Annual redesign was a Faustian bargain

Here is the canonical Prisoners Dilemma setup. If GM and Ford don’t engage in annual model changes, neither has an advantage in the market place (at least for that reason!). For convenience, set the profit of each at 2 and hence total industry profits are 4. Now if Ford engages in annual model changes but GM doesn’t, then Ford gains a lot while GM loses. However, assuming that the overall market is the same size, that shift means lower overall industry profits. The case where GM engages in annual changes but Ford does not is here treated as symmetric. Now look at the bottom Ford row: Ford does better by implementing an annual model change if GM doesn’t, and also does better if GM does. So they will naturally choose the annual model change. Ditto GM. Hence the equilibrium is the bottom right cell, where each earns profits of 1 and total industry profits are 2. Both lose, but they have no way out of this dilemma absent collusion.

With the Department of Justice breathing down the neck of GM, colluding was not an option. Indeed, don’t try to do business history on GM: they systematically kept no records, in sharp contrast to Ford. If nothing was on paper, the DOJ would have a hard time if for some reason they turned their watchful eye into an active investigation.

PD General Motors
No Change Annual Change
Ford No Change 2, 2 -1, 4
Annual Change 4, -1 1, 1

The title is from Offer, p 316.

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