When and how should an incumbent respond to a potentially disruptive event?

Abstract

Incumbents can respond to the competitive threat posed by a startup either by external or organic growth. Incumbents may fail do so in due course due to a phenomenon known as “incumbent inertia.” I develop a dynamic model of investment that stresses a new rationale for such inertia. The incumbent may wait even though the option to delay one response is “deep in the money.” This is because the incumbent has to make a choice among several possible responses and is strategically ambivalent about which is best. Such inertia would be bad news for startup valuations if the incumbent delays a lucrative exit for venture capitalists, but good news for consumers if it sustains fiercer competition.