1 Strategic IntelligenceThe Cognitive Capability to Anticipate Competitor Behavior Sheen S. Levine Mark Bernard Rosemarie Nagel Published in The Strategic Management Journal
2 In Brief How cognition can bring competitive advantage?Analytic skill: The ability to solve abstract problems Strategic intelligence: The ability to anticipate competitors’ behavior First behaviorally measure the two, then examine performance in a highly competitive market Result: Even if market eliminates advantage from structure or resources, some do much better than others. Why? Best performers are those who are not only capable, but also understand how capable the competitors are Highly competitive market = designed to eliminate any advantage stemming from structure or resources, some participants do much better than others.
3 How to become a billionaireHow to become a billionaire? Operate in market with favorable structure or know something that is valuable, rare, and difficult to imitate or substitute Brin Page Soros Buffett Gates Valuable, rare, difficult to imitate or substitute, are the characteristics of a valuable strategic resource (source: Barney, J. B. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17(1), )
4 How to become a billionaire?Manoj Bhargava, $4.0B Butt, Groceries $10.7 Billion Mars, Candy, $54B Taylor, Car Rental, $5.3B Plank, Clothes, $2B Menard, DIY, $10.2B Sources: Forbes list of millionaires 2017, Forbes Profiles 2017, The New York Times, The Wall Street Journal, Detroit Free Press NSF 2012 Budget = $7.03B; NSF 2017 budget = $7.964B Endowment of Penn State in 2012 = $1.5B; in 2016 = $3.602B “Butt” sums of the net worth of the Butt family (source: https://www.forbes.com/profile/charles-butt/) “Mars” sums the net worth of a Jacqueline and John Mars, the two members of the family named on the Forbes list of billionaires “Walton” sums the net worth of S. Robson, Jim, Alice, Lucas, Christy, Ann, and Nancy Walton, all members of the Walton family on the Forbes list of billionaires “Taylor” Reports the estimated net worth of Jack Taylor's estate in 2016 (Mr. Taylor died the same year) Manoj Bhargava’s net worth was estimated at 1.5 billion by Forbes in 2012, But he estimated it at 4 billions in interviews with the Wall Street Journal (2015) and Detroit Free Press (2016) (Sources: https://www.wsj.com/articles/a-day-in-the-life-of-5-hour-energy-creator-manoj-bhargava Walton, Groceries, $128.9B
5 Origins of Competitive Advantage
6 Where Competitive Advantage Comes From?Choosing which industry to enter, shaping a position within it (Caves and Porter, 1977; McGahan and Porter, 1997; Porter, 1980; Porter, 1981) Firm resources and capabilities (Barney, 1991; Wernerfelt, 1984) Individuals and their patterns of interaction (Cohen and Cyert, 1961, 1965; Cyert and March, 1963; Cyert, Feigenbaum and March, 1959; Penrose, 1959; Nelson and Winter, 1982)
7 Managerial Cognitive Capabilities: Theorized but Rarely MeasuredTop managers matter. So do entrepreneurs (Finkelstein, Hambrick, and 2008; Quigley and Hambrick, SMJ 2015) Can modify other capabilities “The capability that wins tomorrow is the capability to develop the capability to develop the capability that innovates faster (or better)” (Collis, SMJ 1994) But how? Least understood area of managerial cognition (Helfat and Peteraf 2015) CONTINUE
8 A Modest Proposal
9 “We devote our intelligences to anticipating what average opinion expects the average opinion to be.” John Maynard Keynes, The General Theory of Employment, Interest and Money, 1936:156
10 知彼知己，百戰不殆 Know the enemy and know yourself; in a hundred battles you will never be in peril. Sun Tzu, The Art of War, 1963:84 (SB Griffith, Trans.)
11 We define Strategic IntelligenceA cognitive skill that allows anticipating competitors’ behavior — for advantage Neuroeconomic evidence Bhatt & Camerer, GEB 2005; Coricelli & Nagel, PNAS 2009
12 Measuring Strategic Intelligence: The Guessing Game“Choose a number between 0 and 100, both included. All other participants do the same and submit their chosen numbers. You win if your chosen number is closest to 2/3 times the average of all submissions.” (Nagel, AER 1995; Bosch-Domènech et al., AER 2002) 100
13 How Strategic Intelligence Affects PerformanceTying measurements to profits in a competitive market
14 Design and Data 1 2 3 Illustration: Yukari Nakamichi
15 A Very Competitive MarketBased on the design of Smith, Suchanek & Williams (Econometrica, 1988) Participants endowed with cash and assets Everyone may buy & sell in 10 public rounds #3 Explain that the value decreases in each round. Hence worth 100 cents in the first period and 10 in the last. Asset/round pays dividend (0 or 20) with p=0.5; no residual Participants paid their earnings in cash; no deception
16 Sample Trading Screen
17 A Very Competitive MarketMatches textbook definition (Cabral, 2000; Farnham, 2014; Mankiw, 2015) Atomicity Product homogeneity Perfect information Equal access to resources Free entry #3 Explain that the value decreases in each round. Hence worth 100 cents in the first period and 10 in the last.
18 Two Study Design Size: 25 markets of 6 traders each, as large as similar method studies (Smith, Suchanek, and Williams, 1988; Dufwenberg, Lindqvist and Moore, AER 2005; Levine et al., PNAS 2014) Participants: from the entire student and staff body of two universities Study 1: “Ivy” Study 2: Regional campus of state university
19 Large Sample, Simple MeasuresStudy 1 Large Sample, Simple Measures
20 Measured by cash profit in a competitive marketAnalytic skill Measured as financial literacy Performance Measured by cash profit in a competitive market Strategic intelligence Measured by distance from the winning number in Guessing Game (one measure in Study 1)
21 Measures Financial Literacy “In the 6th period, how much would I buy for?” Guessing Game Choose a number between 0 and 100 that is closest to 2/3 times the average of all submissions (Nagel, AER 1995) Race to 100 is a number game that has been used to assess backward induction skills (Levitt, List, & Sally, 2011; Sally & Sally, 2003). In the game, players take turns choosing a number between one and nine. The numbers they choose are added cumulatively, and the winner is the player who reaches 100. The game is a good measure of cognitive skill, but not Strategic Intelligence: In the game, a dominant strategy exists for any situation (for each information set, in game theoretic terms). Thus, each player’s optimal action at any situation is unrelated to others’ actions, beliefs about them, own future choices, or distributional preferences. To isolate each participant’s cognitive skill, we created a single-person version of the game. In it, we presented participants with 10 scenarios and asked them about the best response (details in appendix). The Cognitive Reflection Test (CRT; Frederick, 2005) assesses how a person reasons. By presenting problems that seem to have intuitive — but incorrect — answers, the test assesses whether the responder reasons through the cognitive process known as System 1 (executed quickly with little conscious deliberation) or System 2 (slower and more reflective) (Stanovich & West, 2000). This behavior underlies habit, deliberation, routines, and behavioral strategies, thought to affect individual performance (Greve, 2013; Winter, 2013). CRT has been shown to correlate positively and significantly with other measures of cognitive skill, such as SAT score (and its mathematical and verbal subcomponents), ACT score, and the Wonderlic Personnel Test. When it comes to aspects of economic decision making, such as intertemporal choice and choice under uncertainty, CRT has been shown to be the best of second-best predictor of behavior and the only one that related to all of the decision-making domains tested {Frederick, 2005 At the same time, CRT can be completed in a minute or two and offers predictive validity that equals or exceed those of much longer tests. For that, it has become a frequently used measure of cognitive skill {e.g., \Brañas-Garza, 2012 #4467; Laureiro-Martinez, 2014 #5202}
22 Study 1: Strategic Intelligence MattersDV: Profit (1) (2) (3) OLS robust standard errors OLS robust standard errors OLS robust standard errors standardized coefficients Analytic skill 7.463 14.09** 0.204** Strategic intelligence 0.0095** 0.044** 0.703** Analytic skill x Strategic intelligence 0.004* 0.596* Constant 871.9*** 925.3*** Source: How Analytic Skill, Strategic Intelligence, and Their Interaction Affects Earnings in Trading OLS regression with robust standard errors, clustered on individual, with standardized coefficients. Effects are robust to multiple statistical specifications, including OLS jackknife regression, OLS bootstrap regression, median robust regression, and median bootstrap regression. n=96
23 Replication and ExtensionStudy 2 Replication and Extension
24 Study 2: Hypotheses & Measures1: Better analytic skills improve performance 2: Better strategic intelligence improves performance 3: Analytic skills and strategic intelligence unrelated 4: Analytic skills and strategic intelligence interact, affect performance complementarily
25 Measured by cash profit in a competitive marketAnalytic skill Measured by a combination of The Race to 100, Cognitive Reflection Test, financial literacy, and Need for Cognition Performance Measured by cash profit in a competitive market Strategic intelligence Measured by distance from the winning number in Guessing Game (one measure in Study 1; two in Study 2)
26 Measures Financial LiteracyRace to 100 Assesses backward induction, unrelated to Strategic Intelligence (Levitt et al., AER 2011) Cognitive Reflection Test Assesses reasoning, correlates positively with other measures of analytic skill, e.g. SAT, ACT, Wonderlic Personnel Test (Frederick, JEP 2005) Need for Cognition – measures self-reported interest in thinking tasks (Cacioppo & Petty, JPSP 1982) Two Guessing Games — “choose a number between 0 and 100 (0 and 360) that is closest to two thirds (three quarters) the average of all submissions” (Nagel , AER 1995) Race to 100 is a number game that has been used to assess backward induction skills (Levitt, List, & Sally, 2011; Sally & Sally, 2003). In the game, players take turns choosing a number between one and nine. The numbers they choose are added cumulatively, and the winner is the player who reaches 100. The game is a good measure of cognitive skill, but not Strategic Intelligence: In the game, a dominant strategy exists for any situation (for each information set, in game theoretic terms). Thus, each player’s optimal action at any situation is unrelated to others’ actions, beliefs about them, own future choices, or distributional preferences. To isolate each participant’s cognitive skill, we created a single-person version of the game. In it, we presented participants with 10 scenarios and asked them about the best response (details in appendix). The Cognitive Reflection Test (CRT; Frederick, 2005) assesses how a person reasons. By presenting problems that seem to have intuitive — but incorrect — answers, the test assesses whether the responder reasons through the cognitive process known as System 1 (executed quickly with little conscious deliberation) or System 2 (slower and more reflective) (Stanovich & West, 2000). This behavior underlies habit, deliberation, routines, and behavioral strategies, thought to affect individual performance (Greve, 2013; Winter, 2013). CRT has been shown to correlate positively and significantly with other measures of cognitive skill, such as SAT score (and its mathematical and verbal subcomponents), ACT score, and the Wonderlic Personnel Test. When it comes to aspects of economic decision making, such as intertemporal choice and choice under uncertainty, CRT has been shown to be the best of second-best predictor of behavior and the only one that related to all of the decision-making domains tested {Frederick, 2005 At the same time, CRT can be completed in a minute or two and offers predictive validity that equals or exceed those of much longer tests. For that, it has become a frequently used measure of cognitive skill {e.g., \Brañas-Garza, 2012 #4467; Laureiro-Martinez, 2014 #5202}
27 Study 2: Correlations 0.487 Financial literacy 0.477 0.405 0.158 0.008Spearman’s rank correlation coefficient Cognitive Reflection Test The Race to 100 Financial literacy† Need for cognition Strategic intelligence‡ 0.487 Financial literacy 0.477 0.405 0.158 0.008 0.154 Strategic intelligence -0.197 -0.019 -0.103 -0.220 Profit 0.395 0.524 0.598 0.186 0.192 *** p<0.01; ** p<0.05; * p<0.10. All p-values are Bonferroni corrected. † Negative of squared error in the financial literacy measure ‡ Negative of mean quadratic error (distance from winning number) in the Guessing Game
28 Study 2: Strategic Intelligence Matters!DV: Profit (1) (2) (3) Analytic skill 0.568*** 0.567*** CRT score 0.080 Race to 100 score 0.318*** Financial literacy 0.326** Strategic intelligence 0.264*** 0.256*** 0.242** Analytic skill x Strategic intelligence 0.098 Constant 19.563*** 6.479*** 12.140*** OLS regression with robust standard errors, clustered on individual, standardized coefficients
29 Why Strategic Intelligence Affects PerformanceAn exploration of mechanisms
30 Strategic Intelligence Should Affects Trading, But Not Investment(1) (2) DV: Profit from Trading Profit from Dividends Analytic skill 0.554*** 0.136 Strategic Intelligence 0.190** 0.080 Analytic skill x Strategic Intelligence 0.140** -0.083 Constant 9.182*** 2.955***
31 Mechanism: Surplus in TradingPeriod 3: 65 pts. (15 pts. discount) Period 4: 125 pts. (55 pts. premium) Similar to Tobin’s Q: Ratio of Market Price to True Value. Buyers are looking for a value that’s lower than 1. Sellers are looking for a value that’s higher than 1. Two examples illustrate how some participants turned a profit: High Strategic Intelligence was exhibited by a participant in one session (ID #90802), who bought an asset in period 3 for 65 points (15 points discount) and sells it on in period 4 for 125 points (55 points premium). The piquant detail is that these two trades were done with the same counterparty, a trader who may lack in cognitive skills and Strategic Intelligence. One participant (ID #90101) bought an asset at true value (80 points) in period 3 and sold it in the next period for 130, exceeding the true value by 60 point. In period 7, the participant bought an asset at 50 points, paying 10 points above the true value, but resold it immediately in the same period at 150 points. Such behavior suggests a high Strategic Intelligence: the participant understands that if others are poorly skilled, even overpriced assets can be sold at a profit. Of course, if all traders were equally adapt, such a behavior would have been financially ruinous.
32 Mechanism: Surplus in Trading(1) (2) (3) (4) (5) DV: Surplus Surplus as Seller Surplus as Buyer Surplus as Maker Surplus as Taker Analytic skill 0.074*** -0.018 0.148*** 0.061*** 0.086*** Strategic intelligence 0.037** 0.115*** -0.023 0.063*** 0.003 Ana. skill x strategic intelligence 0.022* 0.044 -0.005 0.002 0.042* Constant 0.0638 0.996*** -0.868*** 0.204*** -0.091 Similar to Tobin’s Q: Ratio of Market Price to True Value. Buyers are looking for a value that’s lower than 1. Sellers are looking for a value that’s higher than 1. Two examples illustrate how some participants turned a profit: High Strategic Intelligence was exhibited by a participant in one session (ID #90802), who bought an asset in period 3 for 65 points (15 points discount) and sells it on in period 4 for 125 points (55 points premium). The piquant detail is that these two trades were done with the same counterparty, a trader who may lack in cognitive skills and Strategic Intelligence. One participant (ID #90101) bought an asset at true value (80 points) in period 3 and sold it in the next period for 130, exceeding the true value by 60 point. In period 7, the participant bought an asset at 50 points, paying 10 points above the true value, but resold it immediately in the same period at 150 points. Such behavior suggests a high Strategic Intelligence: the participant understands that if others are poorly skilled, even overpriced assets can be sold at a profit. Of course, if all traders were equally adapt, such a behavior would have been financially ruinous.
33 In Brief How cognition can bring competitive advantage?Analytic skill: The ability to solve abstract problems Strategic intelligence: The ability to anticipate competitors’ behavior First behaviorally measure the two, then examine performance in a highly competitive market Result: Even if market eliminates advantage from structure or resources, some do much better than others. Why? Best performers are those who are not only capable, but also understand how capable the competitors are Highly competitive market = designed to eliminate any advantage stemming from structure or resources, some participants do much better than others.
34 Strategic Management JournalPublished in the Strategic Management Journal