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Financial Markets and

Institutions

E-Commerce Price Wars


A Game Theory Perspective

Group 3
A011- Anuv Jain
A012- Archit Puri
A013-Aruna S.
A014-Ashwant Rajasekar
A015-Bhavishya Pratap
A035-Reshu Natani

What is Game Theory?


Game theory is the process of modelling the strategic interaction between
two or more players in a situation containing set rules and outcomes. While
used in a number of disciplines, game theory is most notably used as a tool
within the study of economics. The economic application of game theory can
be a valuable tool to aide in the fundamental analysis of industries, sectors
and any strategic interaction between two or more firms.
In game theory, the Nash equilibrium is a solution concept of a non-cooperative game involving two or more players, in which each player is assumed to
know the equilibrium strategies of the other players, and no player has anything to gain by changing only their own strategy. Note than were talking
about one player changing his individual strategy, not two or more players
colluding to change their strategies together.

How is it related to the E-Commerce price


war in India?
The top 3 e-commerce firms in the country are itching for a duel in with
all three parties raising USD 4 billion between them recently. This huge
cash pile is widelyexpected to kick start another round of cash burn with
more discounts and offers to woo customers. While this hyper competition isexcellent newsfor customers, it is unlikely that a clear winner with
sustained competitive advantage will emerge as a result of this latest
round of price cuts.
Now lets look at how these discounts and price cuts are funded. The Indian start-up sector is flush with venture capital (VC) and Angel funds
right now. There are investments being made and mire money being
raised every single day. Everyone, right from International bigwigs like
Sequoia and SoftBank to Indian VC funds are jumping on the bandwagon. For instance, if a product priced Rs.100 is sold for Rs.70 by a seller
on an e-commerce website AmaCon (name changed), the online retailer
will collect Rs.70 from the customer, take a cut for itself, and give the
remaining proceeds to the seller. Then, AmaCon will also give the seller
an additional amount to account for the discount offered by the seller.
This amount could be Rs.30 or lower. This amount is usually accounted
as a marketing cost and is debited from the vast pool of investor
monies.

Not just the full-service online marketplaces such as the ones referred to
here, but deep discounting is the norm in all types of start-ups right now.
It is one of the hallmarks of the e-commerce industry in India at this
moment.
None of these top three e-commerce firms have made any net profits
and are not likely to do so in the near future. They are doing all they can
to increase their customer base where and tap into the full potential of
the e-commerce space in India which is currently growing at a CAGR of

30%. But why are they indulging in continuous heavy discounts and
price wars to do so? Lets use game theory to explain this.
Lets take the example of two hypothetical e-commerce companies - FlipHurt and SnapHeal.
In the given scenario they have two options:
1. Accommodate(Ac) - Sell above cost with some profit.
2. Attack(At) - Undercut the competition with discounts and sell at a
loss.
Lets put their payoffs in a matrix. SnapHeals strategies are highlighted
in red whereas FlipHurts are in blue.

Ac
At
SnapHeal
Ac

3,3

0,4

At

4,0

1,1

Now as
you can see that both these companies will
FlipHurt
benefit
from accommodating and will have maximum
profits. But
they will continue to attack as they always
have a gain if they attack (assuming the other firm continues to accommodate). And hence both these firms will end up attacking and earn a
lesser payoff than they would have in the case of accommodating. Thus
Attack-Attack is the Nash Equilibrium according the aforementioned definition of the concept which states the equilibrium is where no player has
anything to gain by changing only their own strategy.
It is a classic setting known as the prisoner's dilemma in game theory,
where both parties would ideally like to lower competitive intensity and
choose Ac-Ac but temptation/ fear of asymmetric gains if one party
chooses Ac and the other At, ultimately is leading both to choose At,
thus minimising payoffs for both.

Conclusion
We can see that these companies are spending billions of dollars to increase their customer base by undercutting each other, which is leading
to humongous losses for all the companies. The good part is that there
are some nifty ways ofaddressing this problem, especially in repeated
competition situations, which is what the present situation is. While
some of those will qualify as collusion, some others can be effectively
practiced by both sides to maximize both individual and collective outcomes, while substantially reducing cash burn for both parties. Another
important point of note is that mixing Attack and Accommodation in particular ways can ensure that you are not blind sided and you minimize
your potential loss in a worst case scenario. It could also be argued that
these firms focus on quality of service delivery and convenience of the
customers rather than indulging in discount battles which are not healthy
for the market.
On the other hand it might give e-commerce brands some relief to see
that consumers are now choosing a website over physical stores for the
experience and convenience over discounts. However, it remains to be
seen how many shoppers will move away from online the day these discounts are the same as in brick-and-mortar retail.

References
1. http://www.investopedia.com/articles/investing/110513/utilizing-prisoners-dilemma-business-and-economy.asp
2. http://tech.economictimes.indiatimes.com/news/internet/e-commerce-firms-say-they-arent-afraid-of-pricing-wars-with-offline-retailers-like-future-group/47183493
3. http://timesofindia.indiatimes.com/tech/tech-news/Indian-ecommerce-industry-to-post-35-growth-Study/articleshow/48843725.cms