A theory of entry dissuasion

Abstract

In an industry with homogeneous goods, this note compares the standard incumbent's strategic capacity choice versus the incumbent's pre-emptive payment (profit) transfer (PPT) strategy (i.e., pre-entry acquisition). It is shown that via the transfer option, the incumbent holds its monopoly position “dissuading” the potential competitor entry for a range of fixed costs larger than under strategic capacity. Moreover, in that range, at least one firm is better off under PPT, while the other is indifferent between PPT and capacity choice. That is, in contestable markets, the incumbent can keep its dominant position in an easier way than standard models predict.