder(s) in the decision, reducing the

possible disagreement about problem definition, requirements, goals and criteria.Then, a general decision making process can be divided into the following steps:

1) Define the problem2) Determine requirements3) Establish goals4) Identify alternatives

5) Define criteria6) Select a decision making tool


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7) Evaluate alternatives against criteria (Single criterion vs. multiple criteria,finite number of alternatives vs. infinite number of alternatives)

8) Validate solutions against problem statement

3 Methods of Decision Making

3.1. Multi-attribute Decision Making Methods

Consider a multi-attribute decision making problem with m criteria and nalternatives. Let C1,,Cm and A1,..,An denote the criteria and alternatives,

respectively. A standard feature of multi-attribute decision making methodology is thedecision table as shown below. In the table each row belongs to a criterion and eachcolumn describes the performance of an alternative. The score aij describes the

performance of alternative Aj against criterion Ci. For the sake of simplicity weassume that a higher score value means a better performance since any goal ofminimization can be easily transformed into a goal of maximization.

As shown in decision table, weights w1,...,wm are assigned to the criteria.Weight wi reflects the relative importance of criteria Ci to the decision, and isassumed to be positive. The weights of the criteria are usually determined onsubjective basis. They represent the opinion of a single decision maker or synthesize

the opinions of a group of experts using a group decision technique, as well.The values x1,...,xn associated with the alternatives in the decision table are

used in the MAUT methods and are the final ranking values of the alternatives.Usually, higher ranking value means a better performance of the alternative, so thealternative with the highest ranking value is the best of the alternatives.

Multi-attribute decision making techniques can partially or completely rankthe alternatives: a single most preferred alternative can be identified or a short list of alimited number of alternatives can be selected for subsequent detailed appraisal.


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3.1.1. Cost-benefit Analysis

Cost-benefit analysis (CBA) is a worldwide used technique in decisionmaking. CBA evaluates the costs and benefits of the alternatives on monetary basis.Recently, attempts have been made to incorporate the environmental impacts withinCBA to improve the quality of environmental decision making. Although advanceshave been made, problems persist in applying CBA to environmental issues, includingthe monetary valuation of environmental impacts.

3.1.2. Elementary Methods

These elementary approaches are simple and no computational support isneeded to perform the analysis These methods are best suited for problems with asingle decision maker, few alternatives and criteria that is rarely characteristic in

environmental decision making.

3.1.3. Pros and Cons Analysis

Pros and cons analysis is a qualitative comparison method in which goodthings (pros) and bad things (cons) are identified about each alternative. Lists of the

pros and cons are compared one to another for each alternative. The alternative withthe strongest pros and weakest cons is preferred. It requires no mathematical skill andis easy to implement.

3.1.4. Maximin and Maximax Methods

The maximin method is based upon a strategy that tries to avoid the worst possible performance, maximizing the minimal performing criterion. The alternativefor which the score of its weakest criterion is the highest is preferred. The maximinmethod can be used only when all criteria are comparable so that they can bemeasured on a common scale, which is a limitation.

3.1.5. Conjunctive and Disjunctive Methods

These methods require satisfactory rather than best performance in eachcriterion. The conjunctive method requires that an alternative must meet a minimal

performance threshold for all criteria. The disjunctive method requires that thealternative should exceed the given threshold for at least one criterion.

3.1.6. Lexicographic Method

In the lexicographic method criteria are ranked in the order of theirimportance. The alternative with the best performance score on the most important

criterion is chosen. If there are ties with respect to this criterion, the performance ofthe tied alternatives on the next most important criterion will be compared, and so on,till a unique alternative is found.


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3.2. MAUT Methods

In most of the approaches based on the Multi-attribute Utility Theory(MAUT), the weights associated with the criteria can properly reflect the relativeimportance of the criteria only if the scores aij are from a common, dimensionlessscale. The basis of MAUT is the use of utility functions.

3.2.1. Simple Multiattribute Rating Technique (SMART)

SMART is the simplest form of the MAUT methods. The ranking value xj ofalternative Aj is obtained simply as the weighted algebraic mean of the utility valuesassociated with it, i.e.

Besides the above simple additive model, Edwards (1977) also proposed asimple method to assess weights for each of the criteria to reflect its relativeimportance to the decision. First, the criteria are ranked in order of importance and 10

points are assigned to the least important criterion. Then, the next-least-importantcriterion is chosen, more points are assigned to it, and so on, to reflect their relative

importance. The final weights are obtained by normalizing the sum of the points toone.

3.2.2. Generalized Means

In a decision problem the vector x=(x1,...,xn) plays a role of aggregationtaking the performance scores for every criterion with the given weight into account.This means that the vector x should fit into the rows of the decision matrix as well as

possible. Meszaros and Rapcsak (1996) introduced an entropy optimization problemto find the vector x of best fit. They pointed out that the optimal solution is a positive

multiple of the vector of the weighted geometric means of the columns, consequently,with

the values


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constitute a reasonable and theoretically established system of ranking values. Byintroducing another entropy optimization problem, based on another measure offitting, the weighted algebraic means (used also in SMART and additive linearmodels) were obtained as best fitting ranking values.

3.2.3. The Analytic Hierarchy Process

The Analytic Hierarchy Process (AHP) was proposed by Saaty (1980). Thebasic idea of the approach is to convert subjective assessments of relative importanceto a set of overall scores or weights. AHP is one of the more widely appliedmultiattribute decision making methods. We follow here the summary of UK DTRL(2000) on the AHP.

The methodology of AHP is based on pairwise comparisons of the followingtype 'How important is criterion Ci relative to criterion Cj?' Questions of this type areused to establish the weights for criteria and similar questions are to be answered toassess the performance scores for alternatives on the subjective (judgmental) criteria.

3.3. Outranking Methods

The principal outranking methods assume data availability broadly similar tothat required for the MAUT methods. That is, they require alternatives and criteria to

be specified, and use the same data of the decision table, namely the aijs and wis.Vincke (1992) provides an introduction to the best known outranking methods;

see also Figueira et al. (2004) for state-of-art surveys. Here, the two most popular

families of the outranking methods, the ELECTRE and the PROMETHEE methodswill be briefly outlined.

3.3.1. The ELECTRE Methods

The ELECTRE methodology is based on the concordance and discordanceindices defined as follows. We start from the data of the decision matrix, and assumehere that the sum of the weights of all criteria equals to 1. For an ordered pair ofalternatives (Aj,Ak), the concordance index cjk is the sum of all the weights for thosecriteria where the performance score of Aj is least as high as that of Ak, i.e.

The methodology of AHP is based on pairwise comparisons of the followingtype 'How important is criterion Ci relative to criterion Cj?' Questions of this type areused to establish the weights for criteria and similar questions are to be answered toassess the performance scores for alternatives on the subjective (judgmental) criteria.


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Clearly, the concordance index lies between 0 and 1. The ELECTRE method isused to construct a partial ranking and choose a set of promising alternatives.

3.3.2. The PROMETHE Methods

The decision table is the starting point of the PROMETHEE methodologyintroduced by Brans and Vincke (1985) and Brans et al. (1986). The scores aij n e e d n o tnecessarily be normalized or transformed into a common dimensionless scale. We onlyassume that, for the sake of simplicity, a higher score value means a better performance. Itis also assumed that the weights wi of the criteria have been determined by an appropriate

method (this is not a part of the PROMETHEE methods), furthermore,m i=1 wi= 1.Preference Ranking Organization Method for Enrichment Evaluation or

PROMETHEE & GAIA aremethods that belong to the family of outranking relationsand that were created in Europe. They both offer a descriptive and a prescriptiveapproach.

On the one hand, the descriptive approach, called GAIA, allows the decisionmaker to visualize his problem. As a consequence, he is able to easily identifyconflicts or synergies between criteria, to categorize alternatives and to highlightinteresting performances. On the other hand, the prescriptive approach, calledPROMETHEE, provides the decision maker both a complete and a partial ranking ofthe alternatives. The acronym PROMETHEE stand for: Preference RankingOrganization METHod for Enrichment Evaluation.

4 Auto Industry Crisis of 2008

4.1. Introduction and Cause

The crisis of the auto industry in 2008 provided an opportunity to use strategicthinking and game theory insights in the real world. While domestic automakers have

been struggling and losing market share for several years, the economic crisis in 2008sent light vehicle sales plummeting. Based on the first three quarters of 2008 sales,annual sales dropped to less than 13.5 million units, down from 16 million units in

2007 and from a post-2001 trend of 16-17 million vehicles per year. Per capita saleswere at their lowest levels since World War II. However, the trigger for the crisis wasthe prohibitively damaging rate of sales that has persisted since September 2008:approximately 10.5 million units per year. That was roughly a 40% reduction in sales

a reduction that could not be accommodated alongside the survival of all OriginalEquipment Manufacturers (OEM) of the automotive industry in operation.

The magnitude of the crisis was publicized by two events: On November 7, 2008 GM announced that its cash reserves could fall

below the minimum required to satisfy covenants with key lenders, andthat the minimum cash position could be breached early in 2009.

Subsequently, the company confirmed that the GM board had discussedbankruptcy, although it had rejected it.


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The Detroit Three CEOs, along with the United Auto Workers (UAW)president, went to Capitol Hill to lobby Congress for federal assistance inthe week of November 20. The harsh reception they received includingrepeated tongue-lashings about such topics as the use of private planes,their failure to improve fuel economy fast enough, the apparently poorservice received on a Congressional spouses car, and other matters bothtrivial and momentous was a stunning rejection of that plea, and anawakening to the lack of political capital the industry had in Washington.By the close of that disastrous week, the Detroit Three were given, ineffect, an ultimatum: submit restructuring plans that satisfied the Houseand Senate leaders, or forget about any aid.

These events had a devastating effect on consumer confidence. In a researchsurvey commissioned by GM, and reported in their December 2 submission toCongress, fully 30% of consumers that very recently decided against buying a GMvehicle in favour of another, cited the possibility of a GM bankruptcy as the topreason.

Worsening economic conditions, a tighter credit market, along withplummeting consumer confidence created tougher conditions for the Detroit Three.Detroit- based automakers had short-term and long-term problems. Seriousness of theshort-term problems were driven by liquidity specific matters. Especially GM andChrysler needed financial support to finance their operations. According to Fordexecutives, the company did not have financial problems as serious as GM andChrysler had. Because of the tighter credit market of late 2008, both GM and Chryslerlooked for some kind of financial aid from the federal government. The Detroit Threeacted strategically to get financial support from the federal government to overcometheir liquidity problems.

4.2. Likely Scenarios for the Automotive Industry

There were essentially five likely scenarios for the auto industry under thecircumstances caused by the financial meltdown of 2008:1. GM and Chrysle rmerger with federal financial aid (such as a bridge loan).2. Federal financial aid and radical restructuring outside of bankruptcy.

3. Federal financial aid and radical restructuring outside of bankruptcy for GM andFord; Chryslers assets purchased by competitors.

4. Chrysler files for bankruptcy; GM and Ford restructure outside bankruptcy.5. Both GM and Chrysler file for bankruptcy; Ford restructures outside bankruptcy.

Although it is difficult to predict how Congress acts, it is clear that the keydividing line among the various scenarios is a commitment to some type of federalfinancing assistance. Based on the auto sales trends as of December 2008 and thefinancial (particularly cash) resources of the Detroit Three, the domestic autocompanies wanted both lawmakers and public to take their situation seriously, and

believe that such a commitment was a must before the end of January 2009 to prevent

any OEM bankruptcy and massive loss of jobs.


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It is possible that a commitment could be signaled by something other than astatute enacted before January ends, if such a commitment was welcomed by otherlenders as firm enough to extend their own resources for a temporary period.

What form could this assistance take? A bridge loan is the most direct, andeconomically effective, method. However, any such assistance will be approved basedon political considerations (the strategic dangers for the Detroit Three which are dis-cussed below), and therefore a large variety of potential structures (and labels) could

be used. The fundamental needs of the automakers are to restore consumer confidencein their operations long enough to restructure their operations in the manner wedescribe here. That requires cash; it does not require specific payment terms.

Fig. 1. Flowchart of the Likely Scenarios

4.3. Sales and Trends

4.3.1. Car Sales

After 2007, the automotive industry experienced a rapid decline in car sales.The downward industry trend in the U.S. market hit all automakers, but hit the Detroit

Three particularly hard. In particular:


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The Detroit Three all had serious reductions in sales. GM, Chrysler, and Fordlost market share in the car segment as well as sales. Chrysler experienced themost significant reduction in car sales, falling by slightly over 23%.

Toyota, which nearly matches the Detroit Three in model lineup, and whosevehicles are often more expensive than their domestic competitors, alsosuffered a decline.

Honda and Nissan were the least affected. Honda and Nissan were the onlytwo brands to increase market share in the car segment. Reflecting itsconcentration in smaller and more fuel-efficient vehicles, Honda was also theonly manufacturer to increase sales, with an increase of nearly 8%.

4.3.2. Truck Sales

Record-breaking fuel prices caused high-margin truck sales to fall 21% in thefirst three quarters of 2008 compared to the similar period for 2007. GM lost onepercentage point market share in the truck segment, Chrysler lost slightly more thanone percentage point, and Ford lost slightly less than half a percentage point. Toyotagained slightly over half a percentage point market share in the truck segment, while

both Honda and Nissan gained nearly a percentage point each.The decline in this segment which was dominated by the Detroit Three and

carries higher profit margins than on most of the car segments compounded thefinancial effects of the overall market decline.

4.3.3. Long-Term Sales Trends

It is unclear how long the economic downturn would last and how severe itwould be. Declining consumer confidence, falling consumer spending, and risingunemployment were a reflection of the impact of the financial meltdown on the realeconomy, and especially on auto sales.

Consumer credit tightened, particularly for the higher risk borrowers. Evenwhen not constrained by credit availability, American consumers spent less and

postponed spending on major durable goods, such as cars and trucks.After the end of the recession, it is likely auto sales will return to a historic

trend of 15 million light vehicles per year. Note that lifestyle changes and livingpatterns, as well as the durability of vehicles and fuel prices, are unlikely to radicallychange in the next few years in a manner that precludes consumer demand forvehicles from returning.

4.4. Investor Confidence in Domestic Automakers and Suppliers

All companies in the automobile industry had difficulty with financing giventhe environment. However, this difficulty varied considerably:

Automotive manufacturers were effectively shut out of the credit market. Thecontinuing sales decline, and the threat of bankruptcy, caused disastrous


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consequences for their equity values. Their bond ratings were similarly verypoor.

Some suppliers, particularly those with high leverage or over concentrationwith one manufacturer, also saw investor confidence diminish.GMs stock price declined from $24 in January 2008 to $3 in November 2008,

and still lower as of this writing. Daimler marked down the value of its stake inChrysler to late in November 2008.

4.5. Discussion of Potential Scenarios

In this section, we discuss each of the potential scenarios, the most likelyscenario in some detail; the others briefly.

Note that these are discussions of possible scenarios; such discussion requiressome speculation about the surrounding market and political conditions, and the

actions of various competitors and constituencies. For this reason, we caution readersthat these scenarios should be considered within the proper context.We anticipate Chrysler going out of business as an independent entity in every

scenario. Given the serious decline in sales, some manufacturers cannot be sustained.Chrysler does not have the overseas presence of GM or Ford. Neither does it have asfull a lineup of vehicles across as many market niches as do its two Detroit-basedcompetitors. However, its short-term cash position may be better than GMs withoutfederal financing. We note that Daimler marked the value of its holdings of Chryslerassets down to zero in late November 2008. Squabbling between Cerberus andDaimler, however, could complicate any negotiations to sell all or portions of

Chryslers assets to a competitor.

4.5.1. The Most Likely Scenario

Scenario 1: A GM-Chrysler Merger with Federal Financial Aid

Based on the conditions of the American automotive industry, as of December2008, the scenario involving a federal aid, such as a federal bridge loan, and a GM-Chrysler merger, is the most likely of the scenarios identified at the beginning of thischap- ter. It is also the least costly in terms of employment and output reductions in

the U.S. Although the most likely scenario in such a complicated situation means aless than 50% chance of occurring, it is still a useful baseline to use when discussingother potential scenarios.

As stated earlier in the chapter, on October 10, 2008, it was first reported thatpreliminary talks concerning a possible merger between GM and Chrysler, LLC had been underway for nearly a month. After a very dynamic month, on November 7,2008, GMs CEO Rick Wagoner stated that General Motors suspended its efforts toacquire Chrysler. GM stated it is more important at the present time to focus on ourimmediate liquidity challenges than to continue pursuing the merger with Chrysler.However, we believe that was a strategic move by GM for two reasons: (1) showing

Congress that GMs concentration is on the current crisis and the liquidity problem ofthe company; (2) pushing the value of the target company down, or getting a better


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position in negotiations with Cerberus over Chrysler. Note that GM officials knewtheir financial situation before November 2008 and they were still pursuing amerger with Chrysler. GM officials later said talks with Cerberus would hinder itsefforts to win additional federal financial support.

Assuming GM can get past the current liquidity crisis with commitment tofederal assistance by January 2009, we believe a GM-Chrysler merger remains themost likely scenario.

Under this scenario, it is highly likely GM and Chrysler will go through heavyrestructuring, and increase the competitiveness of the new company as a result of themerger. It is likely that the new company keeps Chryslers Jeep models an iconic

brand with loyal clientele as well as its minivan segment and some of Chrysler brand entry level and small fuel efficient vehicles. They might also eliminate theDodge brand.

GM likely would sell the Saturn brand, eliminate the Pontiac brand (except forspecialty vehicles) and sell its Hummer and Saab brands.

4.5.2. Other Likely Scenarios

Scenario 2: Federal Financial Aid and Radical Restructuring outside of

Bankruptcy

The second scenario is a radical restructuring which occurs outside of bankruptcy with no immediate ownership changes. This scenario assumes that theDetroit Three structure transforms into the Detroit Two with a significantly smaller-

sized Chrysler.Many or all of the same brands would be eliminated as in the first scenario.Even in this case, we do not believe all three would survive as fully independententities.

Scenario 3: Federal Financial Aid and Radical Restructuring outside of

Bankruptcy; Chrysler Assets Purchased by Competitors

Under the third scenario, Nissan-Renault, Volkswagen, or some other foreign-owned auto producer would purchase some assets of Chrysler, such as Chrysler and

Jeep brands, or minivan line of the company. Ford and GM undertake the same sort ofradical restructuring, outside of bankruptcy, as under the second scenario. They mayalso purchase some of Chryslers assets, such as the Dodge truck, Jeep, or minivan

business.The exact outcome would depend on the nature of the foreign purchaser.

Nissan-Renault, for example, might follow a strategy similar to that outlined for GM,except that it would probably eliminate most if not all of Chryslers small car lines.The foreign automaker might be interested in a strong position in the North Americanmarket and keep Chrysler models aggressively. Vehicle manufacturers from China orIndia might also enter the market through this avenue. However, this is less likely

than the first two scenarios, because congressional representatives would be lesslikely to provide financial support for an entity involving foreign ownership.


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Scenario 4: Chrysler Files for Chapter 11 Bankruptcy; GM and Ford Restructure

outside Bankruptcy

In the fourth scenario, Chrysler would file for bankruptcy while GM and Fordrestructure outside bankruptcy. Chrysler would sell off many of its brands to othercompanies in order to get the cash necessary to emerge. For example, it might sellJeep and keep minivans and some of its entry-level smaller cars.

Under this scenario, both GM and Ford would realize some difficultiesfinancing their operations. We expect to see major plant closures, layoffs, and thecutting of some brands and models under this scenario.

Scenario 5: Both GM and Chrysler File for Bankruptcy

In the fifth scenario, GM would also file for bankruptcy along with Chrysler.Under this scenario, we expect that Ford would get a sizeable fraction of the GM aswell as Chrysler customer base.

This will amount to major restructuring and downsizing, which will affect thedealerships and suppliers in respect to job cuts and other reductions. We believe a

portion of GM would emerge from bankruptcy under this scenario, although it wouldbe smaller than if it did not go through bankruptcy.

4.6. Strategies

Lawmakers have two main strategies: providing federal financial aid to

automakers, or not providing financial support. If they pick the providing financialsupport strategy, they would develop different strategies, such as providing them aconditional loan requiring automakers to commit certain CAFE standards during acertain time period.

Fords main strategy is not to be for or against a merger between GM andChrysler. Additionally, Ford wants to show consumers that the company is strongeragainst the 2008 economy and industry crisis than GM and Chrysler, to appeal tocustomers. As we discussed at the beginning of the chapter, consumers are hesitant to

buy cars and trucks from troubled companies associated with the possibility of abankruptcy. Fords strategies do not play a major role in this game.

GM and Chrysler have some shared strategies such as lobbying for federalfinancial aid, threatening lawmakers with likely bankruptcies resulting in massivelayoffs and reduction in output, cutting production for a certain time period to showthe seriousness of the situation, and filing bankruptcy to get protection against theircreditors and reorganize their companies as they wish.

However, GM and Chrysler have some different strategies regarding themerger, such as negotiating for a lower or higher value for the target company basedon their role in such a merger.

Based upon the conditions of the auto industry and companies, it seems themerger would not be a merger of equals. Instead, it is highly likely GM to acquire

Chrysler. GMs main objective is then to decrease the value of Chrysler as much as


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possible during negotiations. On the other hand, Cerberus, owner of Chrysler, wouldlike to get the highest price possible.

Based on the incentives and strategies we discussed above, we can developdifferent merger games. Decision-tree diagrams of some of these games are depicted

below.

Fig. 2. Decision-Tree Diagram of a Samlpe Merger Game 1


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Fig. 3. Decision-Tree Diagram of a Samlpe Merger Game 2

Fig. 4. Decision-Tree Diagram of a Samlpe Merger Game

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Conclusion

We illustrated three different games with similar strategies above. Every treediagram illustrated above has an important key element; that is, federal lawmakers(Congress) making a decision about providing financial assistance to American car-makers in trouble. Both GM and Chrysler signaled that they are seriously interested ina merger in the fourth quarter of 2008.

Because of the tough economic environment and industry conditions, bothGM and Chrysler decided to concentrate on their most serious problems: short-termliquidity and other credit-related financial problems. As indicated by GM in their

public announcement, they stopped talking to Chrysler regarding a potential merger,

because of the companys current liquidity and other financial problems. A logicalinterpretation of this announcement is that if GM was not having these problems, thecompany would have continued discussing a merger opportunity with Chryslerfurther.

If both companies resolve their current problems after receiving federalfinancial assistance, they are highly likely to go back to merger discussions.

Our decision-tree diagrams illustrated above show that without federalfinancial assistance, a merger between GM and Chrysler is unlikely. If they getfinancial aid from the federal government, a GM-Chrysler merger depends on partiesstrategies. If both automakers act cooperatively, our strategic models predict such a

merger is highly likely. If one party pushes for a better deal, the likeliness of a mergerdepends on the other partys response and willingness of how much to increase ordecrease the price of the deal.

Based on signals sent by the management of the automakers, we believe theautomakers act cooperatively, and successfully merge in the near future.

We identified and analyzed incentives and strategies of the parties in earlysections. By using backward induction, lawmakers could conclude that a merger

between GM and Chrysler is highly likely. After concluding that, they need to reviewdifferent scenarios and alternatives to make an informed decision.

One of the most important incentives of the lawmakers is to protect American jobs and prevent reductions in American output. Lawmakers need to assess theeconomic and fiscal cost of a merger between GM and Chrysler; and then comparetheir assessment results to the other alternatives, such as bankruptcy, or even a

bankruptcy, liquidation.Authors of this book believe that federal financial aid (such as a bridge loan)

and a merger of two automakers is the least costly scenario under the current circum-stances. Based on our industry expertise and assessment, we believe all of the threegames illustrated above have similar results: lawmakers provide federal financialassistance, and GM and Chrysler act cooperatively and merge their companies.


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Bibliography

7.1. Books

Allen, A., Morris, S. (2008), Finance Application of Game Theory, 92-23-B, FinancialInstitutions Center, The Wharton School, University of Pennsylvania.

Anderson, P., Kubilay Geckil, I. (2010), Game Theory and Strategic Behavior, CRCPress, Taylor & Francis Group, A Chapman & Hall Book, Boca Raton, London, NewYork.

Erhun, F., Keskinocak, P. (2003), Game Theory in Business Applications, StanfordUniversity, Stanford; Georgia Institute of Technology, Atlanta, GA.

Kelly, A. (2003), Decision Making Using Game Theory: An Introducing forManagers, Cambridge University Press, United Kingdom.

Stengel, B., Turocy, T. (2001), Game Theory, London School of Economics; TexasA&M University.

7.2. Web Sites

Icmrindia.org (2010), Decision Theory: Chapter 19 ForecastURL: http://www.icmrindia.org/courseware/Quantitative%20Methods/Decision%20Theory.htm

Investopedia (2010), by Pinkasovitch, A., Why is Game Theory Useful in Business?URL: http://www.investopedia.com/ask/answers/09/game-theory-business.asp

Mind Your Decisions (2008), Why Toyota wants GM to be saved: a game theory casestudyURL:http://mindyourdecisions.com/blog/2008/12/16/why-toyota-wants-gm-to-be-saved%E2%80%94a-game-theory-case-study/

NYU Stern, Leonard, N. (2010), From Game Theory to Decision-Making: Skills forSenior ExecutivesURL: http://w4.stern.nyu.edu/execprogfinder/search/display_program_iteration?iteration_id=49

Solution Library (2010), Decision TheoryURL: http://www.solutionlibrary.com/business/business_analysis/decision-

theory_5795

The Times 100 (2007), Decision Tree Analysis


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http://w4.stern.nyu.edu/execprogfinder/search/display_program_iteration?iteration_id=49http://w4.stern.nyu.edu/execprogfinder/search/display_program_iteration?iteration_id=49http://mindyourdecisions.com/blog/2008/12/16/why-toyota-wants-gm-to-be-saved%E2%80%94a-game-theory-case-study/http://www.investopedia.com/ask/answers/09/game-theory-business.asphttp://www.airbus.com/en/corporate/gmf2009http://www.airbus.com/en/corporate/gmf2009http://news.bbc.co.uk/1/hi/business/1563918.stmhttp://news.bbc.co.uk/1/hi/business/1563918.stmhttp://news.bbc.co.uk/1/hi/business/1563918.stmhttp://news.bbc.co.uk/1/hi/business/1563918.stmhttp://w4.stern.nyu.edu/execprogfinder/search/display_program_iteration?iteration_id=49http://w4.stern.nyu.edu/execprogfinder/search/display_program_iteration?iteration_id=49http://w4.stern.nyu.edu/execprogfinder/search/display_program_iteration?iteration_id=49http://w4.stern.nyu.edu/execprogfinder/search/display_program_iteration?iteration_id=49http://mindyourdecisions.com/blog/2008/12/16/why-toyota-wants-gm-to-be-saved%E2%80%94a-game-theory-case-study/http://mindyourdecisions.com/blog/2008/12/16/why-toyota-wants-gm-to-be-saved%E2%80%94a-game-theory-case-study/http://mindyourdecisions.com/blog/2008/12/16/why-toyota-wants-gm-to-be-saved%E2%80%94a-game-theory-case-study/http://mindyourdecisions.com/blog/2008/12/16/why-toyota-wants-gm-to-be-saved%E2%80%94a-game-theory-case-study/http://www.investopedia.com/ask/answers/09/game-theory-business.asphttp://www.investopedia.com/ask/answers/09/game-theory-business.asphttp://www.airbus.com/en/corporate/gmf2009http://www.airbus.com/en/corporate/gmf2009http://www.airbus.com/en/corporate/gmf2009http://www.airbus.com/en/corporate/gmf2009


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URL: http://www.thetimes100.co.uk/theory/theory--decision-tree-analysis--323.php

http://files.aea.be/RIG/Economics/DL/SumRep07.pdfhttp://files.aea.be/RIG/Economics/DL/SumRep07.pdf

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Decision Making and Business Strategy