Incumbent repositioning against a quality (dis)advantaged entrant with spillover effects

Abstract

When confronted by an entrant, incumbent firms can respond by revising their market positions. An incumbent’s repositioning strategy depends not only on additional costs of repositioning, but also on a dyadic relation with the entrant. Quality differences matter, especially when they exhibit some spillover effect. Higher quality of a superior firm’s product, irrespective of whether it is produced by the incumbent or entrant, exerts a unilateral spillover that increases the willingness to pay of consumers for the inferior rival’s product. This paper presents an analytical model to address how an incumbent should reposition itself in response to a new entrant with quality (dis)advantages. Analyses demonstrate that, depending on parameters related to repositioning costs, quality differences, and spillover effects, the optimal strategy of incumbent repositioning is either not repositioning (disregard), repositioning away from the entrant (differentiation), or repositioning closer to it (imitation). Moreover, the existence of quality spillover is shown to make the superior firm more likely to be crowded out of the market’s central position. Eventually, the superior firm might be unable to gain from amplifying its ex-ante quality advantages over its rival in the context of strategic (re)positioning.