Transcript Possible Explanations for Frequency of Entrant Failure

Entry costs and market structure
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There are many potential entrants into a
market.
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.
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The number of firms in the industry
becomes known, and firms compete in
the market.
Entry & market structure,con’t
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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.
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We need to find n* such that:
– (n*)-F  0 > (n*+1)-F
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n* is the “free entry equilibrium”.
Entry & market structure,con’t
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Assume:
– 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.
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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
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Assume:
– Cournot competition.
– Each firm has a constant marginal cost c.
– Demand=(a-P)S where S = size of market.
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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
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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)
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Entry is welfare enhancing only if
cumulative effect is positive.
Entry & social welfare, con’t
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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
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Sutton study of soup markets in US/UK.
– Campbells: pioneer in US, still dominant.
– Heinz: pioneer in UK, still dominant.
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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
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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?
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Natural Advantages:
– Brand loyalty
– Learning-by-doing
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Strategic Advantages:
– Predatory pricing
– Pre-emptive investments
Sequential Entry and Prices
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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
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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
sold.
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
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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.
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Price of pioneers rises slightly after generic
entry.
Price Analysis, con’t
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Conclusions:
– Unique market.
– Although products basically homogeneous,
patented firm able to maintain considerably
higher price and significant market share
(50%).
– Order of entry does make a difference both
for patented firm and for generic entrants.