Dominant Strategy
If a business knows what to do, irrespective of what its competitors are anticipated to do, the business is said to have a dominant strategy.Let's use the controversial practice of Washington Lobbyists in shaping business outcome to illustrate the concept. It may be noted here that even though President Obama came to power with the slogan "Change We can Believe in", the practice of lobbying still shapes policies at the time of this writing (June 2009).
Let us consider two companies X and Y, which sell competing products. Each company has the option to lobby in Washington DC, and will be affected by the other company's decision. Let us assume that based on doing extensive market research, statistical regression, etc., both companies have found out that the following profit payoff matrix holds true, where the numbers are in millions of dollars (the first number before the comma is the profit payoff for company X, and the second number after the comma is the profit payoff for company Y):
In the example depicted above, Company Y has a dominant strategy. Why? Because irrespective of what company X does, company Y makes more profit if it lobbies. Irrespective of what company X does, if company Y lobbies, it can make at least 30 million dollars. $30 million is more than $10 million or $25 million in profit, which are the two possible outcomes if company Y does not lobby. So, company Y will go ahead and lobby to maximize its profits. Lobbying is the dominant strategy for company Y.
How about company X? It is clear that it does not have a dominant strategy. What company X needs to do is NOT INDEPENDENT of what company Y is likely to do. If company Y does not lobby, Company X makes $40 million if it lobbies, but $45 million if it does not lobby; so NOT LOBBYING is the better strategy in this scenario. However, if company Y lobbies, company X makes $20 million if it does not lobby, but $30 million if it lobbies; so LOBBYING is the better option in this scenario. So, what company X needs to do is dependent on what company Y will do.
So, what is the ultimate outcome of the above game? Company X will assume that company Y is rational, and will act in its own best interest. Since company Y's dominant strategy is to lobby, company X will assume that company Y will lobby. When company Y lobbies, the better option for company X is to lobby as well and make $30 million in profit; if it does not lobby, it will make only $20 million. So, company X will go ahead and lobby as well to maximize its profits.
So, what is the ultimate outcome of the above game? Company X will assume that company Y is rational, and will act in its own best interest. Since company Y's dominant strategy is to lobby, company X will assume that company Y will lobby. When company Y lobbies, the better option for company X is to lobby as well and make $30 million in profit; if it does not lobby, it will make only $20 million. So, company X will go ahead and lobby as well to maximize its profits.
Concept Summary: The above game has an equilibrium. The equilibrium is that both companies will lobby. However, while company X uses the concept of Nash Equilibrium to get to its best strategy, company Y has a dominant strategy to start with, and does not have to take recourse to Nash Equilibrium.
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