Possible Explanations for Frequency of Entrant Failure

download report

Transcript Possible Explanations for Frequency of Entrant Failure

Entry costs and market structure
There are many potential entrants into a
Entrants simultaneously decide whether
or not to enter the industry.
– Entry costs F, which is not recoverable if
the firm decides to exit the industry.
The number of firms in the industry
becomes known, and firms compete in
the market.
Entry & market structure,con’t
What is the equilibrium number of firms
in the market?
– As more firms enter, profits decrease.
– Let (n) represent the present value of
each firm’s post-entry profits, as it depends
on the number of firms that enter.
We need to find n* such that:
– (n*)-F  0 > (n*+1)-F
n* is the “free entry equilibrium”.
Entry & market structure,con’t
– Cournot competition.
– All firms are identical and each firm has a
constant marginal cost c.
– Demand=(A-P)S where S = size of market.
– Thus inverse demand is P = A - Q/S.
From our earlier analysis of the n-firm
Cournot model, we determined that
q* = (A-c)/[B(n+1)]
So q* = (A-c)/[1/S(n+1)] = s(A-c)/(n+1)
Entry & market structure,con’t
– Cournot competition.
– Each firm has a constant marginal cost c.
– Demand=(a-P)S where S = size of market.
Then (n) = S[(a-c)/(n+1)]2/r - F.
Thus n*  (a-c)(S/rF)1/2 - 1.
n* is increasing in market size and
decreasing in entry costs, although
impact is less than proportional.
Entry & social welfare
What happens when an additional firm
enters a market?
– Entrant receives profits
– Existing firm profits decrease (business
stealing as well as lower prices)
– Consumer surplus increases (lower prices)
Entry is welfare enhancing only if
cumulative effect is positive.
Entry & social welfare, con’t
When can entry be welfare decreasing,
i.e., inefficient?
– If firms are colluding, then price will not
change with entry so consumer surplus will
not change nor will revenue. However,
additional entry will increase costs.
– If entrants falsely differentiate products,
entry can cause inefficiency.
Empirical Evidence of
Advantages of Early Entry
Sutton study of soup markets in US/UK.
– Campbells: pioneer in US, still dominant.
– Heinz: pioneer in UK, still dominant.
Urban study of market share and order
of entry in 47 markets.
– First firm to enter after market leader has
29% lower market share than leader.
– Second has 42% lower, third 49%, etc.
Empirical Evidence of
Advantages of Early Entry, con’t
Golder and Tellis studied entry order
and success in 36 markets.
– Half of all “pioneers” fail. Average current
market share of pioneers is 10%.
– Average current market share of “early
market leaders” is 28%.
– Sustained dominance: early market
leaders tend to be current market leaders.
Why Does Early Entry Matter?
Natural Advantages:
– Brand loyalty
– Learning-by-doing
Strategic Advantages:
– Predatory pricing
– Pre-emptive investments
Sequential Entry and Prices
Pharmaceutical Case Study:
– Developer of drug gets 17 year patent,
once patent expires any firm can produce it
subject to FDA approval.
– 1984 Drug Price Competition and Patent
Term Restoration act facilitated entry of
generic drug products after expiration of
patent by streamlining FDA requirements.
– Study looks at the effect of generic entrants
on drug prices.
Pharmaceutical Price Analysis
18 major drugs which were exposed to
generic competition between 1983-1987.
Prices measured by average cost per unit
paid by drugstores and hospitals.
Market share is measured by number of units
Questions to be answered:
– How fast does entry occur in new markets?
– How fast does the market share of entrants grow?
– How do prices respond to entry?
Price Analysis, con’t
Within 1 year the avg number of generic
suppliers is 17. Within 2 years, there are 25.
Serious erosion of the market share of the
patented firm. After 2 years, generics had
50% of the market.
Generics come in at 60% of the patent firm’s
price, on average.
– Generic prices fall rapidly -- 22% lower at the end
of the first year, 35% lower by the end of the 2nd.
Price of pioneers rises slightly after generic
Price Analysis, con’t
– Unique market.
– Although products basically homogeneous,
patented firm able to maintain considerably
higher price and significant market share
– Order of entry does make a difference both
for patented firm and for generic entrants.